This American Icon Is Officially 'Junk'
This American icon is officially 'junk'... Moody's becomes the first to downgrade Ford... This popular company is already in trouble... California could soon disrupt the 'gig economy'...
Regular Digest readers know we're cautious today...
However, despite our growing concern about the health of both the equity and credit markets, we've continued to give this long bull market the benefit of the doubt.
The reason is simple...
Big bull markets like this can go on far longer than anyone expects... and as our colleague Steve Sjuggerud has explained many times, the biggest and most dramatic gains often occur at the end. Meanwhile, we're still not seeing the typical signs that a bear market is imminent.
So while we've urged you to own some gold and silver... to hold plenty of cash... and to consider "hedging" with a few short sales or long put options, we've also encouraged you to keep at least a portion of your portfolio in stocks.
But there is one area of the market where we've been downright bearish for several years...
We've repeatedly warned you to stay far away from weak or troubled businesses with highly leveraged balance sheets. Many of these companies should sound familiar to longtime readers... They include several iconic names like General Electric (GE), JC Penney (JCP), General Motors (GM), and Ford Motor (F), among others.
Again, our reason was simple...
We believed these firms would be among the first (and worst) casualties when this long boom finally ended.
That remains the case today...
In fact, some of these firms are already struggling even though the broad markets and economy remain relatively strong.
General Electric has been the most notable example. But as of this week, we can now add Ford to the list as well. As Bloomberg reported on Tuesday...
Ford Motor Co. was dealt a blow by Moody's Investors Service, which cut the carmaker's credit rating to junk on doubts that a turnaround plan by Chief Executive Officer Jim Hackett will generate earnings and cash quickly enough.
Moody's downgraded Ford to the highest junk rating, Ba1, saying the automaker's cash flow and profit margins are below expectations and likely to remain weak over the next two years. The descent to junk status affects one of the largest corporate bond issuers in the U.S. outside the financial sector...
"It's a pretty precarious situation that they're in," Charlie Chesbrough, senior economist of Cox Automotive, said by phone. "When a company gets a junk status rating, it will mean they have to pay a higher interest rate and it means a lot of institutional investors will have to think twice."
If there's a 'silver lining' to the news, it's that Moody's acted alone...
For now, the other two major ratings agencies – S&P Global Ratings and Fitch Ratings – have maintained their investment-grade ratings on Ford. And as long as a company has at least two ratings above "junk," its debt can remain in investment-grade bond indexes. This means institutional bond investors can continue to own Ford's debt for now.
But this may not be the case for long... Both S&P and Fitch have a negative outlook on Ford, so it is likely just a matter of time before one or both agencies follow Moody's and issue a downgrade of their own.
Again, this would require institutional investors to sell Ford's bonds. And it could cause significant volatility in the credit markets. According to Bank of America Merrill Lynch, it would push as much as $34.5 billion of Ford's U.S. bonds into the high-yield indexes – equal to roughly 3% of the entire high-yield market today.
This is concerning...
But as we noted earlier, the real worry is that it's occurring before we've even seen any real signs of weakness in the broad economy. And Moody's itself agrees. As it noted in its report...
The erosion in Ford's performance has occurred during a period in which global automotive conditions have been fairly healthy. Ford now faces the challenge of addressing these operational problems as demand in major markets is softening, and as the auto industry is contending with an unprecedented pace of change.
This is bad news for Ford... and the dozens and dozens of other overly indebted companies we've been warning you about.
Speaking of troubled companies...
Our colleague Bill McGilton recently recommended a bearish trade on ride-hailing company Lyft (LYFT).
In the August 28 issue of Stansberry's Big Trade, Bill noted that the company – which just went public back in March – is already in serious trouble. From the issue...
Investors are mesmerized by Lyft's sales growth. Sales increased from $343 million in 2016 to $2.2 billion in 2018. But the company consistently loses money. Accounting losses went from $700 million in 2016 to $900 million in 2018.
Lyft doesn't generate enough cash to support its business, so its cash outflows are consistently higher than its cash inflows – that's known as a free cash flow deficit. Last year, its free cash flow deficit was $350 million.
Estimates are for Lyft's sales to reach $3.5 billion this year – 10 times higher than 2016. Yet it's expected to burn more cash than ever before. Expectations are for Lyft's cash flow deficit to increase to $1 billion in 2019.
In other words, Lyft isn't becoming profitable with scale...
Instead, it's actually losing more money as it grows larger. As Bill explained, it's only hope of survival is to raise prices or cut costs. But unfortunately, it will be almost impossible to do either.
Lyft [and its ride-sharing competitor Uber Technologies (UBER)] have painted themselves into a corner. Neither can afford to raise prices and risk losing market share and slowing sales.
And Lyft has already done about all the cost cutting it can. It cut its drivers' share of fares from 82% in 2016 to 73% in 2018 – about the same as Uber. That means Lyft's share of a fare increased from 18% in 2016 to 27% in 2018.
So on $8 billion on gross passenger fares, Lyft generated $2.2 billion in revenue in 2018 ($8 billion multiplied by 27%). Had Lyft kept the drivers' share at 18% like it was in 2016, it would have only generated $1.4 billion in 2018 ($8 billion multiplied by 18%).
Reducing the drivers' share of fares made Lyft's numbers look better for its recent initial public offering ('IPO')...
But as Bill explained, the company won't be able to cut this cost much further...
A study by the executive director of the Center for Automotive Research at Stanford found that drivers' profit was around $9 per hour when taking vehicle expenses like maintenance and insurance into account. Other studies have arrived at similar figures.
So drivers make around minimum wage or less depending on what state they live in. It's unlikely Lyft will be able to cut the drivers' percentage further from here.
Drivers across the country have been complaining about plummeting rates. And drivers around the world have already gone on strike – turned their apps off – to correspond with the IPOs. These drivers think Uber and Lyft are benefitting at their expense. The pushback is a real danger. It shows resistance building to lower rates.
As is... Lyft can't raise prices and stay competitive. And it has no room left to cut costs of any significance.
The outlook is already dire...
But Bill noted it could soon get even worse if California lawmakers had their way. More from the issue...
If California's classification law passes, it will alter the status of Lyft drivers from independent contractors to employees and will drive up costs dramatically. And if other states follow California's example – which is likely – Lyft's business becomes even more untenable.
Lyft listed the reclassification of drivers as employees as a specific risk in its IPO filing – stating its potential to harm the company financially and alter its business.
It's estimated that converting drivers from independent contractors to employees will add 30% to Lyft's labor costs. Investment bank Barclays estimates the conversion will cost Lyft almost $300 million per year in California alone.
Just two weeks later, Bill's prediction is already playing out...
California officially passed this bill today. As the Wall Street Journal reported this afternoon...
California passed landmark employment legislation that challenges the business model of such "gig-economy" companies as ride-hailing giants Uber Technologies Inc. and Lyft Inc., some of the brightest stars in Silicon Valley over the past decade.
The proposed law, which intends to force companies to reclassify certain contract workers as employees, passed in the Democrat-led state Assembly on Wednesday with a preliminary tally of 56 in favor and 15 opposed. The bill passed the state Senate in a 29-11 vote Tuesday night along party lines, with the chamber's Republican caucus casting the no votes.
Gov. Gavin Newsom, a Democrat, has said he would sign the bill if it gets to his desk.
New 52-week highs (as of 9/10/19): Booking Holdings (BKNG), CBRE Group (CBRE), Home Depot (HD), Nuveen Preferred Securities Income Fund (JPS), Sysco (SYY), and AT&T (T).
In the mailbag: One reader sends kudos for our recent precious metals warning... while two others weigh in on bitcoin and libra. As always, send your notes to feedback@stansberryresearch.com.
"I have quite a bit (for me, anyway) invested in gold and silver stocks. While I recognize it's been a nice ride and probably will go higher, I also know that pullbacks come.
"When I read Ben and Drew's warning about gold and silver last week, I heeded their advice – not in the way they suggested, but it did cause me to take action. I bought a few puts on a few things that I knew would drop if they were right.
"Within 24 hours of me doing that, the gold correction started. My gold stocks lost about $1200 in two days, but my puts were up about $1200 in the same time. I'm appreciative of the warning. It saved me some money!" – Paid-up subscriber Scott B.
"Thank you for the September 7th [Digest Masters Series essay] entitled "Become a Blockchain Expert in Less Than Four Minutes." It was by far the best explanation that I've ever read on the topic. I learned so much and it was explained in a simple and concise way that everyone could understand. Thank you!" – Paid-up subscriber Kami B.
"A couple points [about Tuesday's Digest on libra]: 'The company's proposed supercurrency would be 100% backed by fiat currencies and government bonds.' Thank you for pointing that out! I didn't know that.
"As far as I'm concerned this is 100% the reason I will never participate in Libra. It's the antithesis of the reason for cryptocurrency, as far as I'm concerned. Why would I allow FB and others to track my spending through Libra without any benefit? Then add in the section of your discussion about Libra's problems ('it could potentially seize assets from people' being a particular issue!) and as far as I'm concerned, it's DOA.
"On inflation: 'Or is it a way for governments around the world to quietly appropriate money from their citizens?' Absolutely!! And this hits the middle class the hardest; those with savings but not enough (or limited options in 401(k)'s) to protect themselves the way the rich can (e.g., buying precious metals), and those that have no savings are not affected as long as their income keeps up with inflation (which in no way is a given).
"IMHO, the 'target inflation rate' should be between 0 and -0.5%. I think the prevailing "knowledge" that deflation is ruinous is exceptionally short-sighted. Yes, people may postpone purchases, but that can last only so long. As long as the deflation rate is low, people won't delay purchases indefinitely (just like I don't rush to buy things because inflation is 2%... ). People won't go without houses, cars, TVs, washers/driers, dishwashers, stoves, phones, etc. They WILL replace these items eventually.
"Yes, there would be a period of adjustment, but I think it'd be for the better, long term. It's my humble opinion that our economy would be much better off if it weren't based on bringing future purchases into the present, but based on pushing current demand into the future. It would result in a far more sustainable prosperity." – Paid-up subscriber C.S.
Regards,
Justin Brill
Baltimore, Maryland
September 11, 2019