Investors looking for a three to four year investment opportunity in the automotive industry should turn to Ford (F). Though the company has a few weaknesses on the balance sheet, I believe the automotive manufacturer is trading at a safe price with good long term upside.
Taking care of business in North America
Ford looks very healthy in its largest market, and appears poised to improve its regional position. In Q3 2012 the company reported an all time best net profit margin of 12%. This represented an increase of 3.4% in North America over Q3 2011. Ford also reported strong revenue growth of 8.3% and higher average selling prices than the prior year. Thanks in part to marked improvement in its wholesale division, the company was able to post better unit volume growth than arch rival General Motors (GM). While General Motors' North America unit volume also grew by 1.75% year-over-year, this represented a smaller improvement in market traction. Indeed, Ford posted 90bp better than General Motors, which saw its market share decline by 190b year-over-year.
Of the two largest American automakers, I like Ford's future growth prospects at home more. Even though General Motors reported higher revenue, Ford North America's pre-tax profits were 28% better. When looked at in conjunction with the aforementioned metrics, I believe this indicates that Ford is showing superior cost management practices. Moreover, it would appear that in the three fields that count the most, Ford is illustrating higher profit margins, better profit growth and stronger unit sales growth. Since North America accounts for both automaker's largest market, I believe it's safe to say that Ford will display an edge when it comes to future performance in the region.
I think this provides investors with piece of mind. Ford's strong prospects for growth at home act like a hedge against potential risks abroad and ought to prevent the company's share price from falling in any sort of significant way. What's more, I'm actually optimistic with respect to Ford's chances overseas, which means that I think there is an opportunity for further upside in the long term.
Europe is Ford's second most important market and I think there is a silver lining to Ford's poor results in the region. Though the automaker saw its sales volume decline by 17% compared to an industry wide decline of 9%, it should be noted that the company, unlike European competitors Volkswagen, Renault, Fiat and Peugeot, did not cut vehicle prices despite fears of a European debt crisis. Instead, the firm took a bit of a different track to cost management. It closed three manufacturing plants in Europe; one in Belgium and two in the United Kingdom. Though plant closures will shrink Ford's capacity by 18%, it will create savings of $400-500 million annually. In light of the tenuous circumstances in Europe, I think that Ford's focus on profitability rather than gross sales will pay dividends down the road. Indeed, even with plant closures and fewer sales, Ford achieved positive net pricing on both a year-over-year and quarter-to-quarter basis. Compared to Volkswagen which slashed prices on its popular Passat model to compete with Japanese automakers in Europe, or Renault which saw its global sales decline by 14.9% in Europe, Ford is better able to absorb hard times given its strength in North America. When compared to the performance of other European competitors like Fiat and Peugeot I think Ford appears to be in a better position as well. Amid the bleak Italian automotive market, Fiat for example, has reported losses of 700 million Euros and is trying to make inroads to other markets to offset the weak buying climate in Italy. In that same vein, things have been so bad for Peugeot, that it was recently removed from the CAC-40 index, which lists France's leading companies.
In South America, Ford has seen weaker results in 2012 than it did in 2011. The combination of trade restrictions that limit vehicle imports and rising competition against a weaker Brazilian currency has hurt profits through the first three quarters of this year. South America however has long been one of Ford's strongest regions (last year the continent generated $900 million in pre-tax profits). I think that as Ford infuses the market with newer models, the company will continue to enjoy strong success despite lower results in the near term.
I'm even more optimistic about Ford's opportunities to drive new revenue in Asia and Africa. In Q3 2012, Asia and Africa revenue increased by almost 14%. This resulted in a swing from a $43 million loss in Q3 2011 to a profit of $45 million in Q3 2012. On aggregate, Ford saw its market share increase from 2.7% to 3.1% as it reported sales growth that outstripped competitors like General Motors by 3.2%. Perhaps most exciting were the results from China. Although the company only sold 60,000 vehicles, these sales represented a 35% increase over last year's levels. The Ford Focus, which was just introduced into the market, did extremely well. It currently ranks as the number three seller of the year despite only becoming available in late May. What with the future introduction of 15 models to China, I believe that Ford stands to gain significantly over the next three to four years from sales in the world's second largest economy.
A hole in the balance sheet?
My recommendation for Ford as a long term play is predicated on the fact that I think it can generate enough revenues to offset the debt on its balance sheet. Indeed, Ford has a pretty high debt to equity ratio of 3.8 compared to the industry average of 0.9. Still, I feel comfortable recommending Ford because in addition to its previously discussed prospects for growth, I believe the company has shown an ability to maintain a high enough average cash flow to assuage doubts of the debt rising. As seeking Alpha author Avilkina Marina points out, Ford's average cash yield over the last five years has been close to 15%, so it's not like the company is just now showing an ability to pay off what it owes.
I really like Ford's current standing and prospects for growth in North America. I believe that this position mitigates much of the risk associated with the investment. Since I am also of the opinion that Ford has significant upside abroad and particularly in China, I believe the company could generate a very solid return for investors over a three to four year period.