Seeking Alpha
Growth at reasonable price, research analyst, newsletter provider, long/short equity
Profile| Send Message| ()  

Ticker: Ford (F)

Rating: Buy

Price Target: Increase from $18 to $20

Introduction

Based on proprietary discounted cash flow analysis done by the Oxen group, Ford shares are a solid BUY, with an implied price appreciation of just about 20%. Ford shares trade at about 9.2x trailing EPS and more importantly 9.3x forward EPS…a discount to the market and its peers. Ford shares should move toward our price target as a result of many fundamental catalysts and economic drivers. These catalysts include price appreciation as a result of cheap peer comps, emerging market trends, domestic strength. The biggest catalyst for Ford is their opportunity to bring American automotive excellence to emerging markets like China, Brazil, India, and more. This trend is potentially very powerful, but Ford has many other reasons to be bullish, including expanding credit in the American economy, lineup trends, and peer performances.

Profile

According to Ford Motor's latest 10k, the company, founded in 1903, is primarily in the business of offering a wide variety of automotive financing products to and through automotive dealers throughout the world. A large chunk of Ford's business comes from financing Ford vehicles and supporting dealers. Revenue comes from retail customers making payments under installment sales and lease contracts. Moreover, interest payments from Ford special rate programs add to revenue. Finally, payments made under wholesale and other dealer loan financing programs add to revenues. The other main section of the business involves the sale of cars and trucks in North America and internationally.

The Oxen Group's target is currently above the market, but the outlined valuation metrics below give reason to accumulate shares.

Thesis

Valuation -

One of the best ways to interpret Ford's value is by looking at other automotive/truck manufacturers. The average forward multiple in the industry is 15x and the median is about 11.3x. The median is a better tell because large and small numbers can skew an average. Ford trades safely below its industry average and median multiple at just over 9x, giving it room for multiple expansion. Despite this discount, Ford also performs better than most of its peers in profitability metrics. The average net margin, for the industry, is 3.15% and the median is 4.7%. Ford is below the median at 4.4% and above the average. Ford's ROE (return on equity) is better than 96% of its peers as well, showing a lot of strength in making money off shareholder equity.

There is however some intense competition coming from overseas. Toyota (TM) has very strong performance metrics too, some better than Ford. TM has ROE and ROIC North of 7% and 3% respectively. Honda also performs rather efficiently, with ROE and ROIC both above 7%. TM, however, lacks the upside compared to Ford and Japan's relatively strong Yen does not help their export situation, but should BOJ (Bank of Japan) efforts start to gain traction, the Yen may weaken.

Ford's turnaround presents an interesting opportunity to buy at a discounted valuation, compared to others that are fully priced.

(click to enlarge)

Catalyst -

Ford has many trends that make shares a BUY. These include a number of catalysts that may unlock value, but a key spark will be the growth of emerging markets.

North America only represents about 19% of global auto sales. The remaining share comes from other countries. 80 - 85 million cars are expected to be sold in 2013.

A specific example of Ford increasing its global footprint is the EcoSport entering the marketplace. South Africa, Middle East and Indonesia, have confirmed the EcoSport for 2013. Indonesia, for example, is currently experiencing 6% GDP growth and is actually home to the fourth largest population in the world and a part of the next generation of emerging markets (MIST: Mexico, Indonesia, South Korea, and Turkey). A presence here is absolutely essential for Ford.

This car is one that capitalizes on a variety of trends. Ford makes more money on larger vehicles and the EcoSport is a small SUV that also plays on the compact trend, in addition to the green movement. More on Ford's future lineup can be found in the variant section.

Economic Moat -

Of the big three American auto manufacturers, Ford is the best one to buy. Fundamentally they are better and the end user better perceives them too; which is huge. Ford's brand recognition is that of quality and dependability for a reasonable price…all around value. It is difficult to emulate this end user goodwill. Ford is in a great competitive position to flourish and capitalize on the American goodwill generated by saying "no thanks" to the government during the crisis.

Additionally, Ford is very well positioned for the future given the large barriers to entry in the automotive sector. These barriers are not only quantitative, but they are qualitative too. Trust is not built overnight, it took Ford over 100 years to establish its footprint and they will not give it up without a fight. This brand loyalty is a massive differentiator. Ford's loyalty is evident in the number of Twitter followers it has. F trumps GM (GM) followers by over 100K. Ford also secured two spots in the Car and Driver "2013 10 Best Cars," where GM had not a single vehicle in the rankings representing any of their brands.

Revenue and EPS Outlook -

Ford showed very strong Q4 results recently, but the quarter was indeed helped by foreign exchange and 'other' in pretax income for North America. There were some red flags in the last quarter that should cause some pause. Looking into the report, European volumes were guided at the low end of the previously established range.

This is reflective of the fragile situation overseas, which will be touched upon in the variant section. Additionally, but also on the Euro topic, the pretax loss increased 25% year over year for Europe. Asia canceling out Euro economic weakness.

Ford must be rather confident in its performance going forward, for it recently doubled its divided. The nominal amount it is going up is not the point however. This shows that management is confident despite European losses and bad headlines. They are signaling to that market that American economic strength is back and is here to stay.

On a related note, Ford recently announced a bond auction. Management may also be signaling to the market that the stock is undervalued, because they did not sell stock. From a corporate governance standpoint, their debt to equity ratio may be too conservative. Ford has 20% of its leverage now when compared to the leverage it had in early 2000. They are also be signaling that Ford is confident that they can cover bond payments until its maturity.

"It just shows the ongoing effects of the restructuring we did over the past several years. As we look ahead at 2013, we're still expecting a margin of 10 percent in North America, but we will have higher profits." Ford CEO

Given that America is such a large portion of Ford's revenue stream, it is interesting to look at what consumer credit is doing. Looking in the drivers of what credit is doing can potentially predict if sales and financing revenues will pick up…and affect EPS and revenues.

Consumer borrowing in North America, for December, for the fifth straight month rose as non-revolving credit surged by the most in 11 years according to economic reports. This will directly affect Ford's business. This could be because of rising home values and job creation. This type of financing directly relates to big ticket items like homes and cars and could absolutely flow into the hands of Ford…making shares an opportunistic BUY.

Ward's Automotive Group is an industry standard for automotive forecasting. They estimate annual auto sales at around 15.3 million.

Other indicators include their closest competitor, GM. GM earnings come up soon, specifically 2/14/13. These numbers will provide essential insight into how troubled areas, like Europe, are doing. Ford recently came in under nearly $130M from Wall Street expectations in Europe.

American economic strength and corporate governance confidence show that Ford shares are ready to start appreciating…a great BUY.

Price Target Analysis

The following price target was configured through a 5-year projected discounted cash flow analysis. The model projects operating income, taxes, depreciation, capital expenditures, and changes in working capital. Using that information, we can project what the company is worth. We can then use that projection and compare it to current prices.

Here is how to calculate price targets using discounted cash flow analysis:

(All figures in millions)

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

2012 Projections

2013 Projections

2014 Projections

2015 Projections

2016 Projections

Operating Income

7000

8050

8450

8800

9000

Taxes

2240

2576

2704

2816

2880

Depreciation

4760

5474

5746

5984

6120

Capital Expendit.

-4750

-5000

-6000

06250

6500

Working Capital

0

0

0

0

100

Available Cash Flow

5010

6224

5996

6734

6620

Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012).

WACC for F: 5.15%

2012

2013

2014

2015

2016

PV Factor of WACC

0.9434

0.8900

0.8396

0.7921

*

PV of Available Cash Flow

4726

5539

5034

5334

*

Step 3.

For the fifth year, we calculate a residual calculation. This number is calculated by taking the fifth year available cash flow and dividing by the cap rate, which is calculated by taking WACC and subtracting out residual growth rate. Residual growth rate is typically between 2-6%. 4% is average growth for industry. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. This is why higher growth companies tend to have higher PE ratios. We will give you cap rate.

Cap Rate for F: 4.00%

2016

Available Cash Flow

$6620

Divided by Cap Rate

4%

Residual Value

165,500

Multiply by 2016 PV Factor

0.79209

PV of Residual Value

$131,092

Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of Available Cash Flows

$20,634

PV of Residual Value

$131092

Cash/Cash Equivalents

13,600

Interest Bearing Debt

86,300

Equity Value

$79,025

Step 5.

Divide equity value by shares outstanding:

Equity Value

79,025

Shares Outstanding

3,810

Price Target

$20.74

Profit/Value Industry Comparisons

Profitability:

Ford

F is Better Than X% of Industry

Operating Margin

4.85%

66%

Dividend

3.11%

77%

Ford is a top of the line firm. F has many valuable attributes, for example F's EPS growth rate is better than 92% of its peers in the auto and truck manufacturing industry.

Variant

Ford seems to be well positioned for the future. In the past, the variant for Ford would have been an oil shock. Back in 2000, 39% of Ford's vehicle mix was large vehicles and an oil shock would definitely decrease the marginal propensity to go out and buy a truck, but now Ford's vehicle mix is skewed towards small cars. Over 55% of Ford's 2020 lineup is estimated to be small cars. The 2010 lineup was 48% small cars to put the estimate into context. A risk is that tastes change, but that may be unlikely given oil fundamentals.

Another major risk to the story includes a slowing EU. The European economy is one of the most fragile situations out there. The market is on pins and needles when economic figures from the Euro zone come out. According to Ford's last 10Q, revenues from Ford's European operation made up 16% of revenues. To put this figure into perspective, North America makes up 66% of revenues. This may actually present an excellent buying opportunity. The market tends to trade on headlines and given that European headlines seem to be on the uptick…macro concerns may knock the stock down to levels where it should be accumulated, because its revenues are mainly domestic and shielded from Europe. A risk to this trade could be contagion or the European recession spreading to North America.

The Bottom Line

Ford is a great multinational to get long. It is naturally prudent to scale into a position, but shares should be bought here. Ford has economic, valuation, and qualitative tailwinds that will push it to our price target.

Source: This Great American Auto Manufacturer Has 50% Upside