Ford: Defying the Odds

The Three Liner:

Despite belonging to one of the three permanently shrinking industries (financials, housing, and automotive), Ford (F) is an attractively valued turnaround company. Improving balance sheets, product demand, cost control (we call this "organic growth"), and a healthy credit facility all suggest a higher share price is likely. Odds are high that it will emerge a leader in the automotive sector.

Summary:

Investing in the automotive sector is likely more suicidal to a portfolio than it is money-making. Yet Ford is defying the odds. It is run by ex-Boeing (BA) execs, and most critically, it refused to obtain government support when its competitors took the bait. Where is GM (GMGMQ.PK) now? Where is Chrysler now? Ford is building a dominant position against both domestic and foreign auto makers, namely Honda (HMC) and Toyota Motors (TM).

In the past, Ford played the consumer "incentives" game to keep sales going, eroding earnings and margins. It can no longer do that. In fact, no car company can. The industry shrank suddenly, and all companies need to shrink accordingly to survive.

In my analysis, I will illustrate that Ford is on track to build market share at the expense of its competitors.

Balance Sheet Analysis:

From a financial balance sheet analysis, Ford would fail as a healthy investment. Graham/Dodd would probably not have taken a second look at this company. Its debt/equity is poor; it reported negative income since 2006 (it was last profitable in the year ending December 31, 2005); the automobile industry is assumed by all to be virtually non-existent.

To coin a phrase that supported the March-June 2009 40% global stock market rally, Ford is doing "less worse" than what the market thought. In fact, it is doing better than its competitors.

GM and Chrysler, as it emerges from bankruptcy, will be distracted from making bold and key decisions. Investors who have written off Ford also believe that these bankrupt companies will undercut product pricing. People thought this too, before the bankruptcy. The thing is, it never really happened. At that point, the fate of the other "big two" was sealed. Now, GM and Chrysler have too many owners and it is under government intervention and supervision.

In reviewing Ford's most recent results, let me now compare the revenue generation against both ongoing and permanent cost reductions.

Cost Reductions:

* Reduced automotive structural costs by $1.9 billion vs $1.3 billion in 2008
* Reduced automotive debt obligations by $10.1 billion
* Lowered annual cash interest payments by over $500 million (note that this is negligible since management indicated credit facility negates net benefit of this expense)

* Lowered annual U.S. labor costs by $500 million
* Manufacturing and engineering costs were over $800 million lower
* Spending related costs improved by about $200 million (lower depreciation)
* Pension and retiree health care expenses were $300 million lower
* Overhead costs were over $300 million lower (achieved via layoffs)
* Advertising and sales promotions were about $300 million lower

Total cost reduction as reported by management: $1.9B. The company forecasts a full-year structural cost reduction of over $4 billion.

Product Supply:

Supply for Q2 (Compared to year-ago period):

North America: 435,000 units (36% decrease)
Europe: 385,000 units (32% decrease)
Volvo: 82,000 units (27% decrease)

Product Demand:

Management indicated a 20% increase in production from Q1 to Q2 for this year. This is bullish. Not only did Ford maintain its price levels, it expects demand to increase.

(All above unit and cost figures provided by seekingalpha.com, April 2009)

Analysis:

There is adequate cash flow to support corporate debt obligations. However, this was achieved by obtaining a ~$10B credit facility. Ford recently issued shares to improve its balance sheet. The market has improved to allow the company to do this again if required.

Still, its debt is too large. My bullish outlook for Ford depends on the company improving its balance sheet through cost reductions, growing demand on all of its key products, and working down inventory.

Past Quarterly Results Q1/2009:

* Revenue was $24.8 billion, a drop of $14.4 billion
Reasons: Lower volume and unfavorable exchange partly offset by higher net pricing.

* Operating loss (excl. special items) was $2 billion
* Net loss $1.4 billion (includes pre-tax special charge gain of $362 million)
* Cash: $21.3 billion of cash, down ~$7.4 billion year-over-year
* Pre-tax loss: $637M
* Cash flow was -$3.2B
* Receivables was 106B ($42B lower than last year)

Analysis and Comments: Weak cash flow was expected, as overall demand plummeted for the industry. However, Ford has reported declining receivables. The company expects to pare this down to $85-$95B this year.

Beating The Competition:

On Improving Quality:

Ford…wait for it…beat Honda and tied Toyota in quality by improving this level by 5% (figures are from the latest Global Quality Research Systems study). The benefits of this are obvious: warranty costs would decrease, and demand would improve (in the latter case, customer satisfaction figures are improving for Ford).

On Increasing Market Share:

Ford has 13.9% of the U.S. market. Its European market share is 9.4%. How was this even possible? It surprised even me as I prepared this analysis that Ford achieved this last quarter. It is clear that management is running the company very well, and, even with the weak auto industry and global economic health, Ford can grow by capturing greater market share.

Analysis:

Japanese auto makers are not growing market share at the expense of U.S. automakers, as everyone had thought. Toyota and Honda Motors are not performing in a way everyone expected. All in all, I believe that Ford has it right from the management of the company all the way to having the right product mix.

There is already strong evidence that the Ford Fusion and the Ford Fiesta are going to be a winning combo globally. Reviews have been good, and "green initiatives" often refer to Ford's hybrid offerings. As I stated previously, Ford's product prices are not falling, suggesting demand is expected to be healthy.

Any media buzz talk about green initiatives will benefit Ford, because ford has its bases covered with hybrid vehicle offerings.

Early indications suggest strength for the Fusion in the North American market, and the Fiesta for the European, Chinese, Australian, New Zealand and South African markets.

Financial Ratios:

* Price / Sales: 0.14
* Market Cap: 17.99B
* ROA, ROI, operating margin, profit margin values are all negative. This is a company in transition so these values should be flagged as poor. For my forecast (below), I will not be applying this to assessing company value.

(All figures from finviz.com)

Company Valuation: I will use the following input values to calculate company value: 1) Margin Improvements to Determine Margin of Safety in Price Target: Ford average margin per vehicle was about $5,700. Historically, the company made somewhere between $8,000 to $10,000, a 47% drop. While product mix, competition, and costs impact this, let me still use the 47% margin decline (round to 50%) in my margin of safety calculation. Note that the absence of “incentives” suggests that the lowered margin is sustainable and should not decline further.

Revenue Forecast (Provided by Management):

Ford is confident it can ramp up sales in the U.S. I agree. I am bullish on its new product line and apply a management-supplied sales growth figure of 25% for North America (435,000 units) and 13% sales growth in Europe (385,000 units).

Cost Reduction: $4 billion for 2009 is achievable by Ford (it already saved $1.9 billion in the first quarter alone). The to-date cost reduction does not even include a rationalization of the supply-side distribution system.

Ford was last profitable for the full year in 2005. It earned $0.50. It is not meaningful to review average EPS for Ford in the past 10 years, since the industry has been completely decimated by shrinking demand. My valuation calculations are therefore dependent on cost cut figures and sales figures in the past year. Ford is also running like a different company, with a solid product line not seen since the 1990's when it exceed all estimates with its "homerun product" the Ford Taurus.

Since I expect earnings to be negative for this year and next (due to ongoing costs exceeding a ramp up in product demand), my company valuation is therefore based on a single estimated EPS for 2011, and applying a margin of error of 50% . This also aligns with management forecast for a breakeven or profitable earnings in 2011.

2010 EPS Estimate: ~ -$0.50
2011 EPS Estimate: ~ +$0.50

Assuming a 10% revenue growth rate, a 50% margin of error applied to the stock target price (forecasting 2 years out is bound to have sufficient inaccuracies), and a 2011 EPS of $0.50 yields a 2011 company value of $7.00.

Price Target and Conclusion:

When Ford stuck a deal with the UAW, the option of a stock payment with a strike price of $2 was issued. This cannot be ignored in determining a basement stock price. I therefore use this as a guide for my “support price” for the stock.

My price target is $7.00, a 23% return from current prices. My strategy will be to accumulate Ford at lower prices, and to buy aggressively if the stock falls to the $2-4 range. Ford will not exceed 5% of my portfolio.

My upper-range price target would fall within a forward P/E in the range of 10x - 15x @14x P/E.

"Quality is Job #1" may have been a slogan for Ford in the past, but from this point forward, it is a key strategy to its survival.

Risks to Price Target:

Increasing auto loan delinquencies (eg: trans union noted a 28% increase in delinquencies >60days), unsustainable discounting by competitors, resumption of incentives spending by competitors, pension funding shortfall, failure by company to meet $4B cost reductions, competitor successful launch of "home run" products, excessive share issuance diluting current shareholders.

Disclosure: Author holds a LONG position in Ford on his KaChing virtual portfolio (a site with over 375,000 registered users). This portfolio is also followed by nearly 400 users.

Comments

[theeye:]

A fine analysis that many investors should study for themselves. While a share price is possible of $7.00 in 2010, you may find that as there will be more money available for investment at the end of 2009 possibly pushing share price to $7.50 - $8.00 range. Also unknown trickle down buying of fleet vehicles by governments around US may mean an increase of sales of Ford 's new fuel efficent vehicles, i.e.,Post Office, State and Local, utilitiy service and transportation company's (Taxi ). Their new Transport van that can be configured to fit many uses comes to mind, this vehicle can also be converted easily to full electric for congested city core deliveries of short stop and start driving, saving untold dollars in fuel savings for these package services. When you put your hand in a bag of dull stones, sometimes a jewel is found!

Jun 19 06:39 PM

[Leftfield:]

Ford has a huge opportunity to become THE American car company and reap huge rewards. Management seems to be on the upswing from the Bill Ford snooze era and perhaps the family put into place smart management when he left.
Like all Detroit companies, they have yet to make full use of their remaining global reach. It is absolutely typical that Europe has had a much better Focus since 2000 and they got a new model in 05 that will come to the US in '10. I think the talk of their having a great lineup now is revisionist. But I guess it's okay by Detroit standards.
I'm sure there is energy in Dearborn not seen in decades to take advantage of the opportunity against Government Motors and, according to this article, everybody. I'm hoping really inspired people are rising to the occasion (hasn't really been true in there since the Model A) and that the politicians and UAW can at least get out of the way.

Jun 20 07:33 AM

[jimdaddy:]

America's car. What a joke. Ford is building as many cars as possible in MEXICO. American men and women are not Building so many Fords. I went to my local Ford dealer to price Fusion Hybrids and they Quoted me $31,000.00 more or less for a Mexican built car. In Mexico Ford pays around $5.00 an hour for labor and charges as if Americans built it. So i guess i will look at Toyota Prius or maybe a Honda. Seems Toyota and Honda are building more and more cars here, while Ford, Gm and Chrysler are building more and more in Mexico and laying off American workers.

Jun 20 08:29 AM

[ksmithdc:]

Interesting read, thanks.

Jun 20 12:36 PM

[bbowen7:]

Ayn Rand's Atlas Shrugged has a wonderful character, John Galt, who leaves Twentieth Century Motors in disgust for collectivism. Life imitates art - now we have one American free market capitalist car company. I'm betting on John Galt.

Jun 20 01:35 PM

[Dubious Bro...:]

It will be interesting to see how much of a backlash exists against the
government and the UAW "owning" GM. It seems that a conflict of interest exists with the UAW "owning" a large percentage of GM and then wanting to represent the Ford workers at the same time. Ford should throw the unions out and build their high tech robotic plants in the US to supply the US cars.

Jun 20 03:38 PM

[Northstar10000:]

No one cares about Chrysler and no one will buy a GM product.
Ford is toast until it breaks 2.00. Look at it when it gets in the 1.50-1.95 range.

Jun 20 05:17 PM

[a. palmer jr.:]

They increasingly make it difficult to buy their products...you want to buy American if you're an American but you really don't want to buy a car that's not made here anyway and you can't afford to buy a car that breaks down shortly after purchase. Like it or not the Japanese cars have a better track record for reliability and it seems they "get it" as far as knowing what consumers want, at least for now.

Jun 20 08:10 PM

[User 283977:]

I think a better play is Ford's commercial paper - (KSK). Every thousand shares of Ford bought today costs you $5,720. If it goes to seven per share in 2011, you made $1,280, a 22% Return over a two year period, 11% per year. Ford shares have no dividend at this time.

That's not bad, but on the other hand you could purchase $5,720 worth of their commercial paper (KSK) currently at $11.48 per share. That buys you 498.25 shares with a yield of 16.1%. That's $920.92 per year, or $1,841.84 over a two year period, a 32.2% return over a two year period, 16.1% per year.

With the KSK investment you have access to dividend returns twice per year. For example, if the price of KSK remained constant at $11.48 per share, you could re-invest your first year profits to purchase an additional $920.92 of KSK in 2010. Now the total two year return is 34.8% JUST FROM DIVIDENDS.

Now add onto this any stock price increases of KSK shares over the next two years, and you are looking at returns of 40 to 50 percent over a two year period.

Of course all of this blue skying is based on Ford's future business. However, if the articles premises are correct, and I believe they are, than I argue KSK, Ford's commercial paper is the superior investment providing over twice the two year projected return based on Ford's common shares.

Disclosure: Long KSK.

Jun 20 08:41 PM

[Tomcat101:]

No thanks, I prefer cars that don't cut off on me and leave me stranded.

Jun 20 10:13 PM

[Boiling Point:]

Quit living the past. Both GM and Ford build as good if not better vehicles than the Japanese. Buick has outscored Lexus more than once or twice on quality ratings and Ford is leading the pack overall in that arena. How many American vehicles do you see in Korea or Japan...the answer is virtually none. I believe it is time Americans wake up and support are own like they do.


On Jun 20 08:10 PM a. palmer jr. wrote:

> They increasingly make it difficult to buy their products...you want
> to buy American if you're an American but you really don't want to
> buy a car that's not made here anyway and you can't afford to buy
> a car that breaks down shortly after purchase. Like it or not the
> Japanese cars have a better track record for reliability and it seems
> they "get it" as far as knowing what consumers want, at least for
> now.

Jun 20 10:33 PM

[ala7575:]

Ford will outcompete Government Motor and Chrysler. Ford maybe can fight with Toyota or Honda for a while. But Ford will definitely lose its battle against BYD and Geely, guys from China. Munger and Buffett is betting that BYD will outbid Toyota. So shall we.

Jun 21 02:59 AM

[beentheredo...:]

FOREVER!!!


On Jun 20 11:59 AM ednaldo cunha wrote:

> How LOng will petroleum be the source of energy IN Market??

Jun 21 09:01 AM

[Doc 224899:]

Look at Pony Cars: the V-8 Mustang GT burns Regular gas and the V-8 Camaro and Challenger burn Premium; the V-8 Mustang GT uses a smaller engine producing less power and torque, and offers as good or better performance because it is a more mature and balanced design where all the parts meld together more harmoniously. The Challenger is based on a Chrysler 300 platform and interior, the Camaro is based on a Pontiac G8 platform, and the Mustang is its own car. A Mustang GT that will beat or match a Camaro or a Challenger costs less. If you compare the Shelby Mustang to the Challenger SRT8, the Shelby wins by a mile, and there is no Camaro even in the same category. Ford does it better. Period.

Jun 21 11:57 AM

[Doc 224899:]

As long as the federal government favors the UAW and plaintiff's attorneys above all other concerns in the auto industry, Ford won't be able to last. As long as the UAW leadership maintains its greedy, petulant, childish character, it will devour and destroy the auto industry the same way steelworkers destroyed America's steel producers. When GM and Chrysler fail, the media will collude with the government in claiming corporate leaders caused the failure, and Ford will be left alone facing the toxic factors that previously had been challenged by 3 carmakers.

Then we'll all be driving Tata cars.

Jun 21 12:10 PM

[gmlover:]

GM cars and trucks rock, they always have, they always will!!!!

You can keep your Japanese pseudo-cars/trucks. I prefer the real stuff!!

Jun 21 08:20 PM

[ETF Grind:]

It's product OK and its market share is stabilizing, but it just has too much debt and legacy costs.

I think it would be better to reorganize. CEO is just pushing the crisis a few years down the line, just like GM did this decade.

Jun 22 12:47 AM

[User 283977:]

June 23, 2009 - Ford got a 5.9 Billion technology loan today. That can't hurt.

Jun 23 12:32 PM

[TruthSayer:]

Congrats on your call - Ford at 7.03 in the pre-market.

Jul 23 09:12 AM