Ford (F) investors had a great period between the summer of 2012 and fall of 2013 as the company's stock price nearly doubled during this period. Of course, other car companies also saw similar rallies around this time when investors realized that the concerns regarding the European auto market were getting subdued, the North American market's recovery was accelerating and the car companies were seeing strong gains in Asia. At the end of last year, Ford reduced some of its guidance regarding full-year of 2013 and 2014, which resulted in a panic-triggered sell-off in the company's shares. Should you back the truck up and load up on Ford's shares based on the recent weakness?
I am cautiously optimistic on Ford's shares and I added to my existing shares with some call options. On the other hand, I am not extremely bullish like I was in the summer of 2012 when Ford bottomed at $8s. Don't get me wrong, I still see a lot of upside in Ford, I just don't think the company's share price will be doubling in the next year.
Ford's new guidance
So, what was so bad in Ford's new guidance that led to a sell-off? There was really nothing that surprising or shocking in the company's updated guidance. Ford's management announced that the full-year results for the total company would be roughly in line with the past guidance. However, there were certain challenges faced by the company in specific geographic locations, particularly North America and South America. In North America, the culprit was Ford's small SUV, Escape. This year's Ford Escape was recalled a total of 7 times for different issues and the expenses associated with these recalls will be around $250-$300 million. This may reduce Ford's operating margin toward the lower end of the 9.5%-10.0% guidance. However, the company's North American business is still expected to generate at least $8.3 billion (closer to $8.5 billion for the entire company across the world) in pre-tax profits for 2013. This is in line with last year's numbers. In South America, the culprit seems to be Venezuela, which has been the case for the last couple years. In Venezuela, the currency fluctuations and economic uncertainty seem to undermine Ford's profitability. Ford expects to reach breakeven in South America due to the issues in Venezuela.
Pension situation is improving
On a positive note, Ford's pension plan is underfunded by only $10 billion. During 2013, Ford made significant contributions to its pension plan and the good market conditions allowed for better discount rates, which reduced the amount the company has to contribute in order to close the gap. As the rate of fixed-income items in Ford's portfolio increased from 55% to 70% between last year and this year (with a goal of 80%), the company's portfolio is expected to be less volatile and easier to manage. Furthermore, 35,000 people took Ford's lump sum offer and the settlement was as large as $4.2 billion, representing 37% of the eligible employees and 25% of the associated liability. This settlement is expected to save Ford a lot of cash in the long run as pension obligations continue to be one of the biggest expense items for the company. In the next 3 years, Ford will have to contribute $1 to $2 billion to its pension obligations, down from an earlier projection of $2-3 billion.
Due to the recovery in the North American market and successes in the Asian market, Ford will be able to post a revenue growth of 10% in 2013 compared to 2012 when it posts its yearly results. The company expects the market to remain challenging in South America due to economic uncertainties, unknown policy outcomes and slower economic growth due to high interest rates. The shrinkage of the car market in Europe should slow down significantly or maybe even see a reverse turn during 2014 depending on how well the continent is able to recover. Ford expects the European economy to grow by 1% during the year even though some countries will grow at much faster/slower rates than others.
Ford will be launching 23 new models during the next year globally, which may be costly and cut into the company's margins in the short term. However, this will fuel more growth in the future. The company will have to be very careful with its future launches so that it doesn't have to recall a bunch of vehicles and leave money on the table. Recalls can be extremely expensive and they can eat a company's lunch in no time. This is one area Ford was doing very well until the Ford Escape incident.
We'll also have to watch Ford's incentives closely. In the last couple years, the North American car industry was able to sell as many cars as it could produce while cutting down on incentives. Towards the end of 2013, it looked like the incentives are coming back and this might be another trend cutting into Ford's margins. However, it's too early to tell at the moment.
Alan Mulally likely to stay?
It also looks like the rumors of Mr. Mulally's Microsoft (MSFT) move are winding down. We still don't know the details but it looks more likely that Mr. Mulally will be staying with Ford for another year. This is a great chance for Ford to continue implementing its one-Ford plan in Europe and elsewhere and continue to deliver profitable growth for all.
Ford's current valuation
Ford's current valuation looks attractive. Currently Ford is trading for 7 times its pre-tax income. Despite all the pension contributions and dividend payments, Ford continues to be cash rich. Ford Automotive currently has $26.1 billion in gross cash, $15.8 billion in total debt and $10.3 billion in net cash. Excluding this figure gives Ford an ex-cash P/E of 6. In a market at all-time high levels, Ford remains to be one of the few companies with low valuation.
If you are thinking of long term and are interested in getting in Ford, this may be the good time to do so. I bought some long term calls after the last correction.