- In a rich market, Ford is one of the remaining attractive values and should trade toward $24 by the end of 2015.
- Capacity cuts are pushing Europe back into the black while an aggressive push into China is starting to pay dividends.
- While North America has been weak, that is due to impending product launches, and these launches should spur sales growth and better pricing going forward.
- Ford is poised to earn $2.00 in 2014, which puts fair value toward $24.
With the stock market trading around an all-time high and about 17x earnings, it is increasingly difficult to find companies that trade at extremely attractive valuations. One of the few remaining sectors where there are many attractive values is the automotive industry. In particular, I like GM (NYSE:GM) and Ford (NYSE:F) and I'm long both names. In a previous article (available here), I explained why I was bullish on GM, and in this article I will focus on Ford. In particular, I believe the market is under-appreciating how Ford's 23 new product launches will boost sales in the back half of this year and in 2015. As a consequence, I expect the company to earn $2.00 in 2015 and expect shares to trade toward $24 in the next 18 months.
Last week, Ford announced it earned $0.40 on revenue of $37.4 billion in its second quarter while analysts were looking for $0.37 on sales of $38.1 billion (all financial and operating data available here). This quarter was Alan Mulally's final one as CEO, and he clearly did a fantastic job during his tenure, keeping the company out of bankruptcy in 2009 by borrowing money before the credit markets froze. Then by focusing on quality, design and costs, he gained market share while improving margins to turn Ford into the profitable juggernaut it is today. While his leadership will definitely be missed, new CEO Mark Fields essentially served as an understudy for two years and should be able to maintain Ford's operational excellence.
Now, revenue was $500 million lower than last year due to a 1% decline in shipments. This led to an 11% decline in EPS. This decline came against the backdrop of a stronger US auto market. In the US, volumes were 5% lower, sending market share down to 15.3% from 16.5% a year ago. At first glance, these results seem poor. However, there are timing issues. Ford has been burning off inventory ahead of new product launches, namely an aluminum F-150. Once the new model is released, it is obviously hard to sell the old model. As a consequence, Ford has been working to cut inventory ahead of launches, which should lead to significant sales growth as these new models hit the market. Impressively even with lower sales and increased promotions, operating margins improved by 1% to 11.6% thanks to investments in capacity and the supply chain. This should facilitate significant profit expansion next year.
While North America has been temporarily hurt by impending launches, results were strong elsewhere in the world. In Europe, Ford has been aggressively cutting capacity to lower its breakeven rate as the auto market has struggled to rebound since 2008. Volumes were only down by 1,000 to 376,000, but Ford has been refocusing production on higher priced vehicles. As a consequence, revenue increased by 9.6% to $8 billion. Higher prices and capacity costs helped Ford swing to a $14 million profit from a $306 million loss last year. Thanks to these cuts, Ford should turn a solid profit in 2015 after years of losses.
Finally, Ford was a little late to get into the China market, but it is quickly making up for lost time. Volume was up 21% throughout Asia to 362k while operating margins expanded by 0.6% to 5.5%. Wholesale volume in China was up an even more impressive 26%. With higher sales, Ford should continue to deliver higher profits in Asia for several years to come. Overall, North America was hurt by timing issues while Europe is improving and Asia continues to be strong.
At the same time, Ford has a pristine balance sheet and now carries $10.4 billion in net cash, which gives the company plenty of flexibility to weather a downturn. It also has room to gradually increase the dividend while selectively repurchasing stock. It also can continue to invest in R&D and capacity to raise margins and continue to launch new products. I expect the F-150 and other new products to propel sales higher and will allow the company to roll back incentives it used to move old inventory. This will be very beneficial to margins. For instance, I expect the new F-150 average selling price to be about $1,000-$1,500 above the current model. Much of this will flow to the bottom line.
Improvements around the world and new products should push EPS to $2.00 next year from about $1.65 this year. With its pristine balance sheet, history of strong execution and fresh lineup, shares should trade at least 12x earnings next year. That suggests a price of $24 or about 36% upside over the next 17 months. At current prices, F is less than 9x 2015 earnings, which is extremely attractive. Even with shares up 14% year to date, Ford has a lot more upside, and I would continue to be a buyer at current levels.
Disclosure: The author is long F, GM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.