There are more than 250 million vehicles in the United States and the average life span is approximately twelve years. Basic arithmetic suggests to us that the long term annual sales rate therefore must be approximately 1/12th of the US fleet size in order for the fleet to maintain its current size.
Based on Ford Motor Co.’s (F) expectation of 13.0-13.5 million vehicles (total industry, not Ford specific) sold in the United States in 2011, it will take 18.5 years to turnover the entire US fleet despite an average vehicle life of approximately 12 years. If you think that vehicle life is going to expand by 50% in the next five to ten years, then we suggest you look at Autozone (AZO) or AutoNation (AN). But we think the best way to play this unsustainable domestic vehicle sales rate is through Ford Motor.
For the major domestic car companies, high sales volume results in higher profits. During the General Motors (GM) IPO roadshow in 2010, a major point was made about how GM had lowered its breakeven annual rate of sales number (i.e. the annual rate of US vehicle sales at which GM would be operating at breakeven).
Assuming all else is equal, such as market share, Ford sales volume should increase substantially over the next decade as the lower annual sales rates of the past three years and 2011 feed higher sales rates in the medium term future. However, Ford is increasing market share in the domestic market, so consider that an added bonus.
Now sales are both a function of volume and price, so the weak point in our argument so far is that higher volumes might be driven by lower prices. We find this highly unlikely to impact Ford versus other car manufacturers as currently Ford has a higher operating margin than GM or Toyota (TM). It sounds cliché but we find betting on the low cost producer in a price war tends to be a profitable relative speculation more often than not.
We have not even discussed here the emerging market opportunity for Ford, as we see that as more of an added kicker. We also think when presenting very compelling opportunities it is best to view things through a conservative and restrained lens so let’s leave the lucrative emerging market opportunity out of this for now.
Based on a normalization of sales rates in the United States and it being the low cost producer, we think Ford is an interesting investment opportunity to consider if the general market breaks out to new highs. Based on the projections we have seen from sell side analysts covering Ford, we think the case can be made for Ford to double by the end of 2014 as a result of earnings growth, increased domestic industry annual sales rate, plus P/E expansion as a result of the increased annual sales rate. A similar return on the S&P 500 (SPY) would require 16% annualized growth in S&P 500 earnings if we gave the market a 15x P/E multiple plus assumed a 2% annual dividend yield.
We like Ford Motors as a long term investment that should outperform the S&P 500.
- Matthew Duarte and Matthew Aizpuru contributed to this report