Ford (F) is the second largest automobile producer in the US and fifth largest in the world. On the verge of bankruptcy in 2006, Ford’s board of directors hired Alan Mulally as the CEO to turn the company around. He implemented the One Ford strategy to reduce cost and to focus on fuel-efficient vehicles. Under Alan’s leadership, Ford reported $6.6B net income in 2010, lowered its labor cost from $76/hr to $55/hr, and significantly increased market shares in all geographic markets.
Long-term outlook for the automobile industry is positive. Deloitte Consulting projected the global auto demand to grow from 60 million in 2010 to 70 million in 2015, with majority of the growth coming from compact cars in Asia and fuel-efficient cars in the developed markets. These two areas are where Ford has invested its resources and has the strongest products.
Proven Management – CEO Alan Mulally has turned Ford around by creating a leaner and more productive company. He sold off different subsidiaries to focus on the core brand, re-negotiated contracts with the Union to lower costs, and boosted operating margin to 6.4% compared to the industry average 4.7%.
Decreasing Leverage – Ford reduced its Automotive debt by $14.5B in 2010, a 46% reduction, and another $4B in H1 2011. Although its interest coverage is 2.16 compared to 3 expected for the industry, the management has prioritized its FCF to pay down the debt. With $14B long-term debt left on its Automotive segment and growing income, the interest coverage ratio should reach industry average in the next 2 years.
Quality Products – Ford has created numerous well-received vehicles. For example, the Ford Fiesta has sold well over 1.5million units since 2008 and is the top selling car in Europe. The subcompact Ford Figo won Indian Car of the Year award this year. Ford has also partnered up with Toyota to develop the next generation hybrid technology.
Investments in Asia – Ford is fast growing in Asia, where 70% of the cars sold is compact cars. With only 2.9% market share, Ford is planning to double the number of dealerships in China and triple in India. It also plans to leverage its strength in compact cars to capture a much larger share of the market. At 6% operating margin in Asia in 2010, any market share increase in the fastest growing region can have outsized impact on its bottom line.
The model assumes 3.5% global demand growth, 2% inflation and Ford continues to capture 1% market share each year. Tax rate is in the low single digits from 2009 to 2011 due to Ford’s tax assets but, as management has indicated, the tax assets will be exhausted by end of the year so assuming 35% tax rate after 2011. The new tax rate will cause net income to decrease in 2012. As debt is paid off and operating income increases, interest coverage ratio is expected to increase to 3.9, and the company’s balance sheet will become less leveraged.
Risks and Mitigants
Global Recession Risk – With European debt crisis still simmering and inflation risks exceedingly high in the emerging markets, the possibility of a global recession is real and a deteriorating economy can significantly reduce demand for automobiles.
Management Change – Alan Mulally turned 65 this year. If he were to unexpectedly retire, there is no clear successor with proven abilities to continue running Ford during this uncertain period.
Based on both PE and price to EBIT valuations, Ford has one of the lowest valuations in the industry. PE distorts the picture somewhat for Ford since it has large tax assets that give the firm a lower tax rate than its competitors. Price to EBIT valuation removes this distortion and shows that Ford is the cheapest multiple. The amount of debt on Ford’s balance sheet seems to be contributing to the lower multiples. With a solid product line and competent management, Ford is expected to generate enough cash to pay down its debt. As the debt in Ford gets paid down, Ford’s multiple will move closer to that of the industry. The price to EBIT valuation gives Ford a price target of $17.22 based on price / EBIT multiple of 9.15.
Toyota (TM) - the largest automative producer in the world with 11% market share. The company has a PE ratio of 37, debt ratio of 65%, and operating margin of 2.5%. While the company is still profitable even after the tragic earthquake, it has suffered quality related issues with its vehicles in recent years. The stock has recovered somewhat from its lows but even at this price, a lot of future growth has been priced in.
General Motor (GM) - the second largest automative producer in the world and the biggest US domestic producer. GM has a leaner balance sheet after emerging from the bankruptcy process. Its products aren't as rated as highly as that of Fords and GM also has lower operating margin of 3.8% compared to 6.4% for Ford.
Honda (HMC) - Honda is the second biggest Japanese automative producer. It hasn't suffered any major quality setback like its rival Toyota, but at 14x PE, Ford is still a cheaper bet. Honda also lacks a compact car line up that can compete with Ford in Asian markets.
Despite the turnaround, Ford’s stock has sold off 40% in 2011. The selloff is contributed to heightened global recession risks and Ford’s heavy debt burden. It represents a unique buying opportunity as the company continues to grow faster than its competitors and reduce its debt in a global slowdown.