Is Ford's Dividend Safe? Let Me Clear The Air Once And For All

| About: Ford Motor (F)

Summary

Ford has cut its dividend four times since 1980. I analyzed the factors that led to each dividend reduction and determined whether or not they are still relevant today.

With automotive markets potentially peaking, understanding the safety of Ford's current dividend in the next industry downturn is more important than ever for income investors.

Has management done enough to get Ford through a full automotive sales cycle without hemorrhaging cash? The stock's P/E ratio of 6.3x suggests skepticism, but let's take a closer look.

With a high dividend yield sitting near 5%, Ford (NYSE:F) has caught the attention of many income investors living on dividends.

However, as most of us know, high yields often serve as a warning sign about a company's health and dividend safety.

The best investment advice is to approach high yield stocks with caution.

Ford's case is a little curious because the company just set an all-time quarterly record in its automotive segment with pre-tax profit of $2.8 billion - more than four times the amount of regular dividends paid ($600 million).

With results like those, what could investors be worried about?

Automotive sales are highly cyclical, and the major auto manufacturers have been absolutely shellacked in past downturns, which are usually sudden and violent in nature.

With U.S. vehicle sales sitting near their prior historical peaks, there is no shortage of anxiety in the market that another downturn could be right around the corner.

While Ford paid out its first dividend way back in 1956, the company's track record doesn't come close to the consistent income growth delivered by the best Dividend Aristocrats.

In fact, since 1980, the company has cut its dividend four times. The chart below depicts the seasonally adjusted annual rate (SAAR) of U.S. auto sales (green line) and Ford's total dividends paid (blue bars) from 1976 through the first half of 2016.

The red circles denote periods when Ford reduced its dividend and are wrapped around the trend observed in U.S. vehicle sales during those times.

Click to enlarge

Source: FRED Economic Data, Simply Safe Dividends

Three of Ford's four dividend cuts were approximately 10 years apart from each other.

With the company's last dividend cut occurring in 2006, investors are wondering if history could repeat itself.

However, the 2016 Ford is a much different company than it was in past decades.

Let's take a closer look at why the company cut its dividend several times in the past 40 years and whether or not another dividend cut could be on the horizon.

1980 Dividend Cut

Ford's first dividend reduction during the period I analyzed took place in 1980. According to the Washington Post, U.S. automakers' production was down more than 30% compared to the prior year.

Lower production volume meant that Ford's large fixed cost base from its manufacturing plants was spread across fewer vehicles, crimping profitability.

Ford posted a record loss of $164 million in the first quarter of 1980 and was on track to lose more than $1 billion for the full year.

General Motors (NYSE:GM), the largest company in the industry, was the only auto manufacturer that managed to turn a profit.

All of Ford's losses were attributable to its North American operations, which more than offset profits from non-auto and foreign subsidiaries.

Ford made its biggest dividend cut in its history (at the time), reducing its payout by 70% in 1980 before completely eliminating the dividend in 1982.

With a loss per share of $12.83, $9.40, and 75 cents in 1980, 1981, and 1982, respectively, Ford had little choice but to cut the dividend, which amounted to approximately 16 cents per share in 1979.

Ford's initial 70% reduction in the dividend saved the company nearly $340 million per year.

Ford began paying dividends again in 1983, but it wasn't until 1986 that its quarterly payout exceeded the dividend amount it was doling out in 1979. That is far too long for income investors to wait.

To conclude, Ford's 1980 dividend cut was caused by weak industry conditions and unproductive manufacturing facilities, particularly in North America.

While there's not much Ford can do about the cyclical nature of automotive sales, it clearly has room to improve the cost-effectiveness of its production facilities.

1991 Dividend Cut

Ford's next dividend cut took place in early 1991.

After sinking to an annual pace of 9-10 million vehicle sales per year in the early 1980s, U.S. vehicle sales rallied sharply to more than 15 million annual units by the end of the decade.

However, U.S. vehicle sales fell nearly 30% from an annual pace of 16 million in January 1990 to less than 12 million just one year later. The U.S. economy had fallen into a recession, reducing demand for vehicles, and the Persian Gulf War also created challenges.

In response to difficult market conditions, management lowered the company's quarterly payout by 53%, dropping it from 75 cents per share to 40 cents.

Ford was also involved in a $3 billion cost reduction plan at the time. Reducing the dividend saved more than $650 million per year.

Interestingly enough, Ford had previously stated that it did not want to lower its dividend if profits fell during the next normal cyclical downturn. The company had even resisted pressure to significantly boost its dividend during the boom times of the 1980s.

What was management's excuse when the dividend was ultimately cut? Here's what Ford's chairman Harold Poling said:

"The situation we face today is much more than a normal trough in the business cycle and in automotive earnings. The automotive industry is in the midst of one of the toughest and most challenging periods it has ever confronted."

Indeed, Ford reported a loss in excess of $600 million during the first quarter of 1991 compared to a profit of more than $500 million during the same period just one year earlier.

General Motors, Ford, and Chrysler lost a combined $3 billion during the first quarter of 1991 - the worst period ever for the automotive industry at the time (cyclical, capital-intensive businesses can be lethal).

Ford wasn't the only company to cut its dividend during this time. Many companies enjoyed a strong gain in profits (and corporate largesse) during the 1980s and somewhat lackadaisically paid out generous dividends to keep shareholders satisfied.

According to the Commerce Department, American corporations had nearly doubled their payout ratio from 23% in 1980 to 44% in 1990. Debt was used to finance much of the dividend growth during this period marked by strong business conditions.

Of course, nothing lasts forever. Once the U.S. economy entered a recession, many dividends proved to be vulnerable as companies were burdened with interest payments and increasingly squeezed for cash.

It wasn't until 1997 that Ford's dividend surpassed its prior peak reached in 1990. Once again, income investors were left hanging.

2002 Dividend Cut

After bottoming out in the early 1990s, Ford's dividend more than tripled over the next decade.

The company's next dividend cut was announced in early 2002 when management cut Ford's quarterly dividend from 10 cents per share to 5 cents, representing a decline of 50%.

The U.S. economy had entered a recession in recent years, but U.S. vehicle sales remained surprisingly resilient - above a 15 million annual rate throughout the entire period.

Prior to announcing its dividend reduction, Ford had more than $16 billion in cash, and analysts didn't believe the company needed to slash its dividend.

Even Ford's CFO said he didn't see any reason to suggest Ford cut its dividend during the summer of 2001.

Why then did Ford cut its dividend?

The company was experiencing intense competition from low-cost foreign competition, incurring heavy marketing costs (dealer incentives were out of control), and facing heavy expenses related to quality issues (e.g. ignition lawsuit; Firestone tire recall; issuing longer product warranties).

Ford was handicapped in many ways that would severely hurt the business heading into the financial crisis as it continued hemorrhaging market share to lower-cost foreign competitors.

For example, according to the Wall Street Journal, Ford's labor contract with the United Auto Workers union did not allow Ford to close any plants unless the company could prove it was in an economic crisis!

It's no wonder why Ford's market share continued to slip and earnings were eroding despite reasonably strong U.S. vehicle sales.

Ford reported a multi-billion dollar pretax loss in its automotive segment in 2001 and lost several hundred million dollars in 2002. The company's S&P credit rating was also lowered from A in 2000 to BBB+ in 2001 and BBB- in 2003.

While Ford wasn't necessarily in a dangerous financial situation or facing another deep trough in vehicle sales, the dividend cut provided the company with some breathing room as it began to more seriously clean up its act.

The dividend reduction saved over $1 billion per year, helping Ford handle its debt load and improve productivity in an effort to stabilize its market position and bring its auto business back to breakeven.

The company kicked off a large number of restructuring actions intended to generate $9 billion in annual cost savings by the mid-2000s - just in time for the company's next dividend cut.

2006 Dividend Cut

After initialing slicing its dividend in half, Ford announced it was suspending its dividend altogether in late 2006. The company would not begin making dividend payments again until 2012.

At the time of the dividend cut, the auto market had not yet severely corrected (it began to fall in earnest in early 2008).

However, Ford's auto segment had lost money for six consecutive years, including a loss in excess of $1.5 billion in 2005 (compared to dividends paid of approximately $730 million).

Ford faced headwinds from high gas prices, which resulted in consumers buying fewer SUVs and trucks in favor of smaller cars and crossover vehicles.

The company also added two extra years to the powertrain warranty of its cars and trucks and took other steps to try and improve the resale value of its vehicles. These moves would further erode the company's earnings.

By the end of 2006, Ford's S&P credit rating had fallen to a B with a negative outlook. Ford was in clear need of a major turnaround effort if it wanted to survive for the long term.

The company's U.S. market share had declined from close to 26% in the early 1990s to less than 19% in 2005. The outlook for the company was dire.

Cutting the dividend was part of Ford's massive restructuring plan, which included reducing its North American workforce by nearly 30% and shuttering over 25% of its production capacity.

These actions have put the company on a more encouraging trajectory today, but that doesn't mean Ford is out of the woods just yet.

Ford's Dividend Safety Today

Ford has clearly experienced a number of rough patches over its lifetime.

While some of its challenges were caused by the cyclical nature of the auto cycle, a lot of its issues were the result of many poor operational and financial decisions made by management.

These strategic oversights compounded over the course of several decades, gradually eroding Ford's market share and creating an existential threat to the entire company.

Today, Ford is arguably in a structurally healthier and more flexible position that enhances the safety of its dividend payment.

The company ended 2015 with only 67 manufacturing plants, which is down significantly from the 113 plants run by Ford in 2005.

Ford also has 199,000 employees today compared to 300,000 employees in 2005. Many of its union labor contracts have been modified as well to provide Ford with additional flexibility to manage through the next downturn.

The company also sold or exited all but two of its brands (Ford and Lincoln) to better focus the firm on its strongest opportunities.

From 2013 through 2015, Ford's automotive segment generated cumulative pre-tax income of $22.7 billion (excluding special items) compared to total dividend payments of $5.9 billion. Its automotive operating margin of 6.8% was the highest since at least the 1990s.

An argument can certainly be made that Ford's automotive business is stronger than ever thanks to healthy industry conditions and legitimate operational improvements made by management.

From a growth perspective, Ford's global market share is showing signs of stability as well. The company's share edged up from 7.1% in 2014 to 7.3% in 2015 and has now gained 40 basis points over the last three years.

Ford has also been launching more than 10 new products around the world each year to keep its vehicle lineup fresh and competitive.

Low gasoline prices have certainly helped as well since they make big-ticket vehicles like trucks and SUVs more appealing.

What does this all mean for Ford's dividend?

My objective is to never own a company that reduces its dividend payment.

The three dividend portfolios in our newsletter have been successful so far. These portfolios have collectively enjoyed over 60 dividend increases and avoided any dividend cuts since they were started.

Companies usually give off a number of warning signs before they actually cut their dividends.

The companies most likely to cut their dividends usually have some combination of high payout ratios, weak free cash flow generation, declining sales and earnings, weak balance sheets, and no proven commitment to paying and growing dividends over time.

Tracking these key metrics is time-consuming, which is why I created a Dividend Safety Score to help me keep tabs on all of these factors for companies I am interested in.

Our Dividend Safety Score analyzes 25+ years of dividend data and 10+ years of fundamental data to answer the question, "Is the current dividend payment safe?"

We look at factors such as current and historical EPS and free cash flow payout ratios, debt levels, free cash flow generation, industry cyclicality, profitability trends, and more.

A Dividend Safety Score of 50 is average, 75 or higher is considered excellent, and 25 or lower is considered weak.

Most companies that end up cutting their dividends score below 25 prior to announcing their dividend reduction.

Kinder Morgan, Potash, BHP Billiton, and ConocoPhillips all scored below 20 for Dividend Safety before announcing their dividend cuts.

Ford's Dividend Safety Score of 39 suggests that the company's dividend payment is safe for now but somewhat riskier than the average dividend stock.

As I previously noted, Ford is generating tons of cash in today's favorable environment.

The company's dividend has consumed just 34% of Ford's free cash flow over the last 12 months, and Ford maintains over $39 billion in cash on hand compared to total dividend payments of $2.4 billion last year.

While the company's U.S. sales slipped 3% and came in below expectations in July, there is no reason to believe that the current auto cycle is unraveling.

The average age of U.S. vehicles sits at 11.4 years, which is its highest level since at least 1995. In other words, demand for new vehicles could remain strong for many years to come.

In this scenario, investors in Ford can almost certainly sleep well at night about the safety of their dividend income.

But what if the auto cycle begins to tumble?

In my view, this is the biggest unknown - how Ford will perform in the next industry downturn.

Will the company's smaller manufacturing footprint and reduced labor force allow its auto segment to at least breakeven?

Will Ford's financial services arm, which is levered 10:1 with over $120 billion in debt and the lowest investment grade credit rating from S&P, face unprecedented challenges if some of its loans go bad (especially subprime)?

If I had to guess, Ford's operational improvements, reasonably healthy balance sheet, $10 billion in available credit lines, and improved cash management philosophy will be enough for the company to finally maintain its dividend during the next industry downturn.

That last point is important. Ford's current dividend policy was built to survive through a downturn. While management thought the same thing back in the early 1990s and was proven wrong, this time seems different.

The new and improved Ford is much more competitive and streamlined. The company's regular quarterly dividend amounts to roughly $2.4 billion per year, which is less than the annual dividends it paid in 2000 despite the company's much improved profitability today.

When times are good, Ford will reward shareholders with supplemental dividends instead of raising its regular payout.

The company paid a supplemental dividend of $1 billion this year and is on track for additional special dividends in future years, assuming vehicle sales remain stable.

Closing Thoughts on Ford's Dividend Safety

Dividend investors have experienced somewhat of a joyride with Ford over the last 40 years. The company has slashed its payout four times and even stopped paying dividends altogether twice.

Barring an unprecedented shock in auto loans' credit quality or some truly nasty combination of events (e.g. spiking gasoline prices, intensified marketing incentives / pricing pressure, total collapse in industry volumes), I believe Ford's regular quarterly dividend will prove to be safe.

However, after several decades of disappointment and potentially peaking industry conditions, it's no wonder why investors are hesitant to reward Ford's stock with a higher earnings multiple (currently trades at 6.3x forward earnings estimates).

To some degree, Ford is largely a "show me" story as management seeks to restore credibility with investors and prove itself during the next dip in vehicle sales.

While income investors will continue to be attracted to Ford's 5% dividend yield, this is still volatile stock that will get whacked during the next downturn - even if the dividend remains safe as I suspect it will. An investment at Ford is not for the faint of heart.

I personally prefer General Motors (GM), which I researched here.

What do you think? Is Ford's dividend safe? What needs to happen for Ford's stock price to rise?

Disclosure: I am/we are long GM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.