Ford (F) is holding its place as the No. 2 automaker in the U.S., behind only General Motors (GM). The automaker just announced a joint venture with Dow Automotive Systems, a subsidiary of Dow Chemical (DOW), to develop methods of using carbon fiber in mass produced vehicles cost-effectively, with a goal of reducing average vehicle weight by 250-750 pounds. This could help Ford meet the 2016 and 2025 CAFE targets for improved fuel economy, and I believe that it will also help boost sales in the U.S. based on cost of ownership considerations for both gasoline-driven and hybrid/all-electric vehicle power trains, pushing up the stock price.
Ford is cementing its overseas efforts to build market share in the BRIC countries with mixed success. The Ford Focus was named Russia's 2012 Car of the Year for its class, but in order to be impressive Ford needs to win over the China market. So far Ford is coming up short, with sales falling 16% in the first quarter of 2012 compared to the first quarter of 2011. While this news did not have any immediate impact on the stock price, I am somewhat concerned about this because demand in China, the biggest global market by volume and potential, remains strong. With consumers in the U.S. market holding on to cars longer, Ford will have to take steps to win over Chinese auto buyers to continue increasing revenue and support expectations for increased growth. Ford has taken steps to do so with plans to expand its manufacturing center in Chongquing to increase production capacity by 63%, from 350,000 vehicles to 950,000 vehicles annually. This expansion is expected to be complete by late 2014.
In 2011 Ford moved 520,000 vehicles in China, compared to 846,000 for Toyota (TM) and 2.5 million for General Motors. General Motors' total includes sales under the Chevrolet and Buick marques, and it's worth noting that as China enters into new-found prosperity, Buick retains a mystique among consumers as a true luxury vehicle -- going back to its initial introduction to this country immediately after China joined the World Trade Organization. As a newcomer to the Chinese market, Ford faces an uphill battle comparing its luxury brand, Lincoln, with the established reputation of Buick in consumers' minds. Though such vehicles will remain out of reach for the majority of Chinese consumers for years to come, the sheer number of consumers who can afford the vehicles makes Lincoln's placement in the Chinese luxury segment a critical consideration.
In the U.S. there is growing consumer anticipation around the all-new Lincoln MKZ and the announcements that Lincoln will be redesigning its existing fleet as well as adding several new vehicles in the coming years. However, Ford is still propping up Lincoln as a luxury brand while it works on reconfiguring the marque into a desirable vehicle. Ford faces headwinds with this in the U.S., though for different reasons than discussed above. U.S. car luxury buyers tend to avoid Lincoln due to a reputation of mismanagement. Yet Ford has made it clear that it intends to focus on Lincoln as its luxury brand. Its efforts have not yet come to fruition, though Lincoln sales did remain flat in 2011 at 85,643 units. BMW, the No. 1 selling luxury brand in the U.S., sold 247,907 cars in 2011. BMW also beat Ford to the carbon fiber body, as it's already using the composites in its M3 overseas and announcing its implementation in the next i3 and i8 models. With Ford still developing this technology, the impact that the announcement will have on sales and stock price will necessarily be lessened if they are last to market.
Ford estimates that in all markets, large and medium vehicle sales will continue to decrease while small vehicle sales increase, which is in line with the expectations of most analysts and consumers. Ford sees a higher profit margin on larger vehicles (130% of total average contribution margin across the fleet, compared to 70% for small vehicles). Nearly 66% of Ford's annual U.S. sales are from light trucks. Ford needs to maneuver its smaller vehicles into consumers' minds as a top buy, especially in the U.S. where Toyota and Honda (HMC) continue to chip away at the light truck market after solidifying their reputations as small car makers.
In the long term, Ford faces competition not just from Toyota and Honda, but also from Chinese and Indian manufacturers who have their eyes on the U.S. market. Already facing downward pressure on prices because of the recession and continued restrictions on credit to consumers, even through its own financing arm, I think that Ford will have trouble fighting off the advances of multiple additional automakers. There is demand in the U.S., but it is being overridden by economic fears. If the U.S. overcomes its economic hurdles to the point where consumer confidence returns, Ford stock stands to benefit in a big way if the company can compete on cost and cost of ownership.
In March, Ford extended the maturity date of $9 billion in revolving credit obligations from Nov. 30, 2013, to Nov. 30, 2015, partly driven by a need for liquidity to free cash flow and finance its One Ford Plan. The One Ford Plan -- begun in 2008 to consolidate brands, product development, processes and suppliers on a global scale -- could save it billions in research, development, and manufacturing costs in the coming years, which is an attractive proposition. It's worth noting that most of this $9 billion is related to obligations incurred during the financial crisis as Ford avoided government funding.
A major recall on the Focus announced in early April due to passenger side windshield wiper malfunctions that could possibly increase the chance of accidents is hopefully limited to the initial vehicles identified, and will not be expanded as several recent recalls from Toyota and Honda have been. Focus remains Ford's best selling vehicle worldwide and I believe that a serious safety-related recall -- such as those from 2009-2011 affecting nearly 15 million vehicles Toyota is still struggling to recover from -- could push Ford's stock price down below its recent average and dampen any chance Ford has of meeting its near-term goals. Toyota was hit hard by the safety recalls related to the faulty brake pedals and has still not recovered production levels since the March 2011 earthquake and tsunami in Japan.
Ford is currently trading at around $12 per share with a market cap of 45.88 billion. It has a P/E of 2.4, compared to an industry average of 8.6 and a price to book value of 3.1 in line with the P/E, behind Honda at 1.2 and Toyota at 0.9. Though the automaker faces many challenges under the leadership of Alan Mulally, I think that the P/E is an overly negative assessment of the stock's prospects for growth. Yet I do not believe that Ford will be able to meet its self-set goals without a massive effort in the coming years. The price to cash flow is 5.0, below the industry average of 6.3, but reflects a better interpretation of the stock's strength. I think that Ford is undervalued, and a reasonable fair value based on market conditions would be around the $17 mark, making Ford a solid buy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.