A Stock Pick That's Built Ford Tough

Ford Motor Company (F) designs, manufactures, and sells cars and trucks worldwide. We like Ford shares and not only because it is somewhat contrarian.

First off, the bear case on F shares is certainly well known. Ford has posted significant losses in North America and sales of its marquee and most profitable F-series and Explorers have been waning. Domestics continue to lose market share to Toyota and pension and healthcare costs represent a major obligation and considerable cost per vehicle. Specifically, the "legacy cost" per Ford vehicle is approximately $2,000 to $2,500, which compares to $500 at Toyota, leaving Ford with a $1,500 to $2,000 cost disadvantage per vehicle. That difference is huge, as it is money that could be spent on improving fuel economy, safety, and quality or on the hefty incentives.

However, don't let this issue keep you from Ford shares. There are plenty of companies in other industries that compete effectively while dealing with the same problems. For example, AK Steel (AKS) never shed its pension and benefit costs in a bankruptcy like most of its competitors, but its shares are doing very well. The same example holds true in the airline industry.

Despite all the negatives, we like Ford. There is finally a good management team in place with Mullally at the helm. To us, Jacques Nasser was the real problem. Frankly, Jacques went on a spending spree (buying Volvo, Range Rover and others and even non-core businesses like automotive salvage yards and repair shops) and Ford lost its focus. The company's quality suffered and it went through the whole Firestone tire issue that damaged consumer sentiment. We believe Mullally and his team will help restore consumers’ attitudes going forward.

Not only has Ford been misguided with bad management, but the company has been impacted by the secular change in gas prices. Historically, the company benefited from low gasoline prices, especially considering its focus on larger vehicles. However, the upturn in gas prices has prompted a significant decline in Ford’s North American sales of trucks and SUVs. Nevertheless, in light of the change, we believe Ford has successfully shifted its focus to smaller, more fuel efficient vehicles, while maintaining its dominance at the large end of the market. In particular, the company has introduced many new, more fuel efficient designs, including the Mariner, Edge, Fusion, MKZ, MKX, Escape, Taurus, Milan, and all new Mazdas. These platforms are evidence of the shift in consumer preference and should help in the market share battle going forward.

Ford’s restructuring program is also tracking (albeit launched after GM (GM)) and should eventually restore profitability. As part of the restructuring, Ford has done a great job of cutting its labor force, negotiating with its union on major issues, and shuddering excess capacity. Finally, Ford stands to benefit as much, if not more than GM et. al, from a new UAW agreement. Specifically, Ford is in a MUCH better position than GM related to the widely expected ratification of a healthcare trust account, dubbed the voluntary employee beneficiary association or VEBA.

The VEBA will be initially funded by the Big 3 with cash and/or stock contributions in order to lift the significant healthcare obligations off their balance sheets, which should help narrow the cost gap with Toyota and result in improved stock prices and higher credit ratings.  GM, Ford and Chrysler have a combined unfunded retiree health care obligation of more than $90 billion!  GM's unfunded obligation is more than half the total at $51 billion.  As such, it is unclear whether GM has adequate liquidity to fund the trust; some analysts believe GM will have to sell stock in order to raise sufficient capital.  This is not the case with Ford, as Ford has $40 billion in cash on hand to fund the trust.  Moreover, Ford still has the “asset sale bullet” in its “liquidity gun”, since GM has already sold major assets such as a stake in its GMAC finance unit, whereas Ford is still expecting to get more cash from the sale of its Jaguar and Land Rover units later this year. 

In short, Ford shares should see a nice bump subsequent to a new UAW deal that includes a VEBA or similar instrument that helps shed benefit obligations.  Anecdotally, Goodyear’s stock rallied from $15 to nearly $40 after implementing a VEBA as part of its new union deal at the end of 2006.  

In conclusion, the new management team, shift in focus, restructuring program, and new union deal should help restore Ford's profits.  We also like the international growth potential in China and other emerging markets.  Anecdotally, we view the recent Chrysler-Cerberus deal as evidence that the Ford story is viable.  Chrysler has all the same problems as Ford and a weaker brand.  Yet, Cerberus bought in for the long haul. Further, we like F shares better than GM, due to less brand confusion, fresher products, and a better management team. We see support for Ford shares at the $7-8 level and thinks the recent rally will continue into 2008. We have a contrarian view on this stock versus the Street, as we believe Ford will be a major player within what we now consider the "Big 6" going forward.

Comments

[Finelady:]

I agree, I bought a new Ford Focus last year and love it. I have been buying little chunks of F stock for the past few years. I think there stock is an excellent buy if you can hold on to it for awhile. I don't see Ford going belly up and at $7 to $8 per share I think it could easily triple in the next 3 to 4 years. If they get back to Henry Ford's values and continue to be innovative I believe they will do well. I'm a strong believer in buying American cars and supporting good American companies. I loved the great information you posted Dominic, it makes me even like my choice better.

2007 Nov 01 09:27 AM