With Ford (F) trading at a respective 2.1x and 6.2x past and forward earnings at a price target nearly 50% above its current price, value investors are undoubtedly eyeing the company. Ford was able to survive the depths of the auto crisis without handouts and is led by a top management team. Better yet, management has already delivered impressive free cash flow: $5.5B in FY2011, or an incredible 13.5% of market value. To put this into perspective, consider that in four years, the company will have generated enough operating cash flow to justify the current valuation.
In this article, I will run you through my DCF model on Ford and then triangulate the result with a review of the fundamentals against General Motors (GM) and Toyota (TM). I find at least 50% upside for the firm, similar to other analysts.
First, let's start with an assumption about the top-line. Ford finished FY2011 with $136.3B in revenue, which represented a 5.7% gain off of the preceding year. I model 8.7% per annum growth over the next half decade or so - a figure that is below what is expected for the S&P 500.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses and capital expenditures. I model cost of goods sold as 85% of revenue versus 8.5% for SG&A, and 3.3% for capex.
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering over 0% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 12% yields a fair value figure of $16.57, implying 55.3% upside. If the upside dips to 10%, the stock would double. The market seems to be factoring in a WACC of 17%, which is much too bearish (especially in the perpetual growth period.) Accordingly, Ford has excellent risk/reward and merits the "strong buy" recommendation on the Street (ratings source: NASDAQ).
General Motors also receives a "strong buy" recommendation on the Street. It trades at a respective 6.5x and 4.9x past and forward earnings. Consensus estimates forecast that EPS will grow 43.6% to $5.57 in 2014 from 2011. Assuming a multiple of just 9x and a conservative 2013 EPS of $4.52, the stock will gain 81.9%. It would take a multiple of 5x to get the company to stay flat over the next three years at that conservative 2013 EPS estimate. By that time, the economy will have already hit full employment and the auto sector will be operating at normal levels. Negativity can only last so long under a full recovery, thus strengthening the bullish thesis for Ford and GM.
Toyota is in a very different situation, obviously, than Ford and GM. As a result, it trades at normal levels with a forward PE multiple of 17.8. For Ford and GM to trade at well below half of that level speaks volumes to behavioral anomalies. Consensus estimates forecast Toyota's EPS declining to $2.12 in 2012 before hitting $6.61 in 2013. At a multiple of 14x and a conservative 2013 EPS of $6.58, the stock would hit $92.12 for 17.2% upside. According to NASDAQ, the stock is rated as a "hold". In total, I expect to see auto investors shifting from Toyota and into Ford and GM as the domestic economy improves. Those willing to take on the increased risk for backing two iconic American companies will be lucratively rewarded.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.