If Investors Don't Buy Ford, The Company Will Buy Itself Back

Jun. 8.12 | About: Ford Motor (F)

Investors have been very skeptical of Ford (NYSE:F) despite its strong balance sheet, improved credit rating and impressive cash flow. The company's performance in the stock market is strongly tied to performance of S&P. It looks like no matter what Ford does, it is unable to beat the market. Of course, this discourages many of Ford's investors, leading them to sell their Ford shares.

These days even good news regarding Ford is being treated like bad news. The company announces strong sales, the stock price plunges by 3%. The company's credit score gets upgraded, the stock price plunges by another 2%. The company increases its future forecasts, the stock price keeps falling and falling. It's really difficult for Ford investors to live through all this and stay upbeat about it.

Even if one were to ignore all the numbers and statistics, one would still be bullish on Ford given its upper management. Ford has a great CEO and one of the smartest boards among blue chips. The company has been taking the right steps in the right direction for a while now. Still, no matter what Ford does, it never seems to be good enough for many investors.

Ford is expected to earn $1.46 per share this year and $1.71 per share in 2013. The company will continue to post growth for the rest of the decade as developed nations are buying their first cars and developed nations are replacing their old cars at a rapid rate. At $10.55 per share, the company is looking at a P/E ratio of 7 by the end of the year and 6 by the end of next year. Before anyone says "but this is much higher than this year's P/E ratio of 2" let me remind you that Ford's exceptionally low P/E ratio of 2 reflects one-time tax benefit it received this year. If we ascribe Ford a conservative P/E ratio of 10, we are looking at a share price of $14.6 this year and $17.1 next year. In a perfect world, Ford would trade for at least these amounts, but what if it doesn't?

Ford is currently saving up cash and the company's cash reserves will continue to grow as its debt will continue to shrink for the medium and long term. Currently, the company has nearly $4 of cash and investments per share. If the company continues to remain dirt cheap for the next couple years, a CEO like Alan Mullaly won't just sit there and watch it. If the company's cash flow continues at its current rate and the stock price remains flat, the company can easily buy about 30% of its outstanding shares back without any trouble by next year. Obviously, this would add great value to each share held by investors. I don't really expect the company to buy a large chunk of its shares all at once, however I expect it to reduce the number of outstanding shares by about 5-10% annually if the company's stock price remains flat in the long term.

At the end of the day, it's a win-win situation. Either Ford's stock price will improve by itself, or the company will buy-back its shares in order to raise value to its investors. Either one of the two options is inevitable because Alan Mullaly's team is committed to returning value to shareholders. This is why the company reinstated its dividends this year.

Furthermore, this year Ford will be able to refinance a significant portion of its debt, thanks to its much improved credit score. I would be really surprised not to see Ford's dividend rate going up within the next year or so. Currently, the company pays 5 cents per share, whereas it earns more than 40 cents per share in average. The company could easily double, or even triple its dividend rate without being hassled.

The biggest threats in front of Ford in the short term are slowing economy in Europe and the potential of material costs to increase. The slowness in Europe can be easily offset by strength in Asia and North America. Also, material prices have been coming down lately, which will be beneficial for Ford.

I am bullish on Ford. In a perfect world, Ford's shares would be worth way more than what they are sold for today. We are not in a perfect world so Ford is worth as much as investors think it is worth, however, if it stays this cheap for long, the company will take advantage of the situation rather than sitting and waiting. At the end of the day, Ford doesn't really have a need to sit on excess cash.

Disclosure: I am long F.