Introduction
The automaker Ford Motor Company (F) is currently trading at close to a 52 week low, and while I don't believe Ford is exactly a fantastic company (as margins are relatively low), the price you pay for this company is too low given its future expected free cash flow.
Methodology
In this analysis I will value Ford through a discounted free cash flow model. I use the same approach as when I valued Procter & Gamble. I estimate 5 factors:
- Future revenue growth
- Adjusted operating margin
- Tax rate
- Sales/capital ratio
- WACC
The future revenue growth and adjusted operating margin are estimated by a detailed analysis of the operations of the company, historical growth rates and estimates by analysts and management.
The adjusted operating margin is calculated as: Accounting operating margin + depreciations, as depreciations are purely an accounting number and not particularly relevant in valuation.
To calculate the free cash flow I deduct the capital that the company invests each year from the operating profit. I estimate this amount by assuming an appropriate sales to capital ratio the company will obtain in the future, where capital is calculated as Equity + Debt - Cash + accumulated depreciation.
This ratio tells us how much revenue the company generates in relation to how much capital (both working capital and long-term capital) the company has invested. A capital to sales ratio of below 1 tells us that for each $1 invested in capital, revenue rises by an amount less than $1.
The tax rate is typically set equal to the historical effective tax rate, and WACC is calculated through the CAPM method.
Revenue and operating margin
Click to enlarge.
Sources: Morningstar.com, Annual reports, own calculations.
Sources: Morningstar.com, Annual reports, own calculations.
2012: Revenue declined slightly in Q1 2012. Management has not reported their revenue estimates for 2012, though they expect operating margin to improve slightly. I estimate that revenue will decrease by 1%, and operating margin will improve to 10%.
2013 and beyond: From 2002 to 2012, revenue has decreased by 1.25%. But I am a slightly optimistic, and therefore I assume that they can grow around 4% on a yearly basis. In the terminal period they will grow with the risk free rate of 2.5%.
The historical average operating margin has only been 9.83%. Best case is that they return to pre 2006 margins, though that is relatively optimistic. 9% seems like a decent conservative estimate for 2013-2021 and in the terminal period.
Sales to capital ratio
Sources: Morningstar.com, Annual reports, own calculations.
The capital is calculated as Equity + Debt - Cash + accumulated depreciation. This ratio tells us how much revenue the company generates in relation to how much capital (both working capital and long-term capital) the company has invested.
For 2012 management expects capital investments of $5.5 billion. Depreciation was last year $4.2 billion, and I am assuming a similar amount in 2012 (which means that accumulated depreciations does not change). This is equal to a capital to sales ratio of 1.29
2013 and beyond: The historical average sales to capital ratio is 1.16, and the ratio has actually improved since 2007, as the reported book value of the assets has decreased by a higher rate than the decline in revenue. I assume that the future sales to capital ratio will return to the historical average (of 1.16).
WACC
In the calculation of WACC I make the following assumptions:
- Tax rate of 27%
- Beta of 2 (Google Finance reports a beta of 2.4 and Yahoo Finance reports a beta of 1.8, but I am using a beta of 2, as I think Ford is a less risky investment today than a couple of years ago).
- Interest after tax of 3.12%
- Risk free rate of 2.5%
- Market premium of 7.7%
This gives me a WACC of 7.94%.
Value of Ford Motor Company
As can be seen in the below table, Ford is undervalued by around 20% according to my estimates. The biggest uncertainty in this valuation is the operating margin. An operating margin of 8.5% (from 2013 to 2021 + terminal period) makes Ford Motor Company fairly priced, and anything below makes it expensive. So even though a margin of safety of 20% seems like a lot, it may not be enough for the cautious investor.
| Terminal value | 145955 |
| PV(Terminal value) | 64559 |
| PV (CF over next 10 years) | 32333 |
| Sum of PV | 96891 |
| Debt | 99689 |
| Cash | 48604 |
| Value of equity | 45806 |
| Number of shares | 4058 |
| Estimated value /share | 11.29 |
| Price | 9.17 |
| Price as % of value | 0.83 |
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
