Ford's gradual acceleration - a teaser for impatient investors
Ford Motors (F), the second largest car manufacturer in the U.S., announced that it had beaten Q2 earnings by two cents. Ford also beat revenues by 4%. However, after the announcement, the stock fell by 1.2%. to values below $9, where it traded during the economic depression of 2009. The fall in the stock price came in light of the outlook provided by the company, which increased the loss from the European auto market from $500 million-$600 million to $1 billion for 2012.
With a weak U.S. auto sales recovery not providing enough cushion against the sliding European auto sales market, decreasing global market shares in passenger cars in an aggressively competitive market, currently declining operating margins and functional problems in its newly designed SUV that has forced the management to recall over 500,000 units from the market, the company does not have much to cheer about.
However, these factors have already been priced in the stock. Therefore, a gradual U.S. auto sales revival, restructuring in Europe, planned improvement in designing of its famous truck line, its increasing efforts to penetrate in the Asian market, and its strong financial arm, will surely help uplift the stock.
The European economy has been squeezed by the debt crisis, and auto manufacturers have been among those who have suffered the most from this development. Ford almost doubled its forecasted loss from the European market from $500 million-$600 million to over $1 billion.
The company generates its revenues from North America, Europe, Latin America and Asia. Following shows the geographical proportions for this quarter:
The chart shows that the company relies heavily on auto sales from the U.S. and Europe. The U.S. auto sales market has shown steady improvement, as the Seasonally Adjusted Selling Rate (SAAR) for the cars hobbles around the 14 million mark. The medial estimate for July's SAAR is also 14 million, which although was lower than June's sales, is 14.5% higher YoY, despite having two fewer selling days. This recovery has surprised economists, as the U.S. auto sales market has outperformed the economy, which is recovering a lot slower.
Given the strong customer base for Ford, along with its popular models, like the Ford Expedition, the company is expected to rebound once the U.S. auto recovery paces up. The U.S. Auto Industry currently employs 779,300 people, which is 9% up YoY and 24% up from 2009 employment levels. The current break-even point of SAAR is 10.5 million, which means that at this level of demand, an average auto manufacturer will be making no loss/profit. With the current level of 14 million, it is highly possible that an average auto manufacturer will be making profits in the market. This gives us some level of certainty for continued profits for Ford from North America.
The table shows sell-side expectations and the actual results. One can see that the U.S. has been the only region where the company has managed to increase its operating profits. The operating profits, currently 10.2% in North America, have improved in the region, as the company restructured its operations accordingly, when the Auto Industry suddenly collapsed in 2009. Another reason for high margins is the signature pick-up trucks of Ford, which are immensely popular in the U.S. However, Ford has not yet extended its sales outside the U.S.
On the contrary, profits in Europe and Asia have been absolute disasters. The turnaround in South America has also brought negative repute to the firm. Profits have declined because of increased competition where competitors are ready to provide heavy discounts, which Ford cannot afford to offer. Weakening currencies and adverse government policies have also played their part in ruining the company's profitability.
However, Ford has plans to change its current situation. The company will increase its production in North America by 3% during the next quarter. It is also expected that Ford will try selling its trucks outside North America, which will bring incremental sales to the firm. The company also plans to restructure operations in Europe, which have been discussed in detail below.
In Asia, the company plans to open nine new plants, six in China, two in India and one in Thailand. In this region, the Auto Sale Industry's growth has slowed down in the last year and a half. Nevertheless, the growth is positive, unlike Europe, and is expected to pace up in the next 6 months, as the local governments are actively implementing expansionary monetary policies.
According to Goldman Sachs, the company is expecting margin reacceleration of at least 1.4% in the second half of the year, as production capacity is enhanced in North America and newer models come in the market. They claim that this has not been priced in the stock. Their target price is around $13-$14 by the end of the next 12 months.
Market Share & Market Size
Increasingly competitiveness has also deteriorated Ford's market share throughout the world. The following chart shows the change:
The table shows that the company has lost its market share in every region of the world. The same factors apply here that are responsible for decreasing the profits of the firm. However, this is a serious concern as a decreasing market share means lesser sales, even if the Auto Sales Industry recovers to its pre-crisis levels. As stated before, the company is increasing its production levels in Asia to snatch a share from local competitors. The company is also thinking of introducing its truck line outside the U.S. The company's R&D is actively working to come up with new prototypes that can be successful in the market, and win additional customers for the company. In this context, the upcoming hybrid models of Ford are a good example.
Restructuring In Europe
Ford's operations are currently running at 63%. The company's practice of restructuring is not new. They are profitable in the U.S. only because they restructured promptly after the crisis hit the market. They also got rid of the Fiesta factory in Dagenham and divested the Jaguar, Land Rover and Volvo production lines. However, the CFO of the company, Bob Shanks, has not clearly stated how the firm is going to restructure its operations in Europe. It will be a mixture of a cost and revenue solution. They have already cut ad expenditure, shortened working hours in factories and fired some of the temporary workers in Europe.
However, it will be important to see how the management is able to fight off the powerful labor unions, and the sooner they do, the better it is for the stock. Meanwhile, they have increased the expected loss estimate to $1 billion.
- The company is planning to use aluminum in place of steel in its F-150 pickup trucks, one of the most popular trucks with farmers. This change will improve the mileage of the truck and make it eligible to be run on smaller and cheaper engines.
- 484,600 Ford Escapes Mavericks have been recalled from all over the world, as the newly designed model is suspected to have a certain throttle problem. If safety regulators find some serious malfunctioning, Ford will be heavily fined, as this problem has led to a couple of fire incidents and the death of a teenager.
- Ford is actively working on development of 'green cars'. Its Ford Fusion is expected to come on the road in 2013; the car is a special hybrid car that can be run on natural gas, gasoline and an electric battery. This will attract a lot of customers in case oil prices shoot up.
Ford recently paid off its debt, and successfully released its pledged assets. It has a solid dividend yield of 2.23%. The firm is not burning cash. Earnings are expected to rise at an annual rate of 11% for the next 5 years. Using a historical P/E of 10x (10 year median P/E is 8x and average is more than 30x), the stock is expected to trade at $18, using long term earnings. The stock has a fair chance to benefit from p/e multiple expansion as well as earnings growth.
Important to see will be how the firm tackles the streamlining of operations in Europe, the trend of margin improvement in the next half, and the outcome of the Escape SUV throttle problem. Trading at cheap valuations, this stock is recommended as a buy.