Why Ford Is An Attractive Investment Idea But Requires Patience

| About: Ford Motor (F)

Ford (F) reported another mixed quarter last week. For the second quarter, the firm saw adjusted earnings fall 39% to $0.30 per share, $0.01 greater than the consensus estimate. Revenue fell 6.1% to $33.3 billion, about $1.1 billion more than consensus expected. Woes in Europe and Asia continue to hamper the firm's profitability, but we remain confident CEO Alan Mulally will be able to navigate difficult conditions abroad and improve the firm's global cost structure. Our valuation remains unchanged. Please click here to view our valuation reports.

The firm's second quarter results confirm the fantastic turnaround we've been witnessing in its North American operations. Revenue grew only about 0.1% to $19.7 billion. However, the segment posted record pre-tax profitability of over $2 billion, representing growth of 5% year-over-year. Operating margins in North America increased 40 basis points to a record 10.2%. Ford ONE has increased operating efficiencies and the leaner, meaner Ford seems on track to reach its long-term operating margin goal of 8-10%.

Market share, however, declined to 15.4% during the first half of 2012 from 16.5% for the first half of 2011. We think the main drivers of this market share loss are increased competition, stronger-than-anticipated recoveries from the Japanese manufacturers, and a lack of new product launches in the first half. We anticipate new products will drive some market share gains. Though we'd like market share to be higher, we'd rather Ford focus on profitable growth rather than taking share at the expense of earnings. The firm raised its full year outlook for SAAR to 14.5-15.0 million units.

Ford Credit has posted a $900 million profit so far in 2012, and management expects the segment to achieve its $1.5 billion profit target. Revenue has fallen slightly year-over-year to $1.9 billion, but we've previously noted that profitability will accelerate when the firm starts to lap more lease terminations, specifically in 2014 and beyond.

Europe was weak, and the region is on track to sell only about 14 million cars this year. Revenue in the region fell 21% to $7.1 billion, and the firm posted a pretax loss of $404 million. The company also forecasts losses in Europe of over $1 billion during 2012. Management was forthright in not only blaming the economy, but also taking blame for the region's cost structure. Overseas expansion of the Ford ONE platform should help lower hurdles for breakeven, and the introduction of new products should help boost market share gains. Mulally acknowledged more intense competition from Korean manufacturers as a negative for the industry, but he also seems optimistic that the firm will be able to reduce capacity. Ford's much healthier balance sheet should allow it to absorb losses while it works out a profitable business model in the region.

Asia Pacific and Africa grew revenues 9.5% year-over-year to $2.3 billion, but posted a loss due to investments and higher costs in the region. Management expects profitability to improve in the second half of the year thanks to higher pricing, new products and a favorable product mix. Ford still has a relatively small product mix in China, and we expect growth to accelerate in the region as Ford covers a greater portion of the market. Mulally noted that Ford will now cover 65% of the Chinese market (was 30%).

Ford's results have been disappointing to us this year. Though we think the firm is undervalued at current levels, the automaker faces a tough road ahead. Competition continues to intensify in the US where consumers have reacquired a taste for new vehicles, and the company is in poor shape in Europe. However, the firm has just scratched the surface of growth in Asia and will be releasing some exciting new products in the back half of 2012 in North America.

With the annual dividend yield approaching 2.25% (click here for its dividend report), an improving balance sheet and a focus on reducing its cost structure, we think Ford is one of the most attractive long-term investments in our coverage universe. Yet, we see plenty of challenges ahead, and barring an economic miracle in Europe, convergence to our fair value will take some time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: F is included in the portfolio of our Best Ideas Newsletter.