There has been a lot of debate on whether Ford (F) or General Motors (GM) is the better investment. Prior to this article, I made a valuation of both companies, and while I find both companies to be attractive investments, I would like to make a direct comparison to find the company that can offer the best future return on investment. Therefore, I analyzed both companies through 5 metrics that I believe are very relevant to the valuation process.
1. Operating margin: General Motors
Ford reported an operating margin of 6.3% in the first half of 2012, while General Motors reported an operating margin of 3.8%. However, these margins are not really comparable, as the large lending operation of Ford (Ford Credit) inflates the operating margin, and General Motors reports its joint-venture in China as equity-income (which isn't included as operating profit). For GM, this means that the high margin and nice growth rates aren't reflected in the operating results. In the table below, you can see the revenue for the joint ventures, the net income, and how much of that income that belongs to General Motors.
|Joint venture (millions)|
Investee net income
General Motors "equity revenue"
General Motors equity income
By adding the revenue and net income from the joint ventures to the revenues and operating profit of the automotive operation, I have come up with an adjusted operating margin for General Motors of 6.4%. By removing the effect financial operations have on the margin, I ended up with an adjusted operation margin of 5.9% for 2012. For Ford, however, the adjusted operating margin is only 4.75% for 2012.
2. Sales to revenue ratio: General Motors
However, we cannot use the operating margin as the only financial ratio in a valuation. We need to combine it with another metric; the sales-to-price ratio, which tells us how much we pay for every $1 of revenue. The sale to price ratio of Ford using my expected 2012 results is 0.21, while the sale to price ratio of General Motors is 0.195. So even though the automotive operation of General Motors has an adjusted operating margin, its revenue is also "cheaper".
3. Future earnings expectations: Tie
By using the 5-year earnings estimates from analysts, it doesn't look like there is a significant difference between the two companies. According to Yahoo Finance, Ford is expected to grow by 10.45% over the next 5 years, compared to the 11.92% of GM. Morningstar has slightly different numbers, as they expect Ford to outgrow GM by 10.5% to 13.8%.
4. Most profitable lending operations: Ford
In my DCF valuation of Ford, I didn't separate the lending operation from the automotive operation. In my valuation of General Motors, I tried to do that, but I used what I now believe to be an inefficient way of valuing the operation. Today, I don't believe that you can value a lending-operation like a bank, Ford Credit, or GM Financial through a free-cash-flow technique. Therefore, I have come up with a new valuation technique. This method relies upon estimating the net earnings of the operations, and deducing the earnings by the cost of equity. For Ford, I estimate that income will rise by 5% y/y, and I use a cost of equity of 15%. For GM, I estimate that earnings will rise by 10% y/y, and I use a cost of equity of 17%. You can see the results below:
As you can see, Ford will only obtain excess returns until 2014. The negative excess returns (from 2015-2017) are ignored in my calculations, as I believe management will avoid non-profitable investments. General Motors, however, will be profitable until 2017, and after 2017, I assume that ROE = Cost of equity.
This means that the value of the lending operations can be calculated as: Sum of the PV of excess earnings + Book value. According to that formula, Ford Financial is worth $9,413 million, which is equal to around $2.70 per share, while GM Financial is worth $2,950 million, which is equal to $1.80 per share.
5. Net debt: Ford
I define net debt as: "Long-term-debt" + "short-term debt" +" unfunded pension liabilities" and other "retirement benefits" - "Total Cash".
As can be seen, Ford actually has a positive net debt, while General Motors will need to use some of its future earnings to pay off debt.
Having calculated the net debt per share and the value of the lending operations per share, I can calculate the adjusted sales-to-price ratio:
Ford is now significantly cheaper, and trades at a ratio of $0.19/revenue, but GM is also slightly cheaper as it trades at an adjusted sales-to-price ratio of $0.205. However, GM has a slightly better adjusted margin, so my conclusion is that they are equally cheap.