Ford Shareholders Face High Potential for Pain

Volkswagen AG (VLKAF.PK), PSA Peugeot Citroen SA (PEUGY.PK), and Fiat SPA (FIATY.PK) beat earnings estimates in the last week. At the same time, however, Ford Motor Co. (F), one of the largest industrial companies in America, missed earnings estimates.

By a lot.

Indeed, the Wall Street consensus called for Ford to lose 27 cents per share; instead, Ford lost 62 cents per share. Even though Ford outperformed in its European, South American and Asia-Pacific operations, the massive undertow of its U.S. operations was just too much to overcome.

That’s not really a surprise, you see, since auto sales in the United States are the weakest they’ve been since 1993, reports J.D. Power and Associates.

U.S. auto sales have been shot down by three key factors:

• The negative wealth effect of the U.S. housing market.
• The credit crunch for the last year or so.
• And, lately, the meteoric increase in the price of oil and gasoline.

All of these detract from consumer wealth and purchasing power even as they weaken the general economy.

But there’s an additional catalyst for Ford’s malaise: While economies of scale in the car industry are very important and volume is critical to keep manufacturing costs down, compensation for Ford’s work force is problematic.

For decades, Detroit’s “Big Three” – Ford, General Motors Corp. (GM) and Chrysler Corp. (now Chrysler LLC) – which once ruled the worldwide auto industry, have been losing their leadership. Call it the typical story of success sowing the seeds of destruction.

With their global dominance of the auto industry, the U.S. Big Three grew complacent and, despite their market and technological leadership, fell into the trap of granting overly rich compensation-and-benefit packages to their work forces. How rich? The pension plans were super-generous and the health-care plans required no co-payments from workers.

Then came the double-whammy that put the U.S. auto sector on a path to destruction: U.S. health-care costs ballooned and carmakers watched their work forces age, forcing the automakers to assume a massive cost burden – one that they ultimately couldn’t afford.

By 2000, in fact, that cost burden was so huge that the companies were no longer making money from automobile production; any profits they were reaping actually came from their auto-financing arms, which finance auto sales.

These longer-term trends left Ford and GM in a highly vulnerable position. And it likely blunted innovation and kept the companies from quicker development of hybrid vehicle lines.

Then came the energy bubble.

The meteoric rise in the price of oil has put an already heavily cost-burdened U.S. auto industry in a near-panic-mode situation, since customers have shifted away from Detroit’s line-up of trucks and sport-utility vehicles to smaller, more-fuel-efficient cars and hybrids offered by Japanese rivals.

With Ford, at least, there has been major progress on the cost-cutting front. In the first quarter, under the leadership of Chief Executive Officer Alan R. Mulally, the very able engineer who turned around The Boeing Co. (BA), Ford was able to secure a new contract with the United Auto Workers Union that allowed for reductions in 20% of personnel. This allowed Ford to start the process of discontinuing unprofitable models without having to keep the workers employed.

At the same time, Ford announced cuts of another 4,000 employees in the most recent quarter, and is in the process of starting another round of layoffs of some 15% of salaried personnel.

Ford opted to cut loose Land Rover and Jaguar to raise cash and improve profitability. It’s launching new, fuel-efficient cars and has dramatically improved the quality of its products – especially its cars.

To deal with the recent effects of the economy, it has postponed the launch of its redesigned F-150 pickup truck, which has been the industry’s standard-bearer for decades. That’s a huge move, given that the Ford pickup truck is an icon in the industry with consumers, collectors, and even hot rodders – and has been for generations — reaching all the way back to the Ford Model T and Model A trucks of the 1920s and 1930s.

Managing liquidity and maintaining enough cash to complete the restructuring plan is a big challenge for Ford, given shifting market tastes and the highly uncertain economic environment. Should the company successfully navigate these dangerous financial straits, Ford’s stock will likely enjoy a major increase, generating huge capital gains for current stockholders.

But there is a significant probability that the company’s equity holders will get wiped out and the bondholders will end up owning the company. This reality is reflected in the upfront cost of almost 30% in credit insurance needed for certain Ford obligations.

Therefore, while Ford’s restructuring plan seems to be moving forward well and even accelerating in pace, and Mulally has distinguished himself with his execution, the unpredictability of oil prices and the slow resolution of the housing crisis ahead makes this stock very speculative. I cannot recommend it without warning that Ford shareholders must accept a large degree of risk and accept the potential for some pain.

A much better play, yet also with the potential for pain, is to look for convertible debt, with the view that even in a restructuring, bondholders will end up owning the company and capture the huge upside that this franchise will have once it finishes dealing with its problems and is able once more to competitively deliver the high quality products that it was known for.

Action to Take: BUY Ford Motor Co. (but as a highly speculative position). This once-great U.S. automaker may once again find its way, but possibly only after the bondholders end up owning the company. If you are going to buy Ford shares, keep the position small.

A BETTER BUY: Ford debt, especially senior convertible issues.

Original post

Comments

[Ben Around:]

The writer failed to mention his position in Ford stock. I assume he is short.

He failed to include the class B shares held by the family and the fact that a bankruptcy would wipe them out. He also forgot about the 6.5 mil shares held by Kerkorian.

I look at Ford as a long term buy with a very low probability of a chapter 11. The issue is to find a good entrypoint. I would expect to see F test the 4.5 point in the future and that would be a good time to buy and hold.

2008 Jul 28 08:49 AM

[hernje:]

Once again, another corporate elbow rubber,posing as an independant columnist, blames the common man ( and his extravagent compensation),for the demise of a " once great" compay. Truth of the matter is Ford and Chrysler's downfall is directly attributable to management's conscious decision to shortchage the consumer on product quality, in order to maximise profits. This shortview management style has been prevalent, with American CEOs for decades. Only problem is, the consumer eventually wakes up and realizes how he's being taken and moves on to a better product. (Toyota and Honda) I was longtime holdout, with the "Buy American" mantra burned in my brain. I eventually broke down and bought a Honda, in 2003. My biggest regret is not buying one years sooner. The difference, in reliability and quality, was extremely noticeable. I'll never go back to the greedy unscrupulous American car makers. Besides, with the numerous Honda and Toyota factories, now in the U.S.A., I am still "buying American".

2008 Jul 28 09:05 AM

[george flood:]

I can appreciate this conservative view point, and
believe timing is everything and this is behind the curve.

2008 Jul 28 10:31 AM

[jenny:]

Agreed, hernje. Companies like Ford and Chrysler began to focus on quantity not quality- an mantra that is inevitably destructive to the consumer. I think a lot of these consumers have woken up to realize that "Buying Ameircan" isn't all that patriotic. On the other hand, Ford's restructing plan does seem to be moving forward, making the best of the situation at hand. Under Mulally, F has been able to make changes at a swifter pace. Indeed this stock is highly speculative, but timing could be everything here. Just a week ago sentiment was extremeley bearish (predictwallstreet.com/...) and has now shifted into bull territory. I overlay the quote on the sentiment graph at PredictWallStree.com to to see if sentiment is preceding the price or vice versa. F price dropped this morning but it seems sentiment has barely budged. Perhaps consumers are keeping high hopes for this beloved American company. I'm interested to see where sentiment is at the end of the week.

2008 Jul 28 12:35 PM

[Gumby:]

It is really about someone's liabliities against any security. There is always a bunch of guys who dont want to see Ford go up as it will steal from other company' capital bases that the bunch of guys like better. That bunch of guys is just not interested in the whole Ford story as it is unfolding in the present and future. They want Ford out of the way no matter what.

2008 Jul 28 01:30 PM

[notsosmart:]

everybody has an agenda.believe nothing & nobody.think for yourself. lying has no penalty attached to it anymore.from the pres of the usa to the ceo of a corp. to many in the media,truthfulness & honor are unknown. nothing matters but the bottom line no matter how you get there. any wonder a whistleblower re illegal or unethical conduct has to be protected by law.

2008 Jul 28 02:46 PM

[kurt walter:]

Ford shareholders have already been crushed.

2008 Jul 28 07:45 PM

[fordf150null:]

if we could outlaw unions in america, recovery could begin.

2008 Jul 28 07:52 PM

[Kunst:]

hernje: Truth of the matter is Ford and Chrysler's downfall is directly attributable to management's conscious decision to shortchange the consumer on product quality, in order to maximise profits.

Truer words were never spoken. But you need to include labor in this equation too. Like management, they fed on the body of the beast until there was nothing left.

2008 Jul 28 11:27 PM

[ggillin:]

Mr. Marquez, I only agree with a small part of your remarks here.
I agree that buying Ford common is so risky that it is a fool hearty gamble at best.
I disagree strongly with your statement advising investors to buy Ford convertible issues. It would be nothing short of a miracle if any of these issues ever payoff at 100 percent, more likely .05 to .30 cents on the dollar at best and that's only for the most senior backed issues. The realistic truth is that any issues that are going to survive and pay 100 cents on the dollar AND all due interest in arrears are all locked up by the banks and none, not even one, will trickle down to the average investor who reads this column. Only the public 'retail' dept is out there and that is going to get wiped out, or nearly so.
You wrote your article but you did not give any mention as to what issues (coupons/dates) Joe. Q. public should be looking for. Interesting. Joe. Q. public, get smart this time, STAY AWAY, let the big boys eat their own mistakes For(d) once.

2008 Jul 29 12:26 AM

[hernje:]

Kunst: Point well taken. I feel you're accurate in your assertion, especially considering the fact it was'nt until just recently the U.A.W. accepted contract concessions. However, if pressed, I'd apportion blame this way: Management-70% ; Labor- 30%. Afterall, management, always, has the final say.

2008 Jul 29 12:34 AM

[PhillyD:]

Management doesn't always have the final say when Unions hold them up at gunpoint AND judges/courts back their play!

That said, Ford cars have always been thought of as lesser in quality and I'm 49 years old from the North East. I moved to Michigan two years ago and cannot believe how the unionized mentality that management (or any leader) is always wrong and how dare he/she make any changes. "We've never done it that way before!" is the leading mantra of Detroit.

Companies have been destroyed and lives are being destroyed. Young families are fleeing Michigan in droves. Ford had better get their European cars here PRONTO (Mondeo, Verve) and had better become the LEADER is MPG PRONTO!

I believe that their new leadership team can do it and I've thrown a $15,000 flyer at it in the expectation that if the company is even around in 2012 that the stock will be at $25.00 minimum and climbing. I feel that this is the more likely scenario than bankrupcy. Why?

1- Ford family will not go bankrupt.
2- They are making a profit of close to $1 billion when North America is removed so worst case they can just cut out NA and get smaller and actually make money!
3- Their cars have improved in quality to the point that JD Power is ranking their New Car Quality ABOVE TOYOTA AND HONDA
4- Their new models are awesome and the hit at the International Car Shows. They've just got to get them out ... NOW!
5- My son is a HS intern for their Alternative Energy Dept working on the computer programs and my son is awesome!
6- I've got a good feel for these things in the past!!!

2008 Jul 29 07:05 AM

[Wadhamite:]

Much of the attention being given to Ford is put on automobiles. Let's not forget that Ford also makes buses, large trucks, tractors, and work vehicles that will continue to be used, no matter what the sentiment of the public and no matter where fuel prices go. Personally, I wish Ford would put more attention on fuel-miser small products; however, I don't believe the company is in trouble overall.

2008 Jul 29 09:26 AM

[Tony the Car:]

Wadham, you may want to check your data. Ford got out of production of most of those items years ago.

2008 Jul 29 03:59 PM

[Kunst:]

hernje: I'd apportion blame this way: Management-70% ; Labor- 30%.

I have to agree again. The US auto industry is a parable for what's happened to America. On top of the world, got arrogant, got lazy, didn't respect their customers, got destroyed by those who paid attention to fundamentals: quality, value, and respect for their workers.

2008 Jul 30 01:43 PM

[IXLR8:]

Everyone knows that a cartel of labor (unions) only works in a monopoly. (See teacher's unions and AFSCME, for good examples) As long as the Big Three were the monopoly, and the union got its "pattern" contract, the individual car company who stood up to the union was left with a massive shutdown while its competitors kept working. It's management's fault, but it's also Wall Street and the investor community who wanted the plants operating.

Now, almost everyone in the automotive world is selling and/or producing in the US, and labor's cartel has lost its punch. Through the "jobs bank", the union was paid if there was work or not, so the companies kept producing and selling with rebates. The cost of union labor at the Big Three was about $75/hr, largely due to the pensions and retiree healthcare costs not borne by the new US producers.

Now, the union is on its knees. It has lost more than 500,000 jobs in the past decade that they are not getting back.

The "jobs bank", in which some workers sat without work but with pay for as much as 10 years, is gone.

Workers who are without work and refuse to relocate geographically to available work in another plant are fired.

They will be assuming responsibility for their own healthcare, through a fund established by each company at around 60 cents on the dollar. (At GM, the number 1 prescription drug was Viagra. You can bet the union won't continue that on their own dime.)

The companies can now hire new employees--up to 20% of its workforce--at $14/hr with no pension and no retiree healthcare cost.

That's why the companies are offering buyouts to get the high-paid to leave. And there is no shortage of applicants at $14/hr.

Ford has already cut $5 billion in annual costs, and by 2012--just a few years--will cut another $5 billion in cost.

Ford will make it, and those that get in and ride it up are going to have a great ride.

2008 Jul 31 06:51 PM

[Car-man:]

Excellent recommendation but it misses on three fronts. First, it blames the situation on workers compensation and healthcare costs. Secondly, it fails to mention that the vehicles put in showrooms and on the streets for the past 15 years have been substandard in design, engineering, style, quality and performance. If Ford would have tuned into to the market and done something about their products many of the problems would have been better addressed. Compensation and healthcare might have been a smaller problem with cars that would sell rather than having to be given away. Additionally much of all things wrong with Ford centers around the control of the Ford family. Simply stated, they just don't have the skill or ability to run the company and that's where the real problem starts.

2008 Jul 31 08:07 PM

[speedster1219:]

Just an FYI of those $14 hour applicants that are so anxious to work at the plant, once on the production floor about 1/2 are quitting because they have believed all the media hype over the years that auto workers sit on their butt and do nothing! They cannot handle the work. Complain that it is too hard on their bodies and wonder why in the world anyone would work there.

Please..........stop the media that is over exaggerating the American auto industry worker.


On Jul 31 06:51 PM IXLR8 wrote:

> Everyone knows that a cartel of labor (unions) only works in a monopoly.
> (See teacher's unions and AFSCME, for good examples) As long as the
> Big Three were the monopoly, and the union got its "pattern" contract,
> the individual car company who stood up to the union was left with
> a massive shutdown while its competitors kept working. It's management's
> fault, but it's also Wall Street and the investor community who wanted
> the plants operating.
>
> Now, almost everyone in the automotive world is selling and/or producing
> in the US, and labor's cartel has lost its punch. Through the "jobs
> bank", the union was paid if there was work or not, so the companies
> kept producing and selling with rebates. The cost of union labor
> at the Big Three was about $75/hr, largely due to the pensions and
> retiree healthcare costs not borne by the new US producers.
>
> Now, the union is on its knees. It has lost more than 500,000 jobs
> in the past decade that they are not getting back.
>
> The "jobs bank", in which some workers sat without work but with
> pay for as much as 10 years, is gone.
>
> Workers who are without work and refuse to relocate geographically
> to available work in another plant are fired.
>
> They will be assuming responsibility for their own healthcare, through
> a fund established by each company at around 60 cents on the dollar.
> (At GM, the number 1 prescription drug was Viagra. You can bet the
> union won't continue that on their own dime.)
>
> The companies can now hire new employees--up to 20% of its workforce--at
> $14/hr with no pension and no retiree healthcare cost.
>
> That's why the companies are offering buyouts to get the high-paid
> to leave. And there is no shortage of applicants at $14/hr.
>
> Ford has already cut $5 billion in annual costs, and by 2012--just
> a few years--will cut another $5 billion in cost.
>
> Ford will make it, and those that get in and ride it up are going
> to have a great ride.

2008 Nov 16 11:58 AM