Ford (NYSE:F) gained just under 17% during the last year on the back of strong global sales. However, at the end of the year, the company announced that it expected the sales growth to slow over the next twelve months. The news came as a surprise to the investors and analysts alike as the company was going smoothly. As a result, the stock witnessed one of the biggest single day falls in the last two years. Year-to-date, the stock is still down about 2%. However, I believe the fall was exaggerated and the long-term growth prospects are bright for the company.
First of all, the decrease in profit will be due to the 23 launches over the next twelve months, compared to the 11 launches during the last year. These launches will play a vital role for the global expansion. Furthermore, the recovering global economy will continue to drive the demand for vehicles over the next 2-3 years, in my opinion. I believe the slowdown in the profit growth will be short-term and the long-term shareholders should not be worried.
The Chinese Market is a Goldmine
Ford made record sales in China last year increasing its sales by 49% as compared to the previous year. Comparing it with the 14% increase in the automobile sales of China last year, we see that Ford's market share in China is increasing considerably. This year, the company expects the Chinese market to grow by 7-8%. If the company manages to increase its market share at the same rate as the last year, we are looking at a substantial increase in sales from the Chinese market.
Further, the company is also making moves which would serve it in the long-term. Ford is investing $5 billion in China to increase the number of manufacturing facilities to nine; previously, the company had four facilities. The first facility to be completed is the Hangzhou plant, which is scheduled to be operative in 2015. Upon completion, this plant will have the capacity to manufacture 250,000 vehicles a year. By 2015, the company expects to increase its overall manufacturing capacity in China to 1.2 million passenger cars, which is double the amount compared to 2012. As these projects come in operation, Ford would be able to cash in on the increased demand in the Chinese market.
Valuation Relative to the Industry
When we look at the overall automobile sector, I think the stock is undervalued. Let us first take the P/E ratio into consideration. The trailing twelve month P/E ratio of the automobile sector is 11.6, compared to Ford's P/E of 8.7. Furthermore, a forward P/E ratio of 7.7 is even more attractive for Ford and makes it cheaper relative to the industry. At the moment, the stock is trading at a discount of about 25% compared to the automobile industry. Ford has increased its earnings by about 24% and the stock has gained about 17% in the same period. The growth in the stock price has been far lower than the growth in earnings.
Next in focus is the Price-to-Cash flow ratio. Ford has a P/CF ratio of 5.9, higher than the industry average of 3.8. When we talk about the automobile industry, it is necessary to understand the capital needs. Automobile companies invest a substantial chunk of cash generated from operations back in the facilities in order to keep the plants in the best shape. In Ford's case, we know that the company is spending heavily on improving its facilities and also building new facilities in China. These capital projects are necessary for the long-term growth and the future cash generated from these projects should bring the ratio in line with the industry.
Let's now look at the margins - the operating profit margin of Ford is 5.7%, compared to the industry average of 1.2%. The Net profit margin of Ford is 4.9%, slightly better than the industry average of 4.6%. However, as there are concerns about the short-term profitability, we might see a decline in the net profit margin in the short-term and it may fall below the industry average as there is not much buffer available to the company.
Tackling the Issues
A recent consumer report was not favorable for Ford as consumers had some issues with its in-car infotainment system, Sync. Over the years, infotainment systems have become an important part of vehicles and the consumers don't compromise on it. Ford has taken necessary steps to tackle the issue as there have been reports that the company is going to leave Microsoft's (NASDAQ:MSFT) Windows in favor of Blackberry's (BBRY) QNX. Blackberry's software is much better than the current version of Sync working in Ford vehicles and also powers Audi and BMW.
Moreover, Microsoft powered sync only offered the services limited to infotainment. On the other hand, QNX may make things simpler for the company as it is capable of powering most of the in-door functioning of the car. For example, seat control. By adopting QNX, the company may be able to solve the problems related to the consumer preferences.
Considering Ford's prospects in China, the company is well positioned to grow from the Chinese market alone. Overall trend in sales and profitability has been extremely impressive for Ford over the past few quarters. A slowdown in the profit growth will be temporary, in my opinion as the company has everything in place to ensure the long-term growth. The global expansion will support the future growth and I believe the growth in fundamentals has been better than the price appreciation - the recent decline gives its long-term stock holders an opportunity to increase their position.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.