Buying on Bad News: Ford and the Lesson From Cedar Fair

Includes: F, FUN
by: Philip Mause

Recently, the market has not been generous in offering opportunities for investors to "buy on dips" or to find entry points on "corrections." Oddly enough, the market seems to shrug off menacing macro news. Next week, I fully expect that a confirmation that an asteroid larger than the one responsible for the dinosaur extinction is about to hit our planet will be met with the S&P opening 3 points down, moving back to even by noon and ending the day up 4 or 5 points.

On the other hand, the market does just the opposite when individual stocks report "bad" news. These stocks are subject to the kind of summary execution the Taliban reserves for members who have untrimmed beards. I am not exactly sure what is going on here - perhaps, something to do with the prevalence of ETFs or some "event driven" hedge fund activity. Or, maybe, the lesson of the 2008 crash is to sell off on the first indication of any bad news. At any rate, it is possible that, if an analysis of the "bad" news reveals that the news is really not so "bad," then these summary executions may offer attractive entry points for individual equities.

In the Fall of 2009, a stock that I had been slowly picking up, Cedar Fair (NYSE:FUN), announced that it was discontinuing its dividend; FUN promptly dropped from $10.34 to $6.10. FUN is the kind of stock that many stockholders hold because of the dividend and the reaction was not surprising. It coincided with a reasonably good financial report: the dividend cancellation was motivated by the desire to pay down debt (of which FUN had accumulated a bundle due to the acquisition of Knotts Berry Farm). I had the advantage of being reasonably familiar with the numbers and determined that the selloff was an overreaction: I picked some up at $8. Within a very short time there was a takeover offer and the stock shot up to the $11 range.

Friday, it closed at $18.19. FUN has a lot of strengths; its amusement parks near major population centers offer cost conscious parents a much less expensive alternative to an excursion to Disney World. FUN owns multiple parks and, in a pinch, one or more could be sold off. In the Fall of 2009, there had been strong private equity interest in the amusement park sector and parks appeared to be viewed as valuable assets.

But, on the other hand, the lesson of 2008 was that investors should climb into lifeboats and abandon ship at the first hint of trouble. After all, look at what happened to those who held on to their positions in Bear Stearns and Lehman.

This brings us to Ford (NYSE:F), which last week sold off from $18.97 to a low of $15.20 and closed at $15.72. It issued an earnings release which tanked the stock. Earnings came in well below estimates largely due to a charge of some $900 million associated with a successful offer to redeem $2.5 billion of convertible notes.

The impending charge had been disclosed in an earlier press release; essentially F retired some $2.5 billion of convertible notes with a 4.25 coupon for some $500 million cash and some 274 million shares.

The transaction reduced net debt by some $2 billion and reduced annual interest expense by roughly $110. F has been paying down debt; Ford automotive now has no net debt. F's balance sheet is complex because it includes both the automobile company and Ford Motor Credit (essentially a finance company or bank). F has considerable debt because, like almost all financial institutions, Ford Motor Credit tries to borrow at low interest rates and lend at higher rates. A review of F's financials reveals that F has been aggressive and inventive in paying down debt and strengthening its balance sheet. Last week, a ratings agency announced that Ford Motor Credit was being upgraded. Ford Motor Credit also completed a substantial debt issuance on favorable terms. To be fair, F's earnings were mildly disappointing for reasons independent of the $900 million charge; European sales were soft and cost pressures are surfacing. But January auto sales numbers look very good.

F is not a no brainer here; its success depends on a strengthening United States car market and F does business in an intensely competitive sector. It has an aggressive union and some unfunded pension liabilities. On the other hand, I think that the cancellation of the convertible notes is an example of exactly the strategy that F should be executing. It strengthens the balance sheet, reduces interest expense, and puts F in a better position to be competitive. Most of the reviews of F's new cars have been very positive, F has excellent management, balance sheet repair has been largely if not entirely completed, and F has positioned itself to grab a meaningful share of the emerging market. F is a cyclical stock and trades at a discount to market PE, but that discount is getting pretty large. This could be one of the better opportunities that a stingy market will offer to value investors in the near future.

Disclosure: I am long F, FUN.