Ford Vs. GM: From A Dividend, Free Cash Flow (And Valuation) Perspective

| About: Ford Motor (F)

Summary

Ford's dividend yield is 4%, and GM's dividend yield is also 4%.

Both Ford and GM look undervalued by 30% from an intrinsic value perspective.

Despite the strong May '15 auto sales number, neither stock has moved much.

Ford (NYSE:F) and GM (NYSE:GM), the two iconic American auto OEMs, are enjoying one of the best years in auto sales since the mid-2000s.

May's auto sales, at a seasonally-adjusted annual rate (SAAR), were 17.7 million cars sold. According to JD Power & Associates, GM's May '15 sales rose 3%, while Ford's fell 1.3%, thanks to limited production of the Ford 150 Truck as the automaker transitions to the all-aluminum body.

And yet, the stocks of both F and GM have stagnated of late.

Here is a table on periodic returns for both stocks:

Ford vs. GM total return(s)

F GM
1-month 1.38% -2.21%
YTD 1.33% 0.29%
1-year -7.31% -3.39%

(Source: YCharts.com)

A recent article on Ford here makes one critical error that I think a lot of retail investors make, in that focusing on the "payout ratio" or the quarterly / annual dividend divided by the quarterly / annual EPS is a less complete way to analyze a company's dividend sustainability, since dividends are a function of free cash flow, while "earnings" or "earnings per share" (EPS) and the payout ratio is an accounting metric.

First, let's look at the historical and projected revenue and EPS growth:

Ford and GM historical and projected revenue / EPS growth rate

F GM
Historical 4-year avg. rev. growth rate +3% +1%
Historical 4-year avg. EPS growth rate -6% +30%
Expected 3-year avg. rev. growth rate +4% +1%
Expected 3-year avg. EPS growth rate +21% +25%

(Source: Internal spreadsheet)

Analysis: GM's Q1 '15 saw the auto giant print $0.86 versus the $0.27 in Q1 '14, so if we exclude Q1 '15 from the historical EPS growth rate in the table above, the "average" historical growth rate drops to 10%.

Here is the kicker: For both Ford and GM, 2015 is expected to be a strong year in terms of EPS growth, with current consensus expecting Ford to grow EPS +37% and GM EPS to grow +47%.

As you can see from the first table, neither stock is exactly shooting the lights out in terms of capital gains this year.

Free cash flow and Dividend analysis

Ford and GM free cash flow and dividend analysis

F GM
FCF ($ bl) Div ($s ml) Div % FCF FCF ($ bl) Div ($ ml) Div % FCF
Q1 '15 4.9 2,000 41% 1.5 3,000 210%
Q1 '14 5.9 1,700 29% 4.0 1,900 47%
Q1 '13 4.5 965 21% 3.2 1,130 36%
Q1 '12 6.3 764 12% 2.1 922 44%

(Source: Internal spreadsheet, all dollar amounts 4-quarter trailing)

Div % FCF: The 4-quarter trailing dividend as a percentage of 4-quarter trailing free-cash-flow

Analysis: While Ford looks to be the more stable and consistent cash flow and free cash flow generator, I do think GM's Q1 '15 was distorted the quarter being a very weak quarter for cash flow from operations (CFFO) for GM, where the 10-Q, shows that GM generated about $375 million in CFFO, versus almost $2 billion in the year earlier quarter.

The point being as we get the 2nd and 3rd quarter 10-Qs, I would expect we will see a normalization of GM's cash flow and thus its free cash flow.

Long-term debt issuance

Ford and GM's L-T debt trends and Debt-to-Capitalization ratios

F GM
L-T debt Debt-to-Cap L-T debt Debt-to-Cap
Q1 '15 $11.4 56% $33.9 19%
Q1 '14 $13.6 55% $22.9 13%
Q1 '13 $14.8 55% $11.5 7%
Q1 '12 $12.5 55% $8.9

(Source: Internal spreadsheet from earnings reports and 10-Qs)

Credit Ratings

Current credit ratings

F GM
Implied Rating BB+ BBB
Standard & Poor's BBB- BBB-
Moody's not available n/a

(Source: Thomson Reuter Eikon)

Analysis: One of the benefits of writing for Seeking Alpha is that in writing the article, the process is much like doing research and thinking through the topic at hand.

Simply looking at Ford and GM's balance sheet and the long-term debt issuance, my first thought was, "Ford looks better and they are containing their long-term debt issuance, unlike GM..." until the debt-to-capitalization ratio was analyzed and the reader gets a chance to view the debt from a total liability and equity perspective, and GM's surge in long-term debt does not look that worrisome.

This also helps explain the sudden interest by activist investors in GM that was seen in late Q1 '15 and early Q2 '15. While I thought that the interest may have been a function of GM's free cash flow, readers now can see that the activist interest was probably driven by the low level of financial leverage that the company was working with.

Summary:

The credit ratings for both Ford and GM have been improving over the last few years, thanks to strong auto and truck sales and improved financial profiles post 2008, although the credit ratings remain low-investment grade at best, and that is the senior unsecured debt.

While Ford is likely given the nod in terms of the dividend consistency and stability, do not discount GM's low level of financial leverage and its ability to issue more debt.

Frankly, both stocks are significantly undervalued, as detailed here, with Morningstar's current intrinsic value ratings being $22 on Ford and $50 on General Motors.

At their current prices, Ford is trading at a 30% to perceived intrinsic value, while GM is trading at a 31% discount to that estimated value.

With 4% dividend yields and the potential for significant capital appreciation, both stocks make sense here for longer-term investors who can be patient.

My concerns regarding Ford and GM:

The advent and growing popularity of hybrid and electric cars is a disruptive force in the global auto OEM business, which impacts the international, integrated oil companies too. (Pleases read the comments section on my recent article on Exxon and Chevron comparison, where I get into the discussion with a few readers.)

Ford and GM provide pretty decent disclosure in their respective earnings reports and SEC filings, so investors can see the financial performance of the auto segment versus the financial segment. The fact is that Ford Motor Credit and GMAC (now Ally Financial) are still very profitable and provide some financial stability to the razor-thin automotive operating margins.

GM had an interesting stat in its Q1 '15 10-Q: +30-day delinquent loans had risen to 5% of the receivables portfolios as of Q1 '15. Is GM doing more than its share of sub-prime auto loans, and are those subprime loans that are starting to rear their ugly heads? (I haven't checked the same number for Ford, so it could be normal delinquencies for the sector.) Personally, given the improvement in consumer credit and personal balance sheets, I think the US consumer has a long way to go before we have to worry about the next consumer credit cycle.

Technically, the $14 area should be good support for Ford on any market pullback. Following the Goldman Sachs downgrade (Goldman upgraded Ford this week, and at the same time downgraded GM), GM is testing its 50-week moving average in the area of $34.60; we probably don't want to see GM trade below $30 on heavy volumes.

Both auto giants have issues with their South American operations and currency volatility, while GM has the still lingering issue of the ignition switch scandal.

With the nice dividend yields, which will only increase on any long-awaited correction of 10% for the S&P 500, look to buy both stocks on any decent pullback.

Deep-cyclical stocks like Ford and GM tend to perform best late in the business cycle. I do think more upside is ahead for both as long as interest rates and auto financing rates do not rise too quickly.

Disclosure: I am/we are long F, GM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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