Ford: 7% Drop Plus 6% Dividend Yield Equals Buy

Summary

• Ford stock fell 7% after giving preliminary earnings results for 2017 and guidance for 2018.
• Earnings grew in 2017, but higher costs and investment spending will cause earnings to decline in 2018.
• Ford is addressing its cost structure with cost-cutting measures, and its investments in electric and autonomous vehicles will fuel future growth.
• In the meantime, Ford also announced a $0.13 supplemental dividend. With a total dividend yield of 6% and a low valuation, Ford is a buy.

By Bob Ciura

Just when things were looking up for the U.S. automakers, shares of Ford Motor Company (NYSE:F) fell over 7% on Wednesday, January 17 when the company announced preliminary earnings for 2017 that came in below analyst expectations. Ford's guidance for 2018 also did not meet expectations.

However, Ford also declared a supplemental dividend of $0.13 per share. Combined with its regular annual dividend of $0.60, Ford's total dividend yield for 2018 is nearly 6%. This places Ford on our list of high-yield stocks. You can see the full list of established 5%-plus yielding stocks here.

Ford is struggling with higher costs, which the company is addressing through renewed efficiency initiatives. Ford is a cyclical company, but has a long history of navigating difficult climates. It has been in operation for more than 100 years. With a dividend yield above 3%, Ford meets our definition of a "blue chip" stock. You can see our full list of blue chip stocks here.

Ford stock appears to be undervalued, given its high dividend and future growth potential. This could make Ford an appealing stock for value and income in 2018.

News Overview

For 2017, Ford expects adjusted earnings per share of $1.78. This came in below analyst forecasts, which called for earnings per share of $1.84. For 2018, Ford expects adjusted earnings per share in a range of $1.45 to $1.70. At the midpoint of guidance, Ford sees 2018 earnings per share of approximately $1.57, compared with expectations of $1.59.

After a boom in the years since the Great Recession, the U.S. automotive industry slowed down last year.

Source: CEO Strategic Update Presentation, page 7

Slowing sales, along with higher costs, caused Ford's adjusted earnings per share to decline 8.8% in 2016. But 2017 was actually a much better year than 2016. Using Ford's updated guidance, earnings per share actually increased 1.1% in 2017. 2018 will see a decline, as Ford invests heavily in new technologies. This investment is necessary to fuel growth.

In the meantime, Ford reiterated its plan to improve operational efficiency while also investing for future growth. To cut costs, Ford is shifting its portfolio toward trucks and SUVs and away from cars. For example, the company will cut orderable combinations of the Fusion and EcoSport to 10-20 for each vehicle, down from thousands of combinations currently offered. This move will cut manufacturing, inventory and logistics costs.

Source: CEO Strategic Update Presentation, page 21

Ford has a strong industry position, thanks in large part to the F-150, which has been the best-selling truck in the U.S. for the past 41 years. In addition, Ford is shifting its portfolio mix, away from low-margin cars. In North America, Ford expects SUV product mix will rise by 10%, while its car portfolio is expected to decline by 10%. This could help improve Ford's profitability, as trucks and SUVs are much higher-margin vehicles than cars.

While Ford's operational restructuring and growth investments will come at a near-term cost to earnings per share, they will provide the foundation for future growth.

Growth Prospects

Ford still generates healthy profits and strong cash flow. The company generated $31 billion of operating cash flow since 2012, which allows it to invest in growth initiatives. Going forward, Ford's three most important growth catalysts include electric vehicles, autonomous vehicles, and growth in emerging markets.

Ford announced it will expand its electric vehicle portfolio to 40, including 16 full-battery electric vehicles by 2022. It also believes it will deliver a full-battery electric SUV that will have at least a 300-mile range, by 2020. Ford will need to invest more than $11 billion in electric vehicles by 2022 to do this, but it is apparent this investment is necessary to compete and adapt to changes in the marketplace.

Source: CEO Strategic Update Presentation, page 38

Next, autonomous vehicles are a growth catalyst for Ford. Ford announced it will have a purpose-built vehicle, along with self-driving technology, to enter production of autonomous vehicles in 2021. It has already announced collaborations with Domino's Pizza (DPZ), Lyft (LYFT) and Postmates to test self-driving vehicles in a pilot program. There will surely be more partnerships to come. This is another wise step to capitalize on an emerging trend. Companies that rely on human drivers are looking to cut costs, and autonomous vehicles are a way to do that.

Source: CEO Strategic Update Presentation, page 46

Lastly, Ford is looking to growth in new geographic regions, particularly the emerging markets. Ford is pursuing partnerships, including with Mahindra in India and Zotye in China, to develop vehicles and services for growth in those markets. India and China are compelling growth markets for Ford, as both nations have large populations and high economic growth rates. Automakers have had a difficult time turning a profit abroad, but the growth potential makes these investments worthwhile.

Valuation and Dividend Analysis

Ford has a strong industry position and growth potential. Furthermore, the stock appears to be undervalued. Based on 2018 guidance, Ford has a price to earnings ratio of 7.8. This is well below the broader market index. The S&P 500 Index has an average price to earnings ratio of 26.7. Of course, investors should not expect Ford to trade at the S&P 500 valuation multiple. Ford has a cyclical business model, and as an automaker the stock typically has a discounted valuation.

However, Ford's valuation is usually not quite this low. According to ValueLine, Ford has held an average price to earnings ratio of 9.2 in the past five years. This means Ford is currently valued at a 15% discount to its five-year average.

If Ford's growth investments spur an earnings recovery in 2019 and beyond, Ford could be significantly undervalued. In addition, Ford has an attractive dividend payout.

Source: CEO Strategic Update Presentation, page 3

The company pays a regular dividend of $0.15 per share. Since 2016, it has also paid a supplemental dividend each year. The 2018 supplemental dividend of $0.13 per share means Ford will have total dividends of $0.73 per share this year. The dividend appears to be highly secure, as Ford will likely maintain a dividend payout ratio of 46% in 2018.

Importantly, Ford's balance sheet is in its best shape since the Great Recession, which helps secure the dividend. Ford's automotive segment had a net cash position of $9.9 billion at the end of last quarter. Ford's improved balance sheet and low payout ratio should help the company sustain its dividend, even during a recession.

Final Thoughts

Ford is not the flashiest company to invest in. This year will be a difficult one for the bottom line, but the investments in electric vehicles, autonomous driving, and the emerging markets should bring about future growth.

Ford is not a growth stock. Instead, it is a value and income stock. Ford is on our list of dividend-paying stocks in the consumer cyclical sector. You can see our list of all 674 consumer cyclical dividend stocks here.

Ford's regular and supplemental dividend will provide a nearly 6% dividend yield in 2018. Combined with a low valuation, the stock has potential for strong returns.

This post was written by Bob Ciura for Sure Dividend.

Disclosure: I am/we are long F. 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.