Despite Ford's October Sales Drop, Revenue Growth Makes It A Long-Term Investment

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About: Ford Motor Company (F)
by: BAM Investments
Summary

While Ford's U.S. sales decreased 3.9% in October, which came in slightly better than the 5% forecasted by Edmunds, I remain optimistic about the long-term value of the stock.

Ford is selling the right sales mix as overall transaction prices continued to increase as Ford’s average transaction price per vehicle gained $1,400, versus an industry average of approximately $330.

This mix is driving top line growth as third quarter 2018 earnings showed a quarterly revenue increase of 3% up to $37.6 billion.

While cash is expected to tighten due to restructuring costs; management is committed to the dividend, and the changes will better position the company for the long term.

Investment Thesis

Ford (NYSE:F) posted a better-than-expected month in October with sales decreasing only 3.9% compared to expectations of 5%. Despite beating expectations, Ford saw a decrease in quantity along with the entire industry. Despite weaker sales, consumer preference continues to shift to larger automobiles due to lower gas prices and an improving economy.

This sales mix is driving higher margin sales which was evident in the 3rd quarter earnings release where revenue increased 3% year over year. Despite the revenue increase, the company saw a reduction in net income due to various headwinds, including Asia/Europe sales, supply chain disruption, and higher commodity costs.

Management is putting restructuring plans in place, which is expected to make cash flow tight over the next few years; however, I believe management is committed to paying the current dividend, and the short-term pains during the restructuring will be worth the changes made to the organization. With a below-industry-average P/E, over 6% dividend yield, and strengthening core business, I continue to recommend Ford as a buy for the value buy-and-hold investor.

Monthly Sales Data

In October 2018, Ford announced U.S. vehicle sales of nearly 193K, down 3.9% from October 2017. The results were slightly better than the estimate from Edmunds, which was expecting a decrease of 5%. Overall, the industry as a whole saw decreases, with forecasters at Edmunds and Cox Automotive estimating overall sales decreases of 2.1% and 1.9%, respectively. It was the second consecutive difficult month for the automakers as rising interest rates plus growing transaction prices are continuing to make new cars more difficult for consumers to afford.

While Ford posted a larger decrease than the industry average, the company continued to benefit from the continued market shift to crossovers, SUVs, and pickup trucks and abandoning passenger cars, which works favorably for Ford. Passenger cars are falling fast and now only make up approximately a quarter of new car sales, which is well below prior averages where cars once made up over half. While volume is down, this is allowing automakers to take advantage of the higher gross margin vehicles and pad their bottom lines.

Given the overall industry’s sales decrease, Ford wasn't the only major automaker seeing a decrease in September. Most saw decreases, including General Motors (GM) -9.1 (no longer reports actual sales - estimated average between Edmunds and Cox Automotive), Honda (HMC) -4.1%, and Nissan (OTCPK:NSANY) -10.6%. On the other hand, Fiat (FCAU) +15.7%, Toyota (TM) 1.4%, Subaru 2.5% (OTCPK:FUJHY), Volkswagen 4.6% (OTCPK:VWAPY), and Kia 1.6% (OTCPK:HYMLF) all posted gains despite the industry downward trend.

Based on the data, it's clear that October was another difficult month in terms of quantity for the industry despite benefitting from the shift to more profitable SUVs and trucks. This is being offset by subdued consumer interest in new vehicles as a result of a slowing economy and higher price tags. The interest rate on new vehicles increased to 6.2% in October which was up 1.3% from a year earlier and the highest it has been since 2009.

Additionally, discounting has slowed down. Only 3.8% of buyers claimed interest-free loans on new cars which were down from the 7.5% rate a year earlier. Furthermore, the transaction price continued to grow with the average new car selling for $37K which was up 3% from last year. While this is the industry trend, Ford isn't an exception. Ford's overall average transaction price gained $1,400, versus the industry average gain of $330.

For Ford, see the below chart showing the monthly U.S. sales for the trailing 12 months. Aside from January 2018, July 2018, and September 2018, U.S. monthly sales have largely remained between 200,000 and 250,000. This didn't happen for the second consecutive month in October, as Ford fell short again, which marked only the 4th month over the trailing 12 months to fall below the 200,000 sale threshold.

Source: Image created by author with data from monthly Ford press releases on company website

Ford's decrease in October sales was largely fueled by the Car and Truck segments decreasing 17.1% and 4.9%, respectively. On the other hand, the SUV segment managed to fuel an increase of 6.7% increase. This was a slight improvement from last month where all 3 segments posted decreases. With these results, it’s not surprising to see the Car segment fall so far given the consumer shift away from smaller vehicles in favor of larger vehicles.

This is especially favorable to Ford with the success of the F-150 and SUV segment which has helped drive Ford’s transaction price higher. It shows that the company has the right mix of cars to take advantage of the consumer shift to larger vehicles.

Ford's success is coming as a result of the success of the F-Series, Expedition, EcoSport, and Lincoln Navigator. While a tough month, the F-Series continued its streak of topping the 70,000-truck mark for the 8th straight month, selling 70,438 trucks during the month. In addition to quantity, transaction prices are running at record levels, with the average transaction price of $47,300 per truck, which was up $2,000 compared to the segment’s industry average.

This is largely due to customers moving away from the base model and are selecting crew cabs and higher-trimmed vehicles. Other large vehicle brands are taking advantage of the shift, including the Navigator, Expedition, and EcoSport, which provide Ford with competitive SUV options that are driving sales numbers and profitability.

See the below chart showing the monthly U.S. sales fluctuations for Ford compared to the same month a year ago. As you can see, its monthly results have been all over the place; however, there is no sugarcoating the downward trend in September and October. As I always disclaim with short-sighted metrics, it shows that an investor should not get excited based on monthly results alone. Investors should be more focused on financial results and the monthly quantity sold.

Source: Image created by author with data from monthly Ford press releases on company website

Inventory

Ford's vehicle inventory finished October 2018 at 87 days' supply, which is up slightly from the 77 days’ supply in September 2018 and from October 2017’s metric of 79 days’ supply. While this level of inventory is concerning, it helped the company weather a disruption in its supply chain reported in early May. The disruption was a fire at Meridian Lightweight Technologies in Michigan.

Meridian is a China-owned automotive interiors supplier to Ford and other automakers. The impact on Ford is huge, as it halted all production of F-150 pickup trucks, which is the company's most profitable and popular model. Despite the potential benefit of excess inventory in the event of supply chain disruptions, the slowing sales, and increased inventory is certainly a concern for the industry.

China

China has been a troubled market for Ford to replicate its success in the U.S. This continued in September, when the company announced another dismal monthly result with a year-over-year decline of 43%, putting the year-to-date decrease in 2018 at 30%. While this is a much smaller number of Ford vehicles, at only 64K being sold in China compared with 197K in the U.S. in September 2018, it shows that Ford is struggling to replicate its success in China. This is likely to get even more difficult with China announcing tariffs of between 2.5% and 25% on imported cars and the ongoing trade war.

At this point, it's difficult to get excited about Ford's possibility in China; however, the company is set to release a more upscale Ford Focus in China, which could help boost sales. Regardless, I don't expect any short-term favorability from this region, as management expects it to be a drag on short-term operations.

Financials

When Ford reported third quarter 2018 earnings, revenue of $37.6 billion was able to surpass estimates, while GAAP earnings per share of 25 cents disappointed. Despite the lower-than-expected earnings per share, management reaffirmed the range for the full year 2018 adjusted earnings per share guidance to $1.30-1.50 that was provided during the Q2 call. As seen by the monthly results, the company was able to drive a revenue increase of 3% in the quarter as a result of the sales mix. This was primarily seen in North America where consumers are buying higher margin vehicles and high-end trim levels.

While North America is strong, management acknowledged struggles in China and Europe. In Asia, the company is focusing on improving local management, cost reductions and localizing more product in China. Additionally, the company is refreshing 60% of its line-up over the next year and a half in efforts to turn around the business segment. In Europe, Ford is going to focus on the Ranger. The company is going to allocate resources to this product while focusing on cost reductions. The turnarounds in these regions are key for Ford to unlock shareholder value, as both regions posted deterioration in 2018.

Looking Forward

Ford, along with most of the auto manufacturers, posted significant weakness in U.S. sales during October. This isn't a concern to me given recent success and the company's success in selling higher-margin vehicles and adding to the average transaction price. In the final quarter of 2018, Ford needs to continue to push high-margin vehicles, such as the F-Series trucks, Explorer, Edge, and Expedition. It's not important to focus on transactions but more important to focus on the product mix. Not only from a make, but also from a trim level and features standpoint.

When the company released third quarter 2018 earnings, it posted a quarterly revenue increase of 3% largely due to the U.S. region. While net earnings are seeing a boost from the lower tax rate and cost-cutting measures, the company faced higher commodity costs mostly due to the steel tariffs, the supply chain disruption, and weakness in Europe and Asia. Despite impressive sales in the U.S., Ford disappointed in the quarterly earnings call.

It's only going to get more difficult, as the industry is expecting to face pressure in the second half of the year. The pressure is a result of increasing interest rates, less built-up demand, and an abundance of used vehicles on the market. This means the pie is likely to get smaller in the U.S. market, which could erode not only Ford's sales but also its impressive transaction gains as competitors utilize higher incentives to attract business. Given the company's ability to sell SUVs and trucks, I think it is in a good position to compete in a tightening marketplace, but it must make strides in other markets to grow value.

In response to the consumer sentiment toward large vehicles, Ford has announced that it would discontinue the Fusion, Taurus, and Fiesta cars within the next few years. Ford wasn't the only automaker to respond this way, with General Motors planning to reduce production on the Cruze compact car and considering stopping production on the Impala and Sonic sedans. As we saw with the Great Recession, consumer sentiment can shift at any moment, and with rising fuel prices, Ford shouldn't completely abandon fuel-efficient cars from its portfolio. However, with the SUVs and trucks becoming more fuel-efficient, this hopefully won't be an issue.

As evidenced by the earnings release, Ford, as well as other domestic auto manufacturers, are seeing uncertainty around tariffs. Given the current administration's proposed tariffs on steel at 25% and aluminum at 10%, it is likely to result in higher commodity prices for Ford despite the company using mostly American steel manufacturers. During the 2nd quarter, the company estimated that the tariffs had a $300 million impact - there wasn’t a discussion in the 3rd quarter on the impact. Experts are estimating that this could have a $1 billion cost impact on Ford, which is approximately 12% of the company's profit in 2017.

However, there is still a lot to be figured out, as the administration is also considering ways to require imported cars to meet stricter environmental standards when entering the U.S. in order to protect domestic automakers.

Valuation

After a sluggish month, the stock decreased slightly in value to approximately $9.38 per share, down up from $9.15 a month earlier. At this level, the Price-to-Earnings Ratio (P/E) of approximately 6.1 appears to be undervalued compared with the current S&P 500 mean P/E ratio of 19.1, but more importantly, the industry average of 10.6. I would expect Ford and industry to be below the current S&P 500 given that it’s a value stock, the current economic cycle, and uncertainty regarding tariffs; however, its P/E ratio shouldn't be trading at just over half of the industry average.

Ever since the stock was downgraded by Moody’s last quarter, Ford’s dividend has been under the microscope, and while results like September’s won’t help the case, there hasn’t been any news on the dividend. For background on this, Moody’s downgraded Ford to just above junk status citing its believed negative outlook for the automaker. More specifically, they cited weakening margins in North America and continued difficulties in Europe and China.

Given these struggles plus restructuring initiatives (cash-related effects of $7 billion forecasted over the next 3-5 years), investors are projecting cash flow issues for the company in 2019 and beyond. Despite this, I still don’t see this impacting the sacred dividend. In the first three quarters of 2018, the company paid out dividends of nearly $2 billion, while it generated nearly $15 billion in operating cash. Additionally, it had approximately $23.7 billion cash to continue funding the dividend, capital investments, and restructuring costs. Management has discussed the dividend during the previous 2 earnings calls.

In the second quarter:

It's important to highlight that we believe we can fund these cash effects without impinging on our other capital outlays including investments for growth and our regular dividend. You'll note that all of the metrics for the quarter were lower than a year ago. These declines were primarily driven by lower volume of high margin products in our North America business due to production disruptions caused by Meridian, along with performance issues in our China operations.

In the third quarter:

And we want to emphasize that we don't know how we've lost control of the way that's been projected, but we've been consistent saying that we plan to pay the regular dividend in this five-year plan.

Conclusion

Given the low valuation and the company's dividend yield over 6%, I believe the stock is attractive at current prices. While domestic auto sales are expected to flatten before settling, Ford is perfectly positioned to continue pushing higher profit margin vehicles with its larger vehicle offering, including the F-Series, Edge, Flex, and Explorer.

Additionally, it is focusing on China and autonomous vehicle-driving technology. I'm excited about the company's future, and I recommend owning the stock with a long-term view. With consumers purchasing more expensive vehicles, it will allow the company to report stronger top line and bottom line growth going forward.

Furthermore, I believe Ford has a strong product mix to take advantage of the growing market and will pay investors a near-6% dividend yield to own the stock. Company management is committed to paying the current dividend, and Ford should be able to generate the cash flow from operations to continue funding it.

While I do expect some short-term pressure as the company restructures to become a more lean company, I think it will come out in better shape on the other side. However, I will continue to monitor how sales are performing in Europe and Asia along with the cash position; however, the success in the U.S. provides a stable value investment. Stay tuned for 3rd quarter results coming soon.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in F over the next 72 hours. 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.