Ford's Earnings And Reported January Sales Have Me Staying The Path

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About: Ford Motor Company (F), Includes: FCAU, GM, HMC, TM
by: BAM Investments
Summary

Ford's U.S. sales increased 7% in January, which came in better than the 3.7% reduction forecasted by analysts.

Ford is selling the right sales mix as the F-Series outsold its nearest competitor by the widest margin ever in Q4.

This mix is driving top-line growth as fourth-quarter 2019 showed a quarterly revenue increase of 1% up to $41.8 billion from the same quarter in 2018.

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 January with U.S. sales reportedly increasing 7% compared to low expectations. In addition to the higher number of cars sold in the U.S., 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 2018 earnings release where revenue increased 2% compared to 2017. 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, nearing 8% 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 January 2019, Ford hopped on the General Motors (GM) train of not releasing monthly earnings. Bloomberg reported that Ford saw a surprise sales gain in January of 7%. This was a much better-than-expected month in January when compared to the expectation of analysts to drop by 1.5%. Overall, the industry as a whole saw a largely good month with Edmunds’ analysts predicting an increase in January 2019 of about 1.3% when compared to January 2018. While modest, this results in an increase of just over 1 million new vehicle sales during the month. This was a slight reversal from the recent trends from the auto industry where consumers were pulling back due to higher interest rates, growing transaction prices, and a fear of a slowing economy. Despite the results, it should be noted that January is a slow sales month in terms of quantity and we should not place too much weight on the results. For the full year in 2019, analysts are anticipating that total U.S. sales will fall short of 17 million for the first time in four years at 16.7 million.

While Ford posted a much larger increase in terms of quantity compared to the industry average, it’s safe to assume that 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 30% of new car sales, which is well below prior averages where cars once made up over half (43% in 2015). This trend is expected to continue in 2019 where 1 in 2 vehicles sold will be SUVs or crossovers. With this trend, the volume is clearly going to suffer but it’s allowing automakers to take advantage of the higher gross margin vehicles and pad their bottom lines.

Ford wasn’t the only major automaker posting an increase with Fiat (FCAU) 2.5%, Honda (HMC) 1.5%, Kia 4.9% (OTCPK:HYMLF), and Subaru 3.9% (OTCPK:FUJHY) each posting gains. On the other end, most of the larger companies saw decreases including General Motors -7% (no longer reports actual sales – reported by Bloomberg), Toyota (TM) -6.6%, and Nissan (OTCPK:NSANY) -18.5%.

Based on this mixed data and my forewarning about January sales, there really isn’t a conclusion to be made based on these results. As we’ve seen in the previous earnings release, the consumers are shifting to higher margin vehicles which are 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. This trend is expected to continue as the Fed Reserve attempts to cool down the economy.

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 $33.4K, up nearly 2.4% from last year. While this is the industry trend, Ford isn’t an exception. In December, Ford's overall average transaction price of $38.4K gained $1.6K or 4.3% increase, versus the industry average gain of $470 or 1.4%.

For Ford, see the below chart showing the monthly U.S. sales for the trailing 13 months. Excluding January 2018 and January 2019, Ford’s average monthly quantity sold has been 212K. As you can see from the chart, the line dips in January on both ends as sales have averaged 165K. Again, as forewarned, January is a very low month in terms of activity following the busy holiday season. And while quantity is important to monitor, it definitely shouldn’t be the company’s only performance indicator for an investor. It’s also important to understand the sales mix.

Source: Image created by author with data from monthly Ford press releases on the company's website and Bloomberg reports.

In full year 2018, Ford’s Car segment saw an -18.4% decrease from 2017. On the other hand, larger vehicles such as SUVs and trucks saw increases of 0.5% and 1.4%, respectively. In total, the quantity was down -3.5% in 2018. Despite this decrease in quantity, the company was still able to increase revenue by 2%. This is a favorable shift for Ford largely due to 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. Full-year F-Series sales were up 1.4% in 2018 with just over 909K trucks sold. This marks the 42nd consecutive year for the F-Series as America’s bestselling pickup. In addition to quantity, transaction prices are running at record levels. 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 on a quantity basis have been all over the place; however, there was a clear downward trend in Q4 2018 before the large jump in January. 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 the company's website and Bloomberg reports.

China

China has been a troubled market for Ford to replicate its success in the U.S. This was evident in 2018 when the company reported that full-year sales were down 36.9% in 2018 vs. 2017. While this is a much smaller number of Ford vehicles, at only ~50K being sold in China compared with ~200K in the U.S., 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 fourth-quarter 2018 earnings, revenue of $41.8 billion was able to surpass estimates, while Non-GAAP earnings per share of 30 cents disappointed. As seen by the monthly results, the company was able to drive a revenue increase of 1% 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 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

While Ford posted growing revenue in 2018 and strong results in January, the company is setting itself up to have a good 2019. This will be done by continuing to sell higher-margin vehicles (F-Series trucks, Explorer, Edge, and Expedition) and adding to the average transaction price while cutting costs.

It's only going to get more difficult, as the industry is expecting to face pressure in the fourth quarter of 2018 and beyond. 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 second 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 $8.31 per share, up slightly from $8.07 a month earlier. At this level, the Price-to-Earnings Ratio (P/E) of approximately 9 appears to be undervalued compared with the current S&P 500 mean P/E ratio of 15.7, but more importantly, other key competitors including GM at 6.9, Toyota at 8.8, and Fiat at 6.3. 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, it makes sense that Ford would be at a slightly higher PE valuation than other automaker competitors given 2018’s success.

Ford’s stock has seen pressure ever since the stock was downgraded by Moody’s last quarter as the company’s dividend has been under the microscope. 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. However, during the month, Morgan Stanley (NYSE:MS) released a report concluding that Ford’s large-scale restructuring could result in the company shedding 25K jobs, as much as GM did later this month. While this restructuring will help Ford in the long run, it’s going to require upfront investment. Analysts are projecting a cash-related impact of $7 billion forecasted over the next 3-5 years, which will cause cash flow issues for the company in 2019 and beyond.

Despite this, I still don’t see this impacting the sacred dividend. In 2018, the company paid out dividends of nearly $3 billion (up from $2.6 billion in 2017), while it generated nearly $15 billion in operating cash (down from $18 billion in 2017). Additionally, it had nearly $17 billion cash (down from nearly $19 billion in 2017) to continue funding the dividend, capital investments, and restructuring costs. Management has discussed the dividend during the previous 3 earnings calls to provide additional comfort to investors.

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 a 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.

In the fourth quarter:

We expect to be able to fund all of our business needs, including the regular dividend but we have to prove that.

Conclusion

While sales volume increased in January and Q4 2018 earnings were mixed, there is no change in my investment thesis for the month. As evidenced by the 4th quarter financial results, Ford is selling fewer vehicles but it's selling higher margin vehicles which is driving profits and revenue despite increasing costs. Given the low valuation and the company's dividend yield nearing 8%, 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 a 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-8% 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.

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.