Ford Is A Truck Company With A Truck-Sized Dividend

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About: Ford Motor Company (F)
by: Arturo Neto, CFA
Summary

Despite all the focus on Tesla and the end of the auto industry as we know it, Ford still has a strong hold of the truck market in the US.

Its shift in production strategy is supposed to drive considerable EBIT growth and build continuity and speed into the production cycle.

At a P/E of 7.9, the stock looks a bit undervalued, but we see considerable growth potential in the dividend, driven by strong projected earnings growth next year.

With all the talk about electric cars and Tesla (TSLA) constantly stealing the limelight, it is easy to miss the fact that there are other auto manufacturers that offer compelling investment opportunities. The initial battle scene in Episode 3 of Season 8 of Game of Thrones showed the army of the dead essentially steamrolling over the good guys' defenses. That is not what Tesla is doing to the other manufacturers, except perhaps in the amount of media coverage it is getting.

The reality is that the auto industry is becoming more and more niche-focused, and there are other US-based companies that have a stronghold on their respective niches.

Here is an example. While total car sales have been declining since 2013, sales of light trucks and medium and heavy trucks continue to climb.

This dichotomy within the sector is what we think will drive good investment opportunities, and in some cases, these opportunities are of the income-generating variety.

Investment Thesis

Ford Inc. (F) recently reported upbeat Q1'19 earnings numbers on April 25, 2019, and while it is difficult to predict whether the company can successfully restructure its business model or at least offset ongoing headwinds, I believe its strong market share within trucks provides stability and a competitive advantage over some of the other auto companies.

The stock recently stopped a year-long decline, and while I wish I could have jumped in earlier this year, I still don't think it's too late. Increased competitive pressures and excess capacity drove the stock price decline over the last several quarters, especially in the Passenger Vehicles segment. The company is investing in new high-potential product lines like trucks or SUVs, as well as into future trends like electric and autonomous vehicles. We expect that could contribute to higher revenues combined with improved EBIT margins that are driven by ongoing restructuring initiatives. The stock trades at a trailing P/E ratio of 10.2x vs. 6.2x peers' median with a dividend yield of 6.3%. Despite competition from General Motors (GM) in the truck category, the F-150 Series has been touted as the best-selling truck for 41 straight years.

Business Transformation

(Source: Investor Presentation, April 2019)

Ford's core business consists of products like the F-Series truck, Transit, Explorer and Ranger that generate the majority of the company's EBIT, and management plans to invest additional capital and resources into those winning businesses. However, the market has been worried about how the company will deal with lower-performing businesses like its sedan line and other passenger products.

I think these concerns are overdone. Ford has a very strong moat, truck leadership with its F-series, less overseas competition within trucks and very loyal customers. While it's true that it faces challenges in the passenger vehicle market, that segment is characterized by aggressive pricing and intensive capex to add consumer-driven features that other manufacturers are first to market. And customers aren't as loyal within the passenger vehicle segment as they are within trucks.

One of the changes the company is making to drive down costs is somewhat of a reversal of previous operational trends. Rather than have production lines focus on multiple vehicle types, Ford is migrating to a product line focus, where employees are more invested in a specific product line.

(Source: Investor Presentation, April 2019)

Each team within the Ford company is expected to understand every small detail of the underlying product and customers they serve. They usually stick with the same product line over several product cycles, which creates a better environment to continuously develop new product lines that address current customers’ requirements or challenges.

(Source: Investor Presentation, April 2019)

With the automotive industry going through rapid technological changes, the ability to refresh the product portfolio rapidly becomes tantamount to maintaining or growing market share.

Expansion Plans or New Opportunities

(Source: Investor Presentation, April 2019)

Management sees a great opportunity in the rugged adventure, off-road segment and has finally decided to compete head-to-head with Jeep. That is why the company puts a strong bet on the Bronco that is expected to enter the market in 2021, replacing outgoing Fusion and other similar products. Management is highly optimistic about its strong impact on profitability - a change of $1 billion EBIT - even though the volume might be lower compared to that for existing products or direct peers.

Okay. And then, maybe to think about the Bronco specifically and for unselfish reasons really to think about the profits here. We look at the Wrangler, right, direct competition, historically 150,000 units, right? Great profitability. We could argue it's almost a third to a half of FCA's total profitability. They ramped that up to 250,000. And then, you have the Gladiator that's launching in. They got Toledo North and South. So, it'll be a 400,000-unit program. So, what was a great program for Fiat Chrysler which is sort of a nichey product that they're kind of taking to a large volume run, it's kind of that risk of maybe, at least in our opinion, fading pretty hard for them over time because they're saturating the market.

Source: Jim Baumbick, BofA Auto Summit

First Quarter 2019 Results

(Source: Press Release, April 2019)

Group Chief Executive Jim Hackett stated:

With a solid plan in place, we promised 2019 would be a year of action and execution for Ford, and that’s what we delivered in the first quarter. We’re pleased with the progress and the optimism that it brings. Our global team continues to restlessly strive to improve our operational fitness, delight customers with ever-improving vehicles and services, and prepare Ford to win in the future. Our goal remains to become the world’s most trusted company, designing smart vehicles for a smart world.”

Source: Press Release, April 2019

(Source: Q1 Earnings Presentation, April 2019)

The company reported total group revenues of $40.3 billion in Q1'19, down 3.8% Y/Y. However, company Adjusted EBIT was 20% higher Y/Y, driven by positive seasonal factors and commercial success. Furthermore, management is highly optimistic that it can achieve strong 2019 full-year results compared to prior years. The company reported Q1 EPS of $0.44, beating the analysts’ consensus estimate of $0.26.

(Source: Press Release, April 2019)

The strong performance of the North American Truck and SUV business continues in Q1'19, with the F-Series continuing to maintain a leadership position by 94,585 trucks compared to its closest competitor GM. F-Series demand was driven by the latest technology offerings, leading to an average transaction price of $47,454. The company sold 9,421 Ranger trucks in Q1'19, adding to Ford’s truck franchise and making it the best Q1 for pickup sales in 15 years. Ford SUVs reported first-quarter record sales totaling 193,753 vehicles, or up 3.5% Y/Y, driven by the strong Expedition line performance totaling 21,773 vehicles sold, or up 61.9% Another high-growth line is EcoSport, up 111.3% Y/Y, and the company anticipates no SUV supply-related issues over the next few quarters. The Ford commercial line is performing exceptionally well, with reported sales of over 50,000 vans and the new Transit Connect line totaling 8,940, or up 34.9% Y/Y.

The passenger car business has been deteriorating over the past several quarters, and the company reported total car sales of 98,265, or down -23% Y/Y. From the flagship economy car products, only the Ford Fiesta line has been performing well, totaling 15,943 vehicles, or up 29.6% Y/Y, while the Focus, C-Max and even Mustang have been in double-digit decline Y/Y.

(Source: Press Release, April 2019)

During Q1'19, approximately 50% of European sales were from commercial vehicles and SUVs. Management expects continued growth of both segments in Europe, driven by the launch of new commercial vehicles like the Transit Custom PHEV and SUVs. In terms of commercial vehicles, the best-performing was the Ford Transit model, up 11.8% Y/Y, and Ranger, up 15.6% Y/Y. Both Passenger Vehicle sales and market share have been in a steep decline in Q1'19, offset by the strong performance of the Ford Focus line totaling 66,900 units, or up 11.7% Y/Y. Management expects a continued positive trend for the Focus line, with the Wagon and Active derivatives boosting European sales and the Focus ST line to enter the European market later in 2019. Overall, reported U.S./European sales numbers show a higher Truck and SUV product mix over the flagship car business, and we believe this trend will continue soon.

(Source: Q1 '19 Earnings Presentation, April 2019)

Management expects to maintain a strong balance sheet and investment grade ratings, driven by robust operational performance in 2019. The company reported $24.2 billion in cash vs. a target of $20 billion and $35.2 billion in liquidity vs. a target of $30 billion. Management is doing its best to increase liquidity and financial flexibility by an additional $3.5 billion in supplemental credit facility and extending the corporate revolver of $13.4 billion at the end of April 2019.

Valuation

The analyst consensus estimate for FY19 and FY20 is total revenue of $145.5 billion and $146.3 billion, respectively. Shares are now trading at a forward P/E multiple of 7.34x.

We believe the market has discounted the current share price over the high uncertainty of how the company will deal with realizing its restructuring plan and, especially, with the slowdown of the core passenger car business. Adverse FX and tariff-related effects, combined with intensified competitive pressures of the global automotive industry, puts additional pressure on the stock. That recently triggered a 15% decline in the stock price, with a bottom price of $7.50 at the end of December 2018 combined with a higher number of analysts’ downgrades over the last year.

The stock is currently trading in between analyst price targets at right around the consensus estimate. With a 6% dividend, I don't mind waiting to see how this plays out.

My Take

This is the auto industry, and despite it being a staple of the US economy for decades, it is going through a significant secular change that, honestly, I don't think anyone can predict. From millennials driving less to self-driving cars, the trend seems to point to fewer cars owned, even if the same number of cars are on the road.

There are also more short-term risks around trade wars, commodity prices, and changes in consumer tastes, not to mention aggressive pricing on certain vehicle types.

While Ford has a stronghold on the truck segment and loyal customers, it might be a matter of time before even Ford diehards start turning in their keys for an Uber (UBER) app. That, however, is a long ways away, and I would be content with collecting dividends until that day comes. If you're excited about Tesla and can deal with its founder and the volatility in the stock, this stock might be too boring for you. But if you're looking for a hefty dividend from an iconic American brand, you might want to take a close look at Ford. We like the 5.8% dividend yield and think there is a good chance it could increase 15% in the next year or two.

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.

Additional disclosure: This article is meant to identify an idea for further research and analysis and should not be taken as a recommendation to invest. It does not provide individualized advice or recommendations for any specific reader. Also note that we may not cover all relevant risks related to the ideas presented in this article. Readers should conduct their own due diligence and carefully consider their own investment objectives, risk tolerance, time horizon, tax situation, liquidity needs, and concentration levels, or contact their advisor to determine if any ideas presented here are appropriate for their unique circumstances. Furthermore, none of the ideas presented here are necessarily related to NFG Wealth Advisors or any portfolio managed by NFG.