Ford Trucks Will Continue Driving Profitability (And Funding Dividends)

Oct. 07, 2019 2:49 PM ETFord Motor Company (F)35 Comments18 Likes
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Summary

  • Ford's U.S. sales decreased an estimated 4.9% to 580,251 units in Q3 2019.
  • Despite the year-over-year volume drop, Ford is selling the right sales mix as Ford’s truck and SUV mix climbed to 87% of total sales compared to only 82% in the.
  • This mix is driving bottom-line growth as second-quarter 2019 Automotive EBIT increased 19% year-over-year.
  • 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:NYSE:F) posted growing automotive profit in the second quarter of 2019 despite declining sales and the trend appears to be continuing with the release of Q3 sales numbers. With the automotive industry slumping in terms of quantity, consumer preference continues to shift to larger automobiles due to lower gas prices. The escalating trade war with China is bringing down the industry’s stock valuation; however, there remains optimism over a resolution.

Within the automotive earnings growing, management is putting restructuring plans in place, which is expected to make cash flow tight over the next few years; however, the company expects to continue paying the current dividend, and the short-term pains during the restructuring will be worth the changes made to the organization. With a near 7% forward dividend yield, and strong core business, I continue to recommend Ford as a buy for the value buy-and-hold investor.

Monthly Sales Data

In Q3 2019, Ford’s U.S. sales decreased 4.9% to 580K units compared to 610K units in the previous year. The sales decrease was larger than previous quarters thus far in 2019 where the company decreased 1.6% and 4.1% in the first and second quarters. Consistent with previous quarters, the decrease was fueled by a 29.5% decrease in car sales as consumers continue to transition to larger vehicles which was at a faster pace than the 23.7% and 21.4% decreases in the first and second quarters of 2019. Despite the overall reduction, the truck segment continued to impress with a year-over-year increase of 8.8% in the third quarter which was higher than the 4.1% and 7.5% gains in the first and second quarters of the year.

As a whole, the U.S. industry is continuing to see a slower pace from the record year in 2016 as the industry is no longer seeing the benefits of 2018’s tax cut and the overall economy is dealing with unfavorable headwinds. Industry-wide sales fell 1.4% year-to-date through September, largely due to a 12% reduction in the month of September. Despite the slowdown, most industry experts are forecasting a full year sales number of roughly 17 million vehicles which is only down slightly from 2016’s record of 17.55 million vehicles sold in the U.S. Estimates are up slightly from the beginning of the year where many analysts expected U.S. sales to drop below 17 million new vehicles sold for the first time since 2014.

In the full year 2018, Ford’s Car segment saw an 18.4% decrease from 2017. The segment is selling at an even slower pace in 2019 with year-to-date sales down 24.5%. On the other hand, the SUV segment is struggling despite the industry shift to larger vehicles. Ford SUV sales are down 5% year-to-date despite increasing by 0.5% in 2018.

For the year, Ford is down 3.5% year-to-date compared to other brand such as General Motors (GM) down 0.8%, Fiat (FCAU) down 1%, Honda (HMC) down 0.1%, and Toyota (TM) down 2.5%. On the other side, Volkswagen and Subaru were two of the few to manage increases through the first 9 months of the year with gains of 4.5% and 4.4%. Despite the drop in volume, the automakers are still expecting a profitable 2019 due to the ongoing consumer sentiment shift to higher margin vehicles. The automakers are benefiting from this shift to crossovers, SUVs, and pickup trucks as consumers are abandoning passenger cars, which works favorably for Ford, which relies heavily on the success of its F-Series pickup truck.

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.

Given the reduction in car sales and increase in truck sales, it’s no surprise that Ford has been able to increase its transaction price. In the 3rd quarter, the average transaction price increased to $37,900 per vehicle which was an increase of $2,200 or 6% from last year. Even with the increase in pricing, Ford sold over 240,000 trucks in the third quarter, making for the best third quarter for the segment in 14 years. It pushed the year-to-date pickup sales up to 6% while F-Series continues to expand its leadership position by 200,000 trucks thus far. Ford clearly knows how to sell a truck and its competitive advantage in this market has never been stronger.

Financials

When Ford reported second quarter 2019 earnings, automotive revenue of $35.8 billion beat estimates by $550 million, while Automotive EBIT was $1.4 billion, up 19% from the previous year. As seen by the quarterly results, the company was able to improve earnings due to the favorable sales mix. This was primarily seen in North America where consumers are buying higher margin vehicles and high-end trim levels. In addition to North America, Europe’s EBIT of $53 million was $126 billion improved from last year while China saw improved revenue by 48% from the prior year. All of these combined allowed management to reaffirm adjusted EBIT guidance for 2019 that shows improvement from 2018.

Looking Forward

While Ford has been able to capitalize on a consumer sentiment shift to larger vehicles and its F-Series pickup truck, overall profits at Ford have lagged due to ongoing restructuring activities. Earlier this year, Ford announced that it was cutting 10% of white-collar jobs as part of global restructuring that will save the company $600 annually. Included in the cuts are 20% of upper-level management positions that will be cut permanently. While costs associated with this restructuring are weighing on short-term results, it should make the company leaner going forward. With the economy signaling a possible recession on the horizon, this is critical.

The slowdown appears to already be hitting the industry and it's only going to get more difficult, as the industry still hasn’t receded significantly from record highs in 2016. 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 trucks and taking measures to restructure the company in order to become leaner, I think Ford is in a good position to compete in a tightening domestic marketplace, but it must make strides in other markets.

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 SUVs and trucks becoming more fuel-efficient, this hopefully won't be an issue.

Ford has announced several partnerships this year. Earlier in the year, Ford announced a partnership with Rivian with a $500 million equity investment. Rivian is an electric truck startup that has already developed two clean-sheet vehicles. The investment will allow Ford and Rivian to work together in developing an all-new, next-generation battery electric vehicle to add to Ford. More recently, Ford entered into a joint venture with Mahindra in order to increase penetration in India. Ford hasn’t been successful in India with a market share less than 5%, but by combining forces with a company that has proven to be successful in the market should be valuable.

In addition to the economy, Ford and the other auto manufacturers are seeing headwinds in tariffs and unions. While Ford and other auto manufacturers were able to avoid potential tariffs with Mexico earlier in the year, there is still uncertainty with China. With the U.S. charging tariffs on certain Chinese imported goods, China is threatening to raise tariffs on certain goods imported from the U.S. Given Ford’s exposure in both countries, they have a lot to lose in a trade war. Despite the escalating trade war, Ford is moving along with plans to build Lincolns in China given the popularity of the vehicle in the country.

As General Motors shareholders have seen, negotiations with the United Auto Workers (UAW) union can be costly. General Motors hasn’t been able to strike a deal with union workers which has resulted in a 3-week strike. The strike has cost the company more than $1 billion as the company has lost production of 118,000 vehicles and there is pessimism about a resolution. On the other hand, the UAW has reported significant progress has been achieved with Ford as 18 out of 20 Ford subcommittees have reached tentative agreements or have made significant progress. While there is a lot that could still go wrong and we don’t know the sticking points of negotiations, Ford only has to look at General Motors to see the impact that a strike can have on a company’s financials.

Valuation

After a sluggish month, the stock increased in value to approximately $9.98 per share, down slightly from $10.30 a month earlier as a result of the earnings release. At this level, the Price-to-Earnings Ratio (P/E) of approximately 6.7 appears to be fairly valued compared with other key competitors including GM at 5.5 and Toyota at 10.7. However, the industry average is at 18.4 and Ford should be at a slightly higher PE valuation than other automaker competitors given their product offering in the current environment. Additionally, the industry continues to trade at a large discount compared to the S&P 500 which could be beneficial as investors move into value stocks.

Given the restructuring initiatives, there has been concern regarding the company’s dividend. 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 made their feelings clear in the third quarter of 2018 earnings call:

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.

Ford has kept true to that word and recently declared a $0.15/share dividend which was in line with the previous dividend. This represents a near 7% forward yield and is showing management’s commitment to the dividend.

Conclusion

While sales volume has been decreasing, the company has been able to sell higher profitable trucks through the first 9 months of 2019. The company is focusing on international markets and restructuring the company to become learner to continue pushing profits higher. Given these profit growth opportunities plus the company's forward dividend yield of near 7%, I believe the stock is attractive at current prices. While domestic auto sales are expected to decrease, Ford is perfectly positioned to continue pushing higher profit margin vehicles with its larger vehicle offering, including the F-Series, Edge, Flex, and Explorer.

While I do expect some short-term pressure as the company restructures to become a leaner company, in addition to headwinds from the trade war with China, I think it will come out in better shape on the other side.

This article was written by

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

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