Ford: Can’t Stop This Stock

by JT McGee

Let me just say that I think the automotive industries is one of the most toxic places for investment capital. It’s cyclical, following the ebbs and flows of the macro trends, subject to the dangerous pork cycle, and known for low returns on capital, high fixed costs (even in labor, thanks to unions) and making investors poor and consumers rich.

Now, all that said, I’m also a hypocrite having invested and held Ford stock options. I think Ford has done what the automotive industry needed for a very long time. It changed the game.

Ford has:

  1. Focused on what consumers want by making MPG the major selling point.
  2. Significantly reduced costs by relying on common platforms.
  3. Gone back to the old days of selling cars “in any color you want as long as its black” by simplifying its line up.

Thanks to these changes, I think Ford is the best positioned of any automaker. Because cars are a relative commodity, and because Ford has the highest MPG cars that it can make at the lowest relative cost (thanks to common platforms, scale, and self-financing), I’m a firm believer in the company going forward.

Ford’s Doubled Dividend

Today Ford announced that it would double its dividend from $.05 per share per quarter to $.10 per share per quarter. This makes the effective yield close to 3% per year, which is consistent with high-quality dividend paying equities that investors love. In my original thesis, I thought a higher dividend would be good for Ford shareholders, since dividend chasers are propelled by Ben Bernanke to buy almost anything. Plus, dividends make it costly for short-sellers to use Ford (F) as a proxy for shorting autos/Europe, which Ford obviously has a lot of exposure to.

It does not appear that a higher dividend will negatively impact the company’s recently earned investment-grade debt rating, either.

Ford’s higher dividend is also good going into Ford’s next earnings report. Raising a dividend before an earnings announcement leaves me to believe that the company’s European concerns are not as big as investors once believed. Ford shareholders will remember the company selling for less than $9 per share last June on European woes. Now 50% higher, investors are much more confident in improving trends at Ford Motor Company.

Ford’s Model Success

Ford now has the best selling car in the world in the Ford Focus, selling more than the Camry, Civic, Corolla, etc. – Ford is besting the Japanese automakers in volume in compact/midsized cars. Additionally, the F-series pickup truck continues to be the best selling truck in the United States. It’s estimated that Ford makes as much as $10,000 per truck, versus $1,000 or less for compact and midsized cars like the Focus or Fusion. Finally, the company’s C-Max hybrid launched at the fastest of any hybrid launch in history. It’s already outselling the two Prius models it was designed to compete with.

I 100% believe Ford’s success is driven by the EcoBoost engine. Ford’s EcoBoost adds 20% more fuel economy to most vehicles while adding only $995 to the cost of a Ford car or truck. This is the most obvious investment a consumer could ever make, as a 20% improvement in fuel economy for a one-time investment of $995 is something that I think most every rational driver would recognize as a tremendous value.

I think automakers like Ford will continue to lead in the recovery because of fuel economy improvements. People are naturally irrational, terrible at hyperbolic discounting. As such, I think people will continue to buy fuel efficient cars and use the future savings in gas mileage to buy cars at a higher trim level. This can be seen in sales of Ford’s Escape, which is an SUV built on the Focus/Fusion/Fiesta platform with impressive reported MPG. Customers are snapping up the SUV at all trim levels. Higher trim levels bring much, much higher margins.

Moving My Money

I have a position in January 2014 LEAPS at strikes of $12 and $17. The total position is up a little more than 50% since initiated in October 2011.

I’m selling (have sold) my $17 calls and recouped 25% of my total investment in the pair. So, now I’m holding only the $12 strikes, which I intend to hold to expiration. At $2.50 each, most of the value is intrinsic value seeing as Ford sits at $13.85 per share.

I’m keeping my price target of $20 per share. I think the tailwinds are good (American auto fleet is the oldest ever), margins will stay high in the United States, and that the operating leverage inherent in a cyclical indebted company can’t be found by just slapping an earnings/ebitda multiple on it. Ford’s common platforms will reduce the amount of capex necessary to retool, which means it can’t be compared on simple ratios to peers. DCF and sum of the parts valuation (including the Ford Motor Credit equity) says $20-22 to me.

Disclosure: I own Ford LEAPs and will continue to write about this position since it’s one I initiated after announcing it on the blog.

P.S. Someone asked why I could be long this/picked it for the 2012 contests and not include it in my stock picks for 2013. Here’s why: Ford is highly-correlated with the broad market (perhaps less so now after the dividend, but I didn’t expect the dividend hike and don’t know anyone who did). SODI, CNRD, and ACAS are not correlated at all and are severely undervalued with what I believe to be obvious catalysts. I didn’t want to overshoot on beta by adding Ford when I could just run with SPY. Planning for a 1 year portfolio is very different than picking stocks to grow your wealth over whatever timeframe. In real life I own F and zero SPY.

{ 7 comments… read them below or add one }

Andrew @ Listen Money Matters January 10, 2013 at 18:45

Very interesting analysis. I always appreciate your market analysis JT, especially your year over year picks and reviews. While anyone can pick a stock, I think your constant reviews give credibility to your picks.

Keep it up! If I weren’t closing on a condo right now I would probably be following you into Ford. Being the only auto maker that didn’t need government support, I already have tremendous respect for them.

Reply

JT McGee January 11, 2013 at 13:21

Thanks for commenting, Andrew. I like to keep up with them if I post them just for clarity. Not fair to talk about something and then let it go.

Ford’s ability to stay afloat without accepting any government money definitely created a tone of goodwill with the American people. Now let’s hope the American people pay it forward by driving a Ford off the lot. ;)

Reply

101 Centavos January 11, 2013 at 05:33

Ford more than the other two has benefited from productivity and outsourcing. I don’t know the exact figure, but their direct labor costs per unit have dropped dramatically over the years, compared with, let’s say 1980.

Reply

JT McGee January 11, 2013 at 13:23

Ford’s production process is all-around a heck of a lot better than its peers. I think a lot of it is coming back to common platforms. If you can build 4-5 different automobiles with 80% of the same key parts, everything is going to be more efficient.

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PK January 11, 2013 at 10:52

Who would have thought we’d kick off 2013 both cheering on auto stocks (TTM, baby!). Good luck.

Reply

JT McGee January 11, 2013 at 13:23

I think we fail as value investors.

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Dustin Small January 11, 2013 at 22:07

I don’t own Ford as an investment but I did buy an F-150 truck recently with a V-6 ecoboost engine. It’s amazing the power that such a small engine puts out — just as much as older V-8s. Quiet, comfortable and with some other great features too. Ford is probably one of the most advanced car manufacturers now as far as technology goes which is great to see.

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