These Ford options are throwing me for a loop. Set to expire in January 2013, and placed at the $10 strike, the bid fell back to my entry price of $1.95. Yesterday I decided to go longer, and have completed my move. I’ve swapped my 2013 calls for January 2014s. I’ve also moved to two different strike prices, both of which are out of the money.
The trade does allow me to double down with twice the position. I purchased the January 2014s with strikes of $12 and $17, while keeping the total outlay at the same amount. Moving up from the $10 strike obviously increases the risk of loss; however, it also gives me an additional year to wait out the trade.
Bond upgrades are not coming as fast as I thought, though Fitch became the first agency to move Ford up to investment grade. Also, the credit markets were surprisingly responsive to the upgrade, as credit default swaps on Ford’s debt fell 40 basis points in today’s trading. Declining long-run cost of debt service only increase the fair market value for the company.
Where the Upgrade Pays Off
Ford recently amended its terms on a credit agreement for short-term capital through a revolving credit facility with a $9 billion line. While the company has only $180 million drawn on the facility, the terms state that the collateral securing the facility and limitations on debt prepayments and dividends to shareholders will be removed upon a second investment grade rating from one of the three major agencies. Fitch is number one, Moody’s or S&P will have to be the second.
Ford essentially signed its life away when in 2006 it pledged virtually every asset available for funding worth $23 billion. It’s one more upgrade away from freeing up that collateral to use for cheaper financing. One more upgrade also enables it more freedom in making prepayments on obligations, and distributing cash to shareholders in the form of dividends and buybacks. Fitch did note that shareholder friendly decisions that burn cash could negatively affect the company’s rating, but I’m going to call Fitch’s bluff and say that they’re full of it – especially if another agency steps up to go investment grade.
Recent sales data for its cars was…well, good enough! Five percent year-over-year growth may appear modest, but there’s very little real growth priced into the company at the present time. Higher gas prices haven’t affected its sales of trucks, which are a key part of its sales mix. Also, the Focus rocked a 65% sales gain compared to the same period a year ago – the company had supply issues that negatively affected Focus sales last year.
In a perfect world, Ford shares would rise to $20-25 per share by 2014, which is what I determine to be a fair value for the company today. A move to $20 per share would give me a return of roughly 500% on the $17 strikes, and 433% on the $12 strikes.
Of course, Ford has to close above $14 per share by January 2014 to breakeven, which is a 22.8% move. That’s a big hill to climb, but we have plenty of time. Conveniently, a 22% move would essentially cover my discount rate I used in my model.
Moving Out Another Year
One additional year before expiration allows for some clearance over a couple obstacles:
- Debt upgrades – Hurry up! Either way, any upgrade takes time to affect the fundamentals of a company, but upgrades always excite Wall Street.
- Industry mix – Toyota and Honda are both back to doing business after the Japanese earthquake and tsnunami. Pent up demand for these two automakers, which have incredible brand loyalty, will likely affect Ford’s supposed market share in the short-run.
- Wall Street – The terrible thing about Wall Street is that being right is contingent on other people agreeing with you. Ford really is, in my view, one of the most underrated bargains on the market.
Catalysts: More institutional demand as dividend puts mutual funds on the radar; increased pace for housing starts, which is good for construction demand; improved employment, which justifies a car purchase; higher gas prices, which gets people to the car lot; and pent-up demand as American cars are now the oldest ever at 10.8 years on average.
Game plan: Hold until expiration in 2014, or until my own greed subsides at $20 per share. Alternatively, put my life savings into long-dated calls if Ford stock drops to $9 per share. (I’m kidding, but not really.)
I’ll keep logging this play as time goes on, since it was a position I openly announced on the blog.