I’ve driven at least 7 different Ford (NYSE:F) cars at some point in my lifetime. Suffice it to say, I am a Ford man. But when it comes to Ford stock I am of a different mind.
Ford’s Stock Performance
First and foremost, lets look at its performance over the past decade. Back in February of 2001 the stock was trading around $28 per share. As of today, its at around $15.50 giving us a negative return over the past 10 years. However, during the worst of the financial crisis the stock dropped as low as $1.72 (November 11, 2008) so if you were smart (or lucky) enough to get in at those prices you would have realized a fantastic return. That said, I analyze all investments from the perspective of a business owner not from that of a trader.
The Fundamental Analysis of Ford’s Business
Looking first at their balance sheet, what I see is simply awful. In its most recently filed 10-Q they had total liabilities of nearly $179 billion. As of that filing the company didn’t have any actual equity! This is a company that played a founding part in the industrial and manufacturing revolutions that took hold in this country beginning in the twenties and nearly a century later it doesn’t have any equity! That alone is a horrible indictment of the management of this company prior to CEO Alan Mullally’s arrival.
Fortunately, Mr.Mulally brought with him competence and a record of achievement that Ford has greatly benefited from since his tenure began. The former Boeing executive brought back the popular Taurus, executed an aggressive and now successful cost cutting strategy, and invested heavily in development of new models. Unfortunately, the cards are stacked heavily against Mr.Mullally as far as future growth is concerned for Ford.
Despite the United Auto Workers’ renegotiation of their wages, pensions, and health care benefits, those expenses and liabilities remain massive. While Ford has renegotiated its debts, they are still massive and still serve as a very large reminder that this firm has substantial financial risk.
The weakness of the balance sheet by itself is not an insurmountable obstacle as it pertains to the question of whether I’d want to own this stock. There are plenty of distressed companies that serve as great long-term investments provided there is a real comeback story to believe in. Where my problems with Ford lie is in the lack of top line growth that we can expect going forward.
Current analyst expectations for earnings growth for the company are around 13% per annum for the next 3 years. I find this to be a highly unrealistic assumption for a variety of reasons. For one, the company made $7.2 billion when the market was at around 17 million vehicle sales per year. Right now, its at around 11.6 million with no expectation of it returning to that heightened level any time soon. Granted, the current incarnation of the company is much more cost efficient than the 1990’s version, but the severely shrunken market is hardly the only top line risk.
Secondly, even the analysts’ expectations for revenue growth are only about 2% per annum which means nearly all expectations for increased profitability from Ford come from cost cutting. But as Friday’s earnings release illustrates there is only so much to be gained from that strategy – Ford missed consensus earnings by 38% due partially to commodity inflation and losses in Europe. Adding insult to injury, revenues actually dropped around 6.6% reflecting the hangover from the expiration of the Cash-For-Clunkers program. As expected, the program merely pulled purchases forward. It did not result in a lasting boost to the industry.
As most business media outlets have been reporting since the Federal Reserve began its aggressive quantitative easing program, commodity inflation has been and continues to be a real fear. Auto manufacturers would be hit in a multitude of negative ways by such inflation and as Ford’s earnings release demonstrates, they’re already beginning to feel that pinch.
But there is another aspect of inflation Ford especially needs to worry about. If inflation runs persistently higher than the 2.5% annual rate the Federal Reserve targets, Ford could see higher borrowing costs in the future. The company has to refinance over $65 billion in debt over the next three years. For every 100 basis point increase in interest rates, Ford will have to pay $650 million more per year for its money resulting in around a $422 million, after-tax, annual reduction in earnings.
Besides the financial and general business risk mentioned above there is also substantial regulatory risk to factor in which can be next to impossible to predict or quantify. The nationwide push for fuel efficiency isn’t going away and both current and future regulations will drive the costs of production of automobiles up. Each state currently has different regulations governing emissions. Some states are lenient while others are not (California being the most strict). Variation in regulation will only serve to keep Ford’s costs of production up and depending upon how future regulations unfold they may very well worsen those costs.
From the time I began writing this piece to today, Ford stock has dropped around 17%. Despite what seems like a buying opportunity, I can not justify purchase of Ford at this time. I see a company with a weak balance sheet and a highly complex cost structure that is potentially victim to inflationary pressures, labor unrest, and regulatory risk.
Even when I run the more optimistic earnings projections through a simple valuation model, I do not arrive at a valuation that is substantially higher than the company’s current valuation to justify the risk of ownership. I have little doubt as to the talent of Alan Mulally, Ford’s Chief Executive Officer. He has more than proven his worth since his arrival at the company in 2006 as he has led a relative resurgence in both the Ford brand and the company overall.
I also believe that Ford will continue to build great cars that I will likely be driving again in the near future. But managing Ford’s survival and executing a true growth strategy are not the same thing. So while I think Ford will survive, I do not see the type of appreciation potential that the market apparently does.
Disclosure: No positions.
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