Is Ford's battered stock a buy? Time to kick tires
Problems abound in the U.S. automotive industry, and in the case of Ford Motor (F), they resulted in a 9% slump in profits in the second quarter, driving down the company's stock about 8% last Thursday, to around $12.50 a share, when Ford reported its dismal quarterly results.
Wall Street's negative reaction was understandable, but the selling was overdone in the mind of some close watchers of the second-largest U.S. producer of cars and trucks.
Most analysts showed their disappointment by downgrading the stock or cutting back their price targets and earnings forecasts for the next several quarters. Rightly so, since Ford management was frank in its assessment of what caused the earnings and sales downturn.
Robert Shanks, Ford's chief financial officer, acknowledged that several factors could weaken U.S. demand for the company's products over the coming year, such as higher costs, the impact of Brexit, and increasing global competition in the auto industry. "We are seeing elevated economic risk for the most part globally, and particularly in what is happening with Brexit," he warned. Shanks added that next year's industry sales could be weaker than this year's.
Part of his dire forecast may be designed to cloud a hitherto sunny outlook among investors and industry analysts. At General Motors (GM), the mood is not as stark: The nation's largest automaker last week raised its full-year guidance and remains optimistic about overall results for all of 2016 versus last year's.
Indeed, some Ford bulls argue that the disappointing second-quarter results were more of a hiccup than something to be concerned about over the long term.
"We expect Ford to overcome the problems it now faces over the long run as it sticks with its growth strategy, including achieving sales gains both from the international and U.S. markets," said Efraim Levy, equity analyst at S&P Global Market Intelligence. He has reiterated his "strong buy" recommendation on Ford even as he lowered his price target for the stock by $3 a share, to $15, based on both historical and peer price-to-earnings-ratio analysis.
At investment firm Piper Jaffray, equity analyst Alexander E. Potter said Ford's stock is "still a good buy despite the unmistakably cautious tone in the second quarter." He maintained his "overweight" rating on Ford's stock, with a price target of $15 a share, down from an earlier $17.
Potter noted that Ford's caution focused on competition in the U.S., macroeconomic uncertainty in Europe, and sudden margin compression in China: "We don't think they signal the onset of an insurmountable cyclical downturn," he argued. These factors will impact the company's financial results (and possibly cause Ford to miss its earnings guidance for fiscal 2016), but he said such problems can be addressed as the industry is adjusting to a "new normal" after six years of strong volume expansions.
And with market-wide production "unlikely to drop significantly, we think Ford will be able to maintain an 8%-10% pre-tax margins in North America," he said. Likewise in China, Ford's upcoming launches of new products should pave the way for a profit margin recovery, Potter predicted. As to Brexit's impact, the analyst cautioned that "our European margin outlook implies that Ford will not achieve its pre-tax profitability targets (6%-8%) anytime soon."
But Potter argued that Ford's stock "is still worth owning," even excluding the dividend, as Ford's dividend yield is approaching 5% after the stock's big sell-off. "This should provide meaningful downside protection, at least until investors gain conviction that an outright earnings implosion is unlikely (at which point the multiple should expand)," Potter pointed out.
His new earnings estimates reflect the pricing and margin pressure. Potter cut Ford's earnings for 2016 to $1.83 a share from a previous $2.14, and his 2017 forecast to $1.88 from $2.18. On revenues, he predicted $150.5 billion for 2016 from a previous $153.7 billion for the year, and his 2017 revenue estimates to $150.78 billion from $155.78 billion.
S&P's Levy said Ford "must now work to offset challenges from Brexit, China, and disruptions from third-quarter product changeover." He expects global demand for Ford's products will snap back before next year and place the company back on its growth pathway. The analyst has higher earnings estimates than Piper Jaffray's Potter's figures -- Levy's new estimates are $1.95 a share for 2016, down 17 cents from his previous forecast, and $1.93 for 2017, down 27 cents in his previous estimate.
His "strong buy" rating on the stock is based partly on Ford's attractive incentives, including a lofty dividend yield of 4.8% and a depressed price-to-earnings ratio of 6.5 times his 2017 earnings forecast. "We have favorable expectations regarding dividend growth and share repurchases," Levy said.
Ford's market share in the U.S. may be challenged by intense competition, Levy conceded, but it will definitely benefit from "fresh products and mix." And China represents one of the potentially largest sales and profit centers for Ford products. "Ford has been gaining market share in China," Levy pointed out, and has been "adding capacity in that region in order to keep up with riding demand for its vehicles."
"Our fundamental outlook for the automobile manufacturers is positive," Levy said. "We see U.S. automotive demand trending higher on a year-over-year basis."