Is it too late to own a stock that’s up over 425%? Editor Kent Lucas analyzes one of America’s most beloved and controversial sectors and its most impressive stock performer.
That the automobile has practically reached the limit of its development is suggested by the fact that during the past year no improvements of a radical nature have been introduced.
– Scientific American, June 2, 1909
See any irony in the quote above? (Hint: Make sure to notice the date – over 100 years ago!) Today I’m going to talk about one of the big performers of 2009: Ford Motor Company (F:NYSE).
Autos – A Very Tough Business to Be In
Over the years, I spent a lot of time in Detroit analyzing the auto industry. (Let’s keep Detroit jokes to a minimum – no need to kick the city when it’s down.) The automotive industry has played a critical role in United States – economically, culturally and technologically. And despite Detroit’s downfall, global vehicle demand will continue to rise and evolve, making autos an intriguing area of the market.
With that said, this is a very tough arena to make money in. More years than not, companies can’t make a positive return on their total investment, especially given the automotive industry’s combination of capital intensity and economic sensitivity.
It’s a horribly structured industry from all angles. Let me name a few issues off the top of my head:
- tremendously high fixed costs and capital intensity
- historically high pension and employee benefit obligations
- terrible pricing and marketing models
- determined (and very good) competition
- an oversupplied and profit-challenged U.S. dealer/distribution infrastructure
To say the least, there are no easy solutions and no quick or easy fixes. So what happened to the automakers this last time around?
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An Unprecedented Downturn
2009 U.S. light vehicle sales were 10.4 million units. That’s the lowest level since 1970, down 21% from 2008 and down roughly 40% from peak years 2000-2007 (17+ million units). It was ugly out there, and it still is.
But Ford, which did not take any government funds, made it through the darkest days (while General Motors obviously didn’t)...
Since 2008, Ford’s market share has grown bigger and bigger. In the 12-month comparison between December 2008 and December 2009, Ford’s market share grew from 14.9% to 17.3%, whereas GM’s shrank from 24.5 to 20.1%.
We Know It’s a Moneymaker
The automotive business is extremely “cyclical.” When the economy is strong and sales are rising, earnings can recover and grow rapidly. That’s when you make the most money in cyclical stocks – on the upswing of the cycle. GM and Chrysler couldn’t survive the downtown – the harshest part of a very harsh cycle – but Ford had saved some cash, borrowed additional rainy day funds at just the right time, and overall managed its business quite skillfully in a dangerous time.
As the panic subsided in early 2009, investors saw evidence of a potential recovery and became more confident that vehicles sales had bottomed. That (along with GM’s demise) caused Ford’s stock price to take off, racking up truly impressive gains in the past year. So what’s next?
Global Picture Improving
Globally, vehicle sales are set to improve. Unemployment, personal income and consumer confidence are critical economic figures that influence the decision to purchase a new car. And for the most part, in my view, the trends appear favorable for this data as we are coming off the bottom.
(And yes, government incentives such as “Cash for Clunkers” have played or will play a major role in many countries, including the U.S., China, Germany and France.)
In addition, global vehicle inventories are now very low. In the U.S, for example, at year-end, there were only 53 days’ worth of vehicle supply (think of the number of days cars sit on the lots) compared to a 93-day supply a year earlier. Ford’s was 87 vs. 60. As consumers start buying up vehicles, manufacturers will have to ramp up production to meet demand.
Also, since few people have been buying new vehicles lately, the average age of U.S. vehicles recently jumped to 9.4 years, the highest level in a quarter century. According to Scotia Group, over half of the 250 million vehicles on the road are over 10 years old. Sooner or later, many people (including myself) are going to buy a new car.
Emerging Market Volumes Strong
Emerging market sales are driving future volumes too. In countries like India, China and Brazil, the rise of the middle class and the transformation from two wheels to four is very powerful. Last year, China became No. 1 in light vehicle sales (cars and light trucks), surpassing the U.S. While developed countries find their economic recovery footing, the fast growth from emerging markets will support sales.
As a mild concern, these volumes won’t directly translate into similar profits. In these markets, the problem is that the demand is for small vehicles, not large ones. Right now, the cost structure for established manufacturers like Ford make it tougher to turn a profit on small cars, especially compared to the profit margins from SUVs, pickups and luxury cars (where the Big Three historically made most of their money).
Upside for the Stock?
Well, the bad news here is that most of the good news I just discussed is already factored into Ford’s stock price. The momentum behind the stock has been incredible, from a low of under $2 to over $11.
What a great move – although the stock price might have more room to run. If sales continue to recover, earnings should follow. For example, if Ford’s 2010 automotive revenues are up more than 10%, or vehicle sales and capacity utilization get back toward historic levels, then earnings could be materially higher.
On the other hand, if all the dominoes fall in the auto industry’s favor, Ford earnings in 2011 could easily exceed $1.10 (current Wall Street estimates). If that happened the stock should surpass $20. But that’s a big “if.”
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It’s good to remember the “ifs,” as there is a lot more to the story and to earnings than just vehicle sales. Who knows, for example, to what extent incentive programs used by various countries to promote sales will continue. Then there is the shift to a less profitable product mix (emphasis on smaller vehicles versus large) that I touched on earlier. Rising commodity prices could further hamper profitability. And, Ford has pending balance sheet concerns; efforts to shore up the balance sheet by raising more capital via the issuance of new shares (a move that has been suggested) would dilute earnings for existing shareholders.
Making sense of these puzzle pieces is what makes investing so challenging and so much fun (at least for me). Let me add here that Ford is currently not in the Safe Haven portfolio (that would have been nice though). As a value investor, I generally don’t like to chase a stock after such an incredible move.
On the bright side, as I dive deeper into Ford’s fundamentals and earnings potential for the next few years, I admit I’m more excited and constructive than I would have guessed for a stock up almost 8-fold off its lows from last spring. There could be more upside to come… stay tuned.
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