Shares in Ford Motor Company (NYSE:F) recently came off significantly following an earnings announcement that didn't quite match analysts' expectations. However, the shares have been a great investment over the past three years, rising from not much more than a dollar in 2008 to nearly USD 20 as stock exchanges recovered and Ford won market share in a recovering US auto market. With a USD56 bn market cap, it's a heavyweight share, with most analysts positive on the stock - so what went wrong to make the shares fall more than 12% in a single day?
On the positive side, Ford looks to have been doing well, having - unlike rivals Chrysler and GM - not taken bankruptcy as a route out of its problems. It's grown its market share for the past two years, with 16% of the market now, though there's still room for it to expand (its market share used to be around 20% in the 'good old days' before Japanese carmakers started making inroads). Toyota (TM), in particular, seems to have lost market share in the US last year. That puts Ford well ahead of the competition. The company has also got one of the youngest product ranges on the market, with 26% of its models recently upgraded and a further 19% to be upgraded or rejuvenated this year. That's well ahead of GM, for a start. Ford's surging sales over the past couple of years can be seen as evidence that it's spending its upgrade money wisely - it's creating new models that consumers really want to buy.
The company has also been paying down its debt. Most car makers have considerable debt - Ford is not the only one - but few are making such good progress on repayments. Moody's raised its outlook on Ford's debt from stable to positive at the end of last year, though it's still two levels below investment grade, and singles out Ford's debt reduction strategy as one of the reasons for its positive opinion.
So why the plunge in the share price?
Industry fundamentals are certainly one reason behind the fall. Commodities prices and oil prices have been spiking northwards. Higher oil prices don't directly hurt Ford, but are likely to put consumers off purchasing cars - particularly discouraging the purchase of larger, less fuel efficient cars, which will make it difficult for car dealers to 'upsell'. At the same time, increasing metals prices increase carmakers' input costs. That's one reason Ford made a loss in Europe last quarter, apparently. And those sparkling new models have also led to increased design and production costs.
Ford's debt also needs to be factored in. Looking at the enterprise value, rather than market capitalization - that is, including debt as well as equity in the financing equation - Ford doesn't seem as cheap. On a PE basis, Ford trades below GM but on an EV/EBITDA basis, the comparison is less favourable because GM only has 8bn against Ford's 19.1bn debt as at year end 2010.
Investors who are not convinced we're out of danger of a double-dip may well be trimming their exposure to indebted stocks. After all, compared to previous recessions, one of the most interesting features of this one has been the fact that we've seen few forced debt for equity swaps... but if anything does go badly wrong at Ford, the worry is that banks could be in the driving seat, and that would leave shareholders highly diluted. (If you want to know just how nasty a debt for equity swap can look, consider the example of Eurotunnel).
The auto sector has been a graveyard for investors, and one of the reasons is its marginal profitability. The highest operating margin in the sector belongs to Indian stock Tata Motors (TTM), at just over 10%; most of the major carmakers are getting six or seven percent, with some coming in way below that. By comparison, Microsoft (NYSE:MSFT) is getting operating margins of 40%; or to compare another manufacturing company, though in the tech not the automotive sector, Cisco (Nasdaq:CSCO) gets 21% operating profit on its sales.
Add to that the possibility of softer sales, and the impact on auto companies which have high operational gearing, and there's not much margin for error - if the car market catches a chill, those companies with low operating margins could quite easily see their next quarterly statements in red ink. Ford does have one of the better ratios - alongside Honda (NYSE:HMC) and Nissan - but it's still pretty slim.
Looking further out, the big question for investors in the sector is where is the exposure to growth markets? It's interesting to look at the research from JD Power, which shows over the next year that - perhaps surprisingly - the US is the place to be for car sales. Power says that global auto sales are rising at 6%, ahead of global GDP growth, but North America is expected to be by a long way the fastest growing market next year.
2011 Growth rate % | Units, m | |
Global GDP growth | 4 | |
Light commercial vehicles | 7 | |
Passenger cars | 6 | |
North America | 11 | 15.5 |
Europe | - | 18.1 |
Asia | 7 | 32.2 |
South America | 5 | 5.1 |
That would seem to be good news for Ford, which has got the US very right indeed in the last couple of years. However, that's only looking at 2011 growth rates. A typical value investor wants to see the likelihood of a five or ten year growth trend. For that, emerging markets offer a more interesting play than the US. First of all, they have younger populations, which means more drivers reaching the age at which they can get their first licence and buy their first car. Market penetration is also way lower than in the West. In the US, there are 1022 cars per 1000 drivers - that's right, more than one car each. In India, there are only 25 cars per thousand drivers, and according to BASF, China, which had 24 per 1000 inhabitants in 2007, will still only have 102 cars per 1000 in 2020.
And the US is no longer the world's biggest car market. That is now China, which is expected to see growth rates of 30% plus. Will Ford benefit from all this emerging markets growth? Possibly not, according to research from Global Insight. In China, Ford ranks only thirteenth in the car market with a 3.5% share. It's GM which is raking in the renminbi, with a 14% market share making it the country's largest automaker. So while GM's share price reflects its loss of market share in the US market, the company is presumably likelier to see its growth coming elsewhere.
Investors in Ford will be presumably watching with interest to see if it can raise its game in the East. Is it this concern that lead to the recent change in sentiment or more general anxieties about the oil price and its impact on the US economy? One reason to suggest that it may be the former is the way in which Ford traded up again this week, after announcing big plans for its Asian expansion. According to Zacks, it plans to introduce 8 new models in Southeast Asia over the next 5 years in order to boost its market share from 3% at present and will invest 7 billion yuan ($1.1 billion) in China in order to expand production capacity, amongst other measures. Shares in Ford were up 3.6% this week by Friday's close.
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