What's Wrong With the Blue Oval?

By Chad Henage - August 3, 2012 | Tickers: F, GM, TM | 0 Comments

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Buying Ford Motor Co. (NYSE: F) today is a bit of a leap of faith. However, buying shares at this point is a much more sure thing than it was in the doldrums of the Great Recession. For those who missed that bargain, the recent drop in Ford shares represents another opportunity. Unlike in 2009, the company today pays a dividend, and is on the cusp of achieving better financial stability.

Though the company's recent earnings report wouldn't appear to show it, cyclical companies like Ford are best acquired when there are doubts about how well the company will do going forward. Usually this is an indication of potential instead of trouble. The company's primary issue is something that has affected many car companies over the years. A temporary setback in quality is one thing; lack of demand for your product is something altogether different. Ford certainly does not show a lack of demand based on its North American division's results, but recent quality issues have been a drag on the stock.

North America is Ford's greatest opportunity, as I found out recently that over 17% of the vehicles in operation in the U.S. are made by Ford Motor. The company has made tremendous strides introducing differentiating technology into each of its models. This is both a blessing and a curse, as greater technology allows the company to charge higher prices for similar vehicles. However, with technology comes both a learning curve and support issues that the company would not have otherwise. In North America, Ford's revenue increased 1.03% and the operating margin increased 0.4%, which led to a pretax profit increase of 5.35%. Given that this quarter is not normally a busy one for vehicle sales, Ford's attractive models and options are pulling in buyers. As proof that Ford is doing the best in North America, consider that the company's operating margin was 10.2% in this region compared to 4.9% overall. Most of the challenges that Ford faces can be solved by applying some of the same thought processes to their international operations that the company currently uses in North America.

The two most challenging regions for Ford are South America and Europe. Both regions showed revenue down over 20%, with steep drops in pretax profit. Ford Asia Pacific Africa showed a revenue increase of 9.52%. This division showed a $66 million loss, versus a $1 million profit last year. In all three cases, the company plans to address these issues with the Ford One plan. The short version is, the company streamlines model choices, and introduces new innovative technology as a differentiating feature. If the company is even half as successful overseas as it has been in North America, each of these divisions should be expected to see better revenue growth, and improved earnings over time. Certainly if each region's economy was more stable, that would help matters too. While investors wait for this turnaround, investors should be encouraged by the improvement in the company's other division, Ford Credit.

While revenue was down 5% and pretax earnings decreased 27.48%, Ford Credit still turned in positive pretax earnings. If the economy continues to slowly improve, this not only benefits Ford's auto sales, but also its credit division. The fact that Ford is lessening the leverage that Ford Credit maintains, should improve both the company's future results and credit ratings. Specifically, this division expects to return $500 million - $1 billion to the parent company this year. In addition, Ford Credit expects leverage to decrease from the earlier target of 10-11:1 to a new target of 8-9:1. Now that we've looked at each of the company's divisions, what does Ford expect for the remainder of the year?

Ford's expectations are for industry volume of between 14.5 million and 15 million vehicles. The company expects to maintain 15.4% United States market share and just over 8% European market share. The best news for investors is, the company expects automotive pretax operating profit of at least $6.3 billion. These expectations are part of why I believe investors have basically two choices when it comes to buying auto stocks.

The first choice, of course, is Ford. The company is easily the strongest domestic auto company, pays a dividend of over 2%, and is expected to grow at over 11% in the next few years. When you compare these numbers to General Motors (NYSE: GM), growth investors could at first see GM as a better option. The company is expected to grow at over 14% in the next few years, and while they don't pay a dividend, the shares appear cheap at just six times forward earnings. However, General Motors still has a massive share overhang from its agreement with the federal government. Since the government has no desire to own the shares, this overhang places a cap on the amount of gains investors could expect from GM. I would recommend investors stay away. This leaves Toyota Motor (NYSE: TM) as another attractive option. Because of supply disruptions and natural disasters, Toyota is coming off some of the most difficult years the company has ever experienced. Because of this, analysts are expecting significant growth in earnings over the next few years. While the company's dividend of 1.3% doesn't quite match Ford, its higher growth rate of over 30% is something that Ford can't hope to achieve. If there's one differentiating factor between these two companies, it is their current operating margins. Toyota's operating margin of just 1.91% falls far behind Ford Motor, which sports an operating margin of 4.9%. Investors should consider which of these two auto manufacturers should be a part of their portfolio. The last several years have created a lot of pent up demand that will benefit the top auto companies in the years to come.

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