This Auto Manufacturer is the Clear Winner
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There is a battle raging between General Motors (NYSE: GM) bulls and Ford (NYSE: F) bulls. Many of the arguments in favor of GM, nicknamed "Government Motors" after accepting a government bailout during the recession, center around the advantages it has due to terrible past performance (namely, NOLs). However, Ford's thesis is based on it being a better company making better products than GM, which is why I side with the automaker that didn't need a bailout.
Cheap Based on Past Operations
One of the reasons I'm feeling bullish about Ford is that it's currently trading at a low multiple of historical free cash flow.
Since 2002, Ford has averaged a 5.54% free cash flow margin. This number includes the company's disastrous results during the recession. If you apply the 5.54% margin to last twelve months sales of $132.4 billion, you get $7.33 billion in 'normalized' free cash flow. At a 10x multiple of normalized free cash flow, Ford is worth $19.22 per share. Another way to look at it is that if you divide normal free cash flow by the current market cap, you get a 16.75% free cash flow yield. By comparison, GM trades at about a 5% free cash flow yield, which is about where it should trade.
I come up with a similar valuation when looking at free cash return on tangible invested assets. Ford earns about 4.15% in free cash flow per dollar of tangible invested assets. If you multiply $149 billion in last quarter's tangible invested assets by 4.15%, you get $6.2 billion in free cash flow. At 10x $6.2 billion in free cash flow, you get a value of $16.21 per share (14.14% yield). Meanwhile, General Motors' relatively modest free cash return on tangible invested assets suggests a value closer to $20 per share vs its recent price near $25.
Since Ford looks cheap based on historical operations, it will necessarily look even cheaper if we expect future operations to improve.
Ford is in Better Shape Today than it was Last Decade
Ford's cost structure has undoubtedly improved since just a few years ago. The most important improvement comes in the form of the company's collective bargaining agreement with the United Auto Workers. As of 2010, Ford is no longer responsible for the retired union workers' health care fund, which is removes an enormous liability from the balance sheet and lowered labor costs near that of foreign competitors.
Another cost improvement comes in the form of fewer auto platforms. Each platform uses a distinct design, requires specific components, and is produced according to its own set of standards. In the past, Ford has had a separate platform for each segment in each geographic location. This resulted in billions being wasted on production inefficiencies. When Alan Mulally assumed the role of CEO in September of 2006, he promised to dramatically reduce the number of platforms used by the company. As a result, the company will realize billions from economies of scale in its platforms.
Ford is cheap based on historical performance and has positioned itself to do better in the next decade than it did in the last. In addition to the recent cost improvements, the company is rolling out a line of much-improved fuel-efficient vehicles. Ford's fuel-efficient Focus and Taurus have received a much better reception than GM's Chevy Volt and other 'green' cars. So it appears that while both Ford and GM will do well in the next few years, only Ford has the staying power of a dominant company, whereas GM hasn't really solved any of its core problems. If you want to buy a U.S. auto manufacturer, buy Ford.
titans8904 has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and General Motors Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!