By Emil Emilov
Over the last 5 years Ford Motor Co. (F) has seen some fairly tough times with the rest of the industry. The company seems in a much better condition than it was in 2006 when its restructuring process began. A shift in the company's focus and some deep cuts allowed Ford to be the only one of the big Three to survive the crisis without getting direct government aid.
After three years of losses, the company posted gains for the years 2009 and 2010. Given the company's results for 2011 to date, we may reasonably expect that it will finish this year with a profit as well. Revenue is still lagging those of the pre-crisis years but the company now looks stronger and more focused. Although Ford is still second in market share amongst the automotive manufacturers in the US, its “One Ford” plan seems to be able to successfully navigate the company through difficult economic times.
The comparative financial strength of Ford toward its competitors is evident in its financial statements. Liquidity ratios are stronger than rival General Motors (GM). During the third quarter of 2011, the company reduced its debt by $1.3 billion, which now stands at $12.7 billion. In efficiency terms, Ford is utilizing its work force better as each of its workers produces about $790 thousand in revenue for 2010. Revenue per employee for GM for the same year is lower at about $671 thousand. Ford managed to increase gross margins last year to 22.9% from about 14.3% in 2009. The company has achieved a 16% gross margin on average for the last 5 years. GM's gross margins are 12.39% for 2010 and a loss in 2009.
Ford signed a four-year contract with the United Auto Workers recently. As this article from Bloomberg states, the contract is expected to increase hourly labor costs for the company to $59 from $58. That could bring an overall annual increase of less than 1% to the company's labor costs. Ford's managers hope to avoid cost increases with improved efficiency.
The closure of the contract should give Ford a more predictable and flexible work environment in the US for the next four years. An interesting feature is that it allows Ford to hire new workers at a lower wage ($15.78) than that of experienced workers (about $28 per hour). For the term of the contract that entry level wage would rise to $19.28. Ford's officials also said the company will offer buyouts to higher-paid workers, which if accepted, could also lower its labor costs over the four-year period. The buyouts range from $50,000 for production workers to $100,000 for skilled-trade employees. The company hopes 900 to 1,000 of the skilled-trade people will accept the offer.
That would mean about $1B of cash outflow but would allow the company to hire less costly workers or cut production runs. With cash relative to current assets amounting to about 14%, such a cash outflow should not pose a problem. In the long run however, the accepted buyouts would lower further the costs of goods sold and have the potential to increase the company's margins.
Upon contract closure, Ford's credit rating was increased from each of the three major credit rating agencies. Fitch Ratings was the first to announce its upgrade, followed by Standard & Poor's and Moody's Investor Service. All of the agencies put Ford's credit rating one level below investment-grade.
Higher credit ratings could allow Ford cheaper access to capital. That in turn would allow some debt restructuring to take place in order to take advantage of lower rates. Still the company has to stick to its plan of reducing its debt to $10B by mid-decade in order for the credit rating to sustain or improve.
Apart from its strong financials, Ford’s advantage over competitors remains its focused approach toward production lines. Optimizing the global costs of production could help Ford increase its margins and provide greater value to investors.
Although long-term profitability is intact, the short-term still poses challenges for the automaker. One such event, which could weigh on Ford's fourth quarter results, is the Thai flood last October. Ford estimated that a loss of 30,000 vehicles is possible due to disruptions in supplier factories. This could lead to a decrease of inventories and a possible supply shortage at some point.
The volatility in Europe also presents some danger to the company's development and results as the strong US dollar holds back the company's profits from its European segment in dollar amounts.
Current trailing price to earnings stands at around 6.7 times and price to cash flow is close to 6.1 times. The stock has lost 22% over the last 12 months to close around $11.15 recently. A long position in the stock could be hedged by options in order to minimize the downside risk as the stock's price could break out of its range. A January 2013 put option with a strike of $10 was priced at $1.56 as of the time of writing. Although we could use shorter options to hedge against the effect of a temporary event like the Thai flood, we don't know exactly how long it will take for the volatility from Europe to disappear. Chances are the further in time we go, the less volatility we have. That makes the January 2013 puts a suitable choice. Paying the put premium would effectively increase the stock price for the investor with the amount of the premium. Thus the break-even price increases to about $12.71. These puts limit the downside risk to about 21% while allowing the investor to take full advantage of a possible increase in the stock's price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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