Rising Star Buy: Ford

This article is part of our Rising Star Portfolios series.

When Ford Motor (NYSE: F  ) landed on the watchlist for my Messed-Up Expectations portfolio, I was a bit surprised. With better than a dozen analysts following the company, I wouldn't expect the market to ever reach a point where growth in free cash flow (FCF) was expected to be so low as to pass my screen, but that's exactly what happened. And I, for one, am not going to let the opportunity to invest in this strong, and strengthening, company pass me by.

The catalyst to this opportunity, I believe, is Ford's recent earnings report, which wasn't quite what the market expected. First, analysts were worried about costs in the fourth quarter that increased more than expected. Several analysts asked questions on the conference call focusing on this issue. Second, Ford's European division reported an operating loss of $51 million and more than a percentage-point drop in market share. Third, in the days following the report, several analysts cut their one-year estimates and/or price targets.

While those concerns are valid, I believe Ford is doing several things to minimize their effect. In combination, they show that Ford is focused on margins and growth.

Ford's response
First, the company's "One Ford" strategy is simplifying its engineering and manufacturing process. One result is that Ford is now building cars off the same base, with just regional differences, all around the world. CEO Alan Mulally referred to this in the last call when he said, "10 different top hats off that new C1 platform, with 80% of the parts the same." With that much the same, efficiency -- and cost savings -- follow all down the line.

Second, Ford consciously chose not to chase low-margin business in Europe last quarter. While that hurt market share in the short term, Mulally is confident that the new models coming out and the recovery in "the fundamental market" will lead to renewed growth in Europe.

Third, of the U.S. and Asian automakers, Ford was one of only two to significantly reduce incentives in the U.S. in January. While Ford's January sales grew by 13%, behind GM's 22% growth, boosting incentives to grow sales is of limited value over the long term, especially when costs increase, like commodity costs are doing currently.

Company

Average Incentive

Year-on-Year Change

Chrysler $3,414 (1.3%)
Ford $2,407 (11.0%)
General Motors (NYSE: GM  ) $3,663 16.0%
Honda Motor (NYSE: HMC  ) $2,016 41.0%
Nissan $2,510 (16.0%)
Toyota Motor (NYSE: TM  ) $1,962 24.0%

Source: Autodata Corp.

Finally, Ford has done a wonderful job toward right-sizing its balance sheet. In 2010, it paid off $14.5 billion in debt and ended the year with its automotive division in a net cash position. Considering that it had $8.7 billion more in debt than in cash a year ago, that's outstanding. The discipline and focus that that demonstrates will serve Ford well going forward.

A kicker
The biggest risk Ford faces is a collapse of the world economy back into recession. Yet the further we get from the end of the Great Recession, the less likely that appears, at least in the near term.

On top of that, there's pent-up demand. The recession put a damper on new car buying, with auto sales dropping for three straight years before 2010 saw a turnaround. Just before the Presidents Day holiday, one dealer in Boston noted, "The average age of the car on the road right now is in excess of 12 years, which is the oldest it's been since World War II. So a lot of people will be buying out of need versus desire."

My response
At last night's closing price of $15.23, Ford had very low expected growth of FCF priced in. Just 3.5% per year for the next five years, 1.8% for the following five, and nothing after that (discounting at my hurdle rate of 15%). Given the above, I believe that is too low.

Analysts are expecting earnings to grow by nearly 18% per year for the next five years. Given the company's increased efficiency and pent-up demand, I can easily see Ford growing by 10% for the next five years. If it does that and then drops down to a 2.5% terminal growth rate, the company is worth over $21 a share, nearly 40% higher than it is currently.

Ford is a cyclical company in a cyclical industry. While 2010 was great, I believe we're still on the upswing side of the cycle. Tomorrow, the Messed-Up Expectations portfolio will buy about $350 of this carmaker, with an eye toward increasing this initial 2% portfolio position.

After you add Ford to My Watchlist, come tell me what you think on my discussion board or follow me on Twitter.

Fool analyst Jim Mueller owns a synthetic long option position in Ford, but has no position in any other company mentioned. He works for the Motley Fool Stock Advisor newsletter service. General Motors is an Inside Value recommendation. Ford Motor is a Stock Advisor pick. 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's disclosure policy is never messed up.


Read/Post Comments (7) | Recommend This Article (43)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 23, 2011, at 9:28 PM, jesterisdead wrote:

    Personal expenditures are outstripping increases in salary by a long shot. We are in for another bubble. Recessions generally take a few bounces before they reach a stable baseline.

  • Report this Comment On February 23, 2011, at 11:27 PM, jasman52 wrote:

    I drove by a Ford dealerhip today and the lot was filled with big trucks. With the state of todays oil prices, I think Ford is in for a few tough quarters.

  • Report this Comment On February 24, 2011, at 10:24 AM, SMOKEN42 wrote:

    MR. MUELLER IS SPOT ON !!!!!!!!!!!!! MOST AUTO ANALYSTS ...........AND BOY, SOME ARE JUST LOST..........HAVE COST INVESTORS BIG MONEY, IF THEY FOLLOWED THERE ADVICE ON FORD THE PAST THREE YEARS..............IT'S ALL ABOUT.......PRODUCT...PRODUCT....AND FORD HAS IT NOW, AND IN THE PIPE-LINE FOR THE FUTURE !!!!!!!!!!!!!!!!!!!!!!

  • Report this Comment On February 24, 2011, at 10:24 AM, esadumf wrote:

    Not really. If you need a truck, you need a truck. A civic won't tow my boat or haul firewood. We just bought a new F150...it is awesome.

  • Report this Comment On February 24, 2011, at 10:30 AM, DelT47 wrote:

    The Ford Motor Co. is "righting" itself to its "core" market......lots of trucks and an ever-improving carline. The Fusion, Taurus and Lincolns are greatly improved over the last 4-5 years, and the F-150 is still the best truck on the market. The gas mileage of the 2011 F-150 is incredible.

  • Report this Comment On February 25, 2011, at 11:49 AM, SpyGlass500 wrote:

    Ford is looking good on paper. As is GM. Competition abounds, oil goes higher, people still need to drive. I followed the last round of buy Ford advice here on the Fool and got hammered when it dropped 12% in a week. I won't be increasing an already underwater position anytime soon..........but I will hang on to see if it recovers

  • Report this Comment On February 25, 2011, at 2:05 PM, mudman90039 wrote:

    I had F at an average of $2.50/share and it went to $12+ I decided to sell and buy a flat screen TV. Later I found F+S preferred stock so bought some and got 6.5% Yield. That was an experiment and now Ford is calling it. I'll buy more Ford common stock because I believe in the company.

    I also have had 2 Focus cars and love them, a nice sporty ride with 30+ gas economy. I sold my 2004 to my best friend who loves it as much as his old Alfas and he has electrics that work and wonderful A/C which the Alfas lacked.

    I think the higher gas prices will again spur on junking guzzlers and buying smaller efficient cars. Also, things like Synch for media and hands free phone is an incredible advantage in a new car. The new redesigns and models are going to be a real boon for Ford. I'm investing long term and hope they start up with the dividend again.

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