Ford's Suddenly Cheap. Should You Buy?

It's $10, Mr. Market? Seriously? For a leader in a wide-moat industry that earned $0.59 a share in its most recent quarter?

Knowing only those things, it sounds awfully cheap, even in this environment. Trading on Monday, Ford (NYSE: F  ) dropped below 7% at one point in the trading session. It traded below $10 for the first time in more than a year.

Of course, there are a lot of good companies selling at what seem like big discounts at the moment, thanks to the sudden gaping pit of economic uncertainty that opened after S&P's downgrade last Friday. Those looking for bargains have no shortage of interesting opportunities to explore.

But here's the question: Should Ford be one of them?

A steal? Or a justified sell-off?
Despite the fact that I own Ford stock and plan to hold it, it's not a simple question to answer, as I discovered early this morning when a longtime Fool (hi, Paul) took me aside at the gym to ask me exactly that. On the one hand, as auto companies go, Ford's in unusually good shape with another possible recession brewing:

  • A solid balance sheet. Ford still has around $13 billion of long-term debt left over from the mortgage-everything self-financed turnaround plan it initiated in 2006. But that's much less than the schedule called for, and meanwhile the company has amassed a $22 billion cash hoard. That should be more than enough to sustain product development through another downturn while continuing to fund expansion in places like China and India.
  • Great management. I can't say enough good things about the job that CEO Alan Mulally has done since joining Ford in 2006. Over and over, he made changes that longtime Detroit-watchers thought would be impossible, turning Ford into a relentlessly focused and unified global powerhouse with a solid financial foundation -- despite the worst economic crisis in decades. This company will be well-led through any downturn.
  • A low break-even point. This is a big deal. Automakers are cyclical companies, and for decades Detroit made big bucks during good times and posted losses during tough ones. But a drastically improved cost structure has meant that Ford has been solidly profitable during this very sluggish recovery. Even during the rough first quarter of 2009, Ford was close to breaking even before special items -- and the company's costs and products have improved further since then. That bodes very well for the company's chances during another downturn.
  • An enviable (and envied) product line. Auto companies live and die by product, and simply put, most of Ford's are now excellent. Defying the Detroit stereotype, Ford has leveraged its global organization to develop a series of genuinely class-leading products. That's a direct result of the huge borrowing spree Ford went on in 2006 -- thanks to that cash, the company was able to sustain its product-development programs during the downturn, when rivals such as General Motors (NYSE: GM  ) , Honda (NYSE: HMC  ) , and even Toyota (NYSE: TM  ) were cutting back.

Long story short: Despite that debt, Ford is probably as well-positioned as any global automaker to thrive during and after an economic downturn.

But here's the bigger question, the one I struggled with when talking to Paul at the gym this morning: Is this a good time to buy any automaker?

Would you buy a car right now?
All of the automakers on my watchlist took a beating yesterday -- Ford, GM, Toyota, even Tesla Motors (Nasdaq: TSLA  ) were all down sharply, just like most of the rest of the market, thanks to the acute sense that economic suffering lies ahead. Automakers suffer when their customers (including individuals as well as the corporate and municipal fleet buyers that drive about a quarter of Detroit's sales):

  • Put off purchases because money's tight.
  • Can't get financing because credit is being constrained.
  • Downsize to less profitable smaller vehicles because of cost concerns, or because of related factors like rising gas prices.
  • Skimp on options to keep the price down, because options like "infotainment" systems and luxury or performance packages have very high margins.

All of those things happen during recessions. While it's true that the current level of auto sales in the U.S. is still far below pre-2008 norms, those sales have been profitable ones for Ford. Many buyers have been downsizing, but they've been choosing profitable options packages like Ford's SYNC "infotainment" system for their smaller cars. That has helped keep Ford's margins strong, and that could be at risk.

Another looming near-term concern
There's another concern. Automakers also suffer when competitors boost margin-killing incentives (those "cash back" or "0% financing" deals), as they have to respond in kind or risk losing market share. Even before Friday's downgrade, auto worries were rising after Toyota executives signaled that the company will offer major incentives this fall.

Toyota's recovering after months of lost production due to the tsunami, and the company wants to re-establish its leading position in the all-important U.S. market. That means a sales battle, and while that could help get more recalcitrant consumers into dealers, it's likely to hurt margins for everyone. I wasn't too worried about this last week, when it looked like incentives might help bump up the overall level of sales. But right now, that looks less likely.

The upshot: Proceed with caution and open eyes
Ford's renaissance is still an unfolding story, and it's still a good one. And there's no doubt that it's cheap at today's prices, with a P/E around six -- though as I said, the direction of future earnings is an open question right now.

I am convinced that there will come a day when today's prices for Ford look like a bargain, and that if you buy here, you will make good money in time. But it might be awhile: Even if Ford remains profitable through another downturn, those profits are likely to look relatively skimpy by recent standards.

In the end, here's where I'm at: If you're willing to hold for a while, you could do a lot worse than to buy Ford. But right now, you might also be able to do better.

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Fool contributor John Rosevear owns shares of Ford and General Motors. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of Ford and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.


Read/Post Comments (4) | Recommend This Article (14)

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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 August 09, 2011, at 9:25 PM, FlixFool wrote:

    John,

    Great article. Thanks for answering my initial question so articulately !

    When you say "be willing to hold for a while", how long is "a while"? 3 years, 5 years, 10, longer ?

    --

    Paul - from the gym :)

  • Report this Comment On August 10, 2011, at 6:25 AM, TMFMarlowe wrote:

    @pllntooz: Good question. How long do you think the economic stinkage will last? :-)

    Ford's profits will rise and fall with the economy, more or less, and its share price will rise and fall in anticipation of those profits. Historically, when it was healthy, Ford has been valued around 10 times earnings. Right now it's well below that, but to some extent that's because the next few quarters are looking murky, as I said in the article.

    If and when we see signs of an actual recovery, assuming Ford has continued on its well-managed path and not hit any big potholes (or piled up significantly more debt) along the way, a price of $20 or more seems completely plausible. When's that? Hopefully within a year or three, but we'll see.

    John

  • Report this Comment On August 10, 2011, at 10:30 AM, TruffelPig wrote:

    I got long at 10.24. :) - could have saved some but hey, this will be a great buy! I was thinking going in when the stock was at like 14 or 15 and in the medium term that would have been ok too. Before the down drop I only bought dividend stocks, now its back to the more normal ones on drops to 1100 in the S&P or when they are overly punished like TTMI recently in earnings.

  • Report this Comment On August 10, 2011, at 3:21 PM, ldkoehler wrote:

    Ford's a great buy at the moment thanks for the recent precipitous drop in prices for almost all stocks. Now is the time for investors to take advantage of the speculator's panic - buy F and other attractive stocks at a panic discount.

    Ford's current price around $10 implies that cash flows will drop by 50% and stay there forever. That's stunning for an established company with an ROIC of 12%. Sure, the automobile market is changing and recessions are a difficult time to sell cars and trucks, but Ford can outperform expectations by keeping cash flows above 50% of their current levels. This strike me as an exceptionally low hurdle given their performance.

    Disclosure: I work for a research firm that (1) rates F as Very Attractive, has it on its Most Attractive stocks list for August and (2) is affiliated with a hedge fund that has a long position in F.

    For more info on quantifying market expectations:

    http://blog.newconstructs.com/2010/05/19/how-to-make-money-p...

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