How Ford Motor Company Could Triple Value Returned to Shareholders

There's a common bearish argument against Ford Motor Company regarding its cash flow. While cash flows have been stagnant, there's huge potential over the next couple of years.

Jul 15, 2014 at 1:15PM

One of the biggest knocks against Ford Motor Company (NYSE:F) as an investment is simple: The automotive industry is capital intensive, which puts pressure on Ford's free cash flow. That's a problem when many investors want to invest in a cash churning juggernaut that can return more value to shareholders.

Now, the flaw behind this thinking is that Ford can't produce strong free cash flow because of the capital-intensive production machinery, material costs, and facility requirements. While this is partially true, it doesn't explain the entire story. Even with stagnant free cash flow, Ford is a couple of years away from spending its cash wildly differently, which should enable management to return significantly more value to shareholders.

Show me the money!
Cash flow is a vital factor to follow for any company you own stock in, especially one in a cash-intensive industry. Ford must use its cash flow to invest in its future growth through building new factories, investing in research and development, improving technology, and improving its financial status. If Ford lacks the cash flow to innovate vehicle designs and technology, keep production facilities up to date, or its financial status healthy, its business could decline quickly in the highly competitive automotive industry.

The remaining lump sum, after Ford's capital expenditures, is its free cash flow which represents the cash it has to reward shareholders through increased dividends and share repurchase programs. The more free cash flow Ford produces, the happier investors will be, period.

While a common argument is that Ford doesn't produce enough free cash flow to warrant a strong investment opportunity, because of its capital intensive industry, the bears might not understand where Ford's cash has really been going and when it will be used differently.

An invisible cash hog
Most bearish arguments about cash flow overlook that Ford's cash has been going to fix one of the automaker's most overlooked problems: a massively underfunded pension plan. In fact, at the end of 2012 Ford's pension plan was underfunded to the tune of $18.7 billion -- a bigger obligation than Ford's automotive debt at $14.2 billion, also at the end of 2012.

But Ford decided to fix this problem over the past two years dumping a combined $8.4 billion into the fund. With Ford's largely voluntary dumping of cash into its pension fund it cut the plan's underfunded status in half, to only about $9 billion, at the end of 2013.

This year Ford plans reduce its contributions significantly and will contribute between $1 and $2 billion into its pension fund through 2016; that's favorable compared to 2012's and 2011's contribution of $5 billion and $3.4 billion, respectively.

After 2016, when Ford has fully derisked its pension plan, its annual contribution will be roughly half of the current $1 billion to $2 billion. Now, it's important to note that this reduction of pension contributions won't actually increase Ford's free cash flow. So, if this reduction in pension plan contributions won't increase Ford's free cash flow, where is it going and how will it impact investors?

F
Table source: Ford Motor Company's annual report

Down the road
Ford has learned its lesson since the great recession and has focused on strengthening its financials. For this reason, with the underfunded pension largely resolved, expect management to put more of an emphasis on paying off its automotive debt before anything else. Ford expects to have its automotive debt reduced from $15.7 billion at the end of last year, to roughly $10 billion at the end of next year.

After Ford brings its automotive debt down to that level, it creates a potential sweet spot in time for investors.

Consider that in 2015 and beyond, Ford will have largely supplied its underfunded pension plan, considerably lowered its automotive debt, Europe will be break-even which would have added roughly $1.6 billion to Ford's bottom line in 2013, as well as absorbed costs from two years of launching its most aggressive and costly vehicle launch schedule in history.

With those major developments taking less and less of Ford's cash flow it sets the table for Ford's gross cash to balloon or the cash could be refocused to increase its dividend at an accelerated rate to reward patient shareholders. The cash could also be used to repurchase a significant amount of shares which have been diluted over the years; heck, without massive pension fund obligations Ford would have the free cash flow to do both at a very accelerated pace, compared to today's levels.

How much would that enable Ford to increase its dividend, you ask?

Well, for additional perspective, consider this: Ford's combined pension contributions of $8.4 billion, from 2013 and 2012, are more than three times the cost of its dividend, at $2.7 billion, for the same time frame. While the latter figure doesn't account for Ford's recently increased dividend, simply imagine if those pension contributions and dividend payments were reversed? Hypothetically, Ford spending $8.4 billion on dividend payments over a two-year period would equate to a quarterly dividend of $0.26 per share -- that's more than double what Ford pays now, five times more than it paid in 2012, and an amount the automaker hasn't paid since 2001. 

Bottom line
Ford appears to be treading water now, as it spends much of its cash on building for its future. That's the type of company you want to own shares in, even in a capital intensive industry. When Ford begins to spend less on its problems of today, and more on shareholder friendly returns of tomorrow, patient investors should reap the rewards. I suppose the bears are right in one respect: Ford's free cash flow could remain stagnant. But does stagnant free cash flow really matter if the amount returned to shareholders doubles or even triples over the next few years? It certainly doesn't matter to me, a long-term shareholder, and the additional cash returned to shareholders should boost Ford's stock price.

What technological shift is Ford calling "fantastic"?
A major technological shift is happening in the automotive industry. Most people are skeptical about its impact. Warren Buffett isn't one of them. He recently called it a "real threat" to one of his favorite businesses. An executive at Ford called the technology "fantastic." The beauty for investors is that there is an easy way to invest in this megatrend. Click here to access our exclusive report on this stock.

Daniel Miller owns shares of Ford. The Motley Fool recommends Ford. The Motley Fool owns shares of Ford. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers