Lately, value investors looking for great dividends have seen Ford Motor Company (F 0.17%) turning up in their searches. At current share prices, the Blue Oval's dividend yield is a whopping 5.6%. That's very high.
But with a dividend yield that high, there's always a question: Can the company sustain those payments? Typically, a dividend yield over 5% means the stock price has fallen recently. That can (but doesn't always) mean that a company is headed for big trouble -- and that can (but doesn't always) mean that a dividend cut is on the way.
What's the deal with Ford?
Ford is a giant global company, but nothing is more important to its profits than U.S. sales of its mighty F-Series pickups. A weakening U.S. market will spell trouble for the Blue Oval's bottom line. Image source: Ford Motor Company.
The trouble with Ford stock isn't the usual "big trouble"
First off: Ford isn't "headed for big trouble" in the sense that we usually mean. There's no scandal, no big losses, no huge debt coming due, nothing at all like that. In fact, Ford's core business of making and selling cars, trucks, and SUVs is quite healthy.
What has happened is that Ford's stock has been in a slow downward slide since about the beginning of 2014. It's now selling at just about 7 times its expected 2017 earnings, a low valuation. That's despite record pre-tax profits in 2015, and near-record pre-tax profits last year.
The story that has put ice on Ford's stock price has two parts. Let's look at each.
The disruption threats holding back Ford's valuation
First, there are concerns that Ford, and other big automakers, could be disrupted by new technologies and new business models around personal mobility.
The big idea here is that self-driving technology, combined with the ride-hailing systems pioneered by companies such as Uber Technologies, mean that many of us will be giving up personal car ownership in favor of robot taxis in a few years.
If that were to happen, the thinking goes, it would mean fewer vehicles sold by companies like Ford. Some analysts have also argued that self-driving technology will take cars the way of phones: The software will have much more value, and deliver much higher profits, than the hardware. Of course, Ford is seen as a hardware maker in that scenario.
I think the reality is that some of the traditional automakers will fail to adapt to these technological changes. I also think Ford is better positioned than many of its rivals to not just survive but to thrive and profit in the new shared-mobility world.
Ford's self-driving R&D effort is thought to be quite advanced. New CEO Jim Hackett may step it up further soon. Image source: Ford Motor Company.
There's a related concern here specific to Ford, in that some analysts felt Ford wasn't moving quickly enough to embrace new technologies under now-retired CEO Mark Fields. Specifically, the concern has been that rival General Motors (GM -0.05%) has made much more -- or at least much more visible -- progress on things such as electric vehicles and self-driving tech.
Ford's board responded to that concern and others in May by replacing Fields with Jim Hackett, who has promised to speed Ford's transition to those future-minded businesses.
I think Hackett and his team will do just fine, and that Ford will in fact profit and thrive for a long time yet. And I think we'll learn a lot more about Hackett's future-tech plans in another month or two, so stay tuned. But I also think it may take a few years for all of this to become clear to investors, and so it's unlikely to turn Ford's stock around any time soon.
Slipping auto sales could hurt Ford's profits in the near term
The other concern is that the pace of new-car sales in the U.S., and to some extent elsewhere, is softening in ways that suggest a slowdown could be coming. If so, Ford's profits will come under heavy pressure.
There's no arguing with that one: It's happening. Autos are a cyclical business, and it's becoming clear that we're closing in on the downward part of the cycle. The signs started to appear early last year and have become more pronounced in the past several months. That's a big concern, because automakers have high fixed costs. A 25% sales decline would wipe out much more than 25% of Ford's profits.
Ford's SUVs have always been strong contenders and highly profitable products. Strong demand should help sustain Ford's profits even as the overall U.S. new-car market slips. Image source: Ford Motor Company.
The good news is that Ford is well prepared. Its U.S. inventories are in very good shape, so it won't have to cut prices and sell off excess vehicles at a loss if sales suddenly fall. It also has a hefty cash reserve -- $28.4 billion as of the end of the second quarter -- that is intended to ensure that it can continue investing in new products and technologies even if its profits become thin or even go away entirely for a while.
So what about Ford's dividend?
Simply put, it's not that Ford's dividend is unreasonably or unsustainably high. Rather, as we've seen, Ford's stock price has been under pressure for reasons that are mostly outside its control, but not threats to its business anytime soon. That's why it has a high dividend yield right now.
CFO Bob Shanks has said Ford's dividend is set at a level that it expects to be able to sustain through a recession. Of course, some recessions are worse than others. The real story is that Ford will probably sustain its dividend as long as it hasn't burned through its cash reserve. Ford has credit lines to fall back on if that $28.4 billion cash reserve gets depleted, but it won't be using those to pay dividends.
Long story short: Unless the next recession is truly dire, Ford can comfortably sustain its dividend payments. And while there are reasons to be concerned about the stock, there are also good reasons to think it might be a buy at current levels -- if you're wiling to be patient.
