Following another subpar earnings report issued last month and a guidance cut, Ford Motor (NYSE:F) shares have continued to sink to new multiyear lows. Recently, a number of Wall Street analysts have warned that Ford's dividend is danger. Ford's quarterly dividend of $0.15 per share works out to a lofty annual yield of 6.3%. Many investors -- including members of the Ford family! -- count on these payouts to generate steady income.
It's true that Ford's cash flow is under pressure right now and might not rebound in the near future. Nevertheless, fears of a dividend cut are greatly exaggerated. The key reason is that Ford has multiple initiatives under way to boost earnings and cash flow. Unless they all fail, Ford's cash flow is set to rebound in the years ahead, allowing the automaker to sustain its dividend.
Analysts are worried about a dividend cut
In recent weeks, several Wall Street analysts have opined that Ford should cut its dividend. They note that cash flow has been on a declining trajectory and is no longer to sufficient to cover the company's dividend payments. Furthermore, Ford recently warned investors that it could incur up to $7 billion of cash restructuring costs over the next few years.
However, Ford executives have countered that they are committed to maintaining the dividend. In the short run, at least, the company is willing to use some of its $9 billion of net cash to fund dividend payments. As a result, it appears that Ford would have to be in severe financial distress for a dividend cut to come into play.
Ford CFO Bob Shanks recently told my Foolish colleague John Rosevear that the automaker isn't likely to face such dire straits. He noted that Ford has recently been reinvesting most of the profit from its Ford Credit division to drive growth, but that Ford Credit should be able to send at least $1.6 billion to the parent company in a typical year. That alone would cover about two-thirds of Ford's dividend payments.
Multiple paths to cash flow improvement
While Shanks' point about Ford Credit distributions covering most of the dividend is somewhat comforting, there's still a meaningful risk that in an economic downturn, rising default rates would quickly erode that division's profitability.
For Ford's dividend to be safe, investors need to feel comfortable that its core auto business will get back to producing meaningful cash flow within the next couple of years. Fortunately, there are at least three distinct ways that Ford is reshaping its business to boost cash flow.
First, Ford is about to enter a major new product cycle in its home market. It will stop selling traditional sedans in the U.S. over the next few years, while updating virtually all of its existing crossover, SUV, and truck models and introducing several new ones. This will remove a long-running source of losses and boost the profitability of Ford's domestic crossover/SUV portfolio.
Second, the automaker recently provided more details on a plan to cut $25.5 billion of costs by 2022. By adopting a modular approach to vehicle design, Ford will be able to dramatically reduce engineering, design, and material costs. It also expects to improve the efficiency of its marketing and incentive spending. These efforts should boost cash flow by billions of dollars annually within just a few years.
Third, Ford executives have made it clear that the company will exit underperforming markets if cost cuts and the introduction of new models won't be sufficient to drive a return to sustainable profitability. Ford estimates that its high-performing businesses generate 150% of the company's operating profit, but that a substantial chunk of this profit is being squandered right now because of losses from its worst businesses.
The Ford dividend is safe -- unless a lot goes wrong
Ford's dividend costs the company about $2.4 billion a year. For comparison, Ford is targeting an 8% operating margin by 2020, which would translate to more than $10 billion of pre-tax profit.
Cash flow will lag reported earnings for the foreseeable future because of high restructuring costs, pension contributions, and growth-related investments. Nevertheless, if Ford were to hit its earnings target, near-term cash flow would be several times the level of its dividend payments.
In other words, even if Ford doesn't hit all of its 2020 targets, the company should still be able to significantly increase cash flow to more than cover the dividend. A lot would have to go wrong for Ford's cash flow to continue declining. Its new models would have to be busts, Ford would have to continue funding losses in perpetually weak lines of business, and the company's cost-cutting plans would have to come up empty.
It's absolutely true that in a deep economic downturn like the Great Recession, Ford might have to cut or even eliminate its dividend to avoid a cash crunch. But today, Ford has a remarkable $36 billion of liquidity, more than enough to get through a normal recession. Unless all of its turnaround initiatives fail, Ford should have no problem maintaining its hefty dividend.