Despite all-time record profit in 2015, and strong profits in the years following that result, Ford Motor Company's (F +0.00%) stock has been stuck in neutral as Wall Street couldn't move past the fear that peak auto sales were just around the corner. Doom and gloom surrounds the industry's sales, as do rising aluminum and steel costs, and a dismal second quarter now has Ford's stock trading in the single digits for the first time since 2012. Due to that decline, and Ford's recent price-to-earnings ratio of around 6, its dividend yield of 6% has become very attractive for income investors.
As pessimism mounts, some Wall Street analysts think Ford should cut its dividend to save cash. But here's some background on Ford's dividend mentality, along with two surprising reasons it likely won't be cut.
A trip down memory lane
Amid all the headlines naming reasons for a dividend cut, or questioning Ford's ability to continue funding the payment, it's often lost that Detroit's automaker has been ahead of the curve with its dividend for some time. Remember that Ford reinstated its dividend during the first quarter of 2012 -- roughly two years ahead of its crosstown rival General Motors – a feat it followed by doubling the dividend in 2013, then bumping it another 25% in 2014 and 20% in 2015.
Those increases wouldn't have been made in the years following the Great Recession if management wasn't completely confident in its ability to fund the dividend through downturns. That notion is backed by Ford's next move: to end annual increases in favor of annual special dividends, paid out depending on profitability. Ford paid a special dividend of $0.25 per share in 2016, on top of its regular dividend; $0.05 per share in 2017; and $0.13 per share in 2018.
By paying out special dividends, Ford believes it isn't overextending its ability to fund the dividend and remain flexible between the good times and the bad. So why the concern?
Ford's Dearborn headquarters. Image source: Ford Motor Company.
Concerns come calling
To be fair, a number of concerns have popped up for Ford recently, causing angst about the dividend. During the dismal second quarter, results in China collapsed, hurting Ford's cash flow and income; this, along with results in Europe, caused management to reduce full-year guidance. Using China as an example, Berenberg analyst Alexander Haissl noted to investors that Ford's joint ventures in China generated $1.4 billion in equity income during 2017, which could fund a significant chunk of the company's $2.4 billion dividend payment. However, during the second quarter, Ford's equity income from Chinese joint ventures declined 98% ($192 million) from the prior year, barely breaking even. And while Ford hopes its China 2025 strategy gains traction soon, business in the region could get worse before it gets better.
Another concern from the second quarter came when management announced Ford would initiate a restructuring effort with a massive $11 billion price tag. That restructuring project could take as long as three to five years, but the issue that really struck Wall Street analysts was management's lack of transparency. There were few details and Ford even canceled September's investor-day presentation until further notice, leaving little confidence that there's a concrete strategy for Ford's turnaround and restructuring goals. A massive $11 billion price tag with few details, among Ford China's other struggles, could understandably cause investors to doubt Ford's ability to maintain dividend levels.
Despite uncertainties hanging above the folks in Dearborn, Ford CFO Bob Shanks remains confident about the dividend. "The regular dividend is not at risk, and all those commentaries coming after the quarterly call – while I can understand the sentiment -- are all baseless," Shanks said, according to Bloomberg. "We're very comfortable with our strategy on the dividend."
Two reasons for confidence
While investors' confidence will likely fall short of Shanks', there are two surprising reasons Ford's dividend will likely remain safe.
First, though it's easy to forget, the Ford family has skin in the game and has a lot to lose if the dividend is cut. Only descendants of Henry Ford can hold Class B shares, and the dividend pays at least $42.5 million in annual income to those holders. Those special shares give the Ford family a heavy influence on the company with 40% voting rights, and much of the Ford family income is tied to the dividend, and Ford's business in general. It's likely one reason the company favors dividend increases over share buybacks, as the family stands to benefit more from a robust dividend. Historically, the only difference between Ford's share classes have been voting rights, and when the common stock dividend gets cut, the Ford family feels the pain right along with investors – and neither party wants that if at all possible.
Second, while Ford faces automotive operating cash woes thanks to overseas markets, many investors forget that Ford Credit is very profitable. In fact, in 2016 and 2017 Ford Credit generated $1.9 billion and $2.3 billion annually in pre-tax income, respectively. Let's compare that to some overseas operations during the second quarter: Ford Credit generated $645 million in pre-tax earnings compared to Asia Pacific's loss of $394 million, Europe's loss of $73 million, and South America's loss of $178 million. While Ford Credit's pre-tax income is different than its cash flow, Ford's CFO Bob Shanks told Motley Fool's John Rosevear how much cash he predicts to send back to Ford.
Before we break it down, here's what Shanks had to say: "What that means is we should be able to expect that [Ford Credit] will send back to Ford, in general, about $1.6 [billion]-$1.7 billion every year, which is that 11% on the $15 billion – and the $15 billion will grow. That pays for around 70% of the dividend on its own."The $15 billion Shanks refers to is the amount of equity that supports Ford Credit managed receivables, and Ford aims for 11% return on that equity annually. Previously, Ford Credit had been reinvesting its cash flow back into that equity base to support more managed receivables, but now management wants to cap the amount of managed receivables and can use that cash to help support Ford's dividend instead.
Ultimately, many investors forget that the Ford family depends on its special class of shares for millions in annual income. Many also forget that Ford Credit generates loads of cash and is now able to support a vast chunk of the dividend payment. Those are two key reasons Ford will very likely maintain its dividend even amid a downturn – which has always been the plan.
