It's hard to find an industry that is more out of favor with investors at the moment than autos. Most auto stocks were clobbered in the late-2018 market sell-off, and many are still selling at surprisingly low valuations. The problem: Auto sales are cyclical, rising and falling with consumer confidence -- and the current cycle is quite old by historical standards. History suggests that a cyclical decline is likely sooner rather than later, and when auto sales decline, automakers' profits (and stock prices) inevitably follow.
That said, whenever an entire industry is out of favor with Wall Street, there are often good buys to be had for investors who can afford to be patient. Below, we'll take a look at two value-priced global auto giants to see whether either (or both) are good bets for new money now: Ford Motor Company (NYSE:F) and Volkswagen AG (OTC:VWAGY).
Valuation and stock performance
The market's big sell-off in late 2018 hit most auto stocks, including Volkswagen and Ford, pretty hard. Both have increased in value since the beginning of 2019, but not without volatility.
With respect to valuation, automakers have historically traded at around 10 times earnings during periods when sales are strong, as they have been for the past few years. Volkswagen is trading at about 6.1 times its earnings over the past 12 months, excluding one-time items, while Ford is trading at about 6.5 times its adjusted earnings over the same period.
By historical standards, both Ford and Volkswagen look somewhat cheap. But why?
Why Ford is cheap
In Ford's case, it's because the company is undergoing a major restructuring that will result in a total of about $11 billion in one-time charges over the next couple of years, the company has said. That has analysts concerned, for obvious reasons -- but there are two things to know about Ford's plan:
- A significant portion of that $11 billion will consist of noncash accounting charges.
- Once the plan is completed, Ford's margins should be substantially improved. In fact, Ford expects margin improvements to be visible by next year, assuming the economy remains strong.
Simply put, Ford is working through a global restructuring that should boost its margins and bottom line over the next few years. That restructuring, or "redesign" as CEO Jim Hackett calls it, includes a slew of new higher-margin products (including electric vehicles) that will play to Ford's traditional strengths.
But the costs of that redesign effort has meant that Ford's recent earnings haven't looked so great, and that's a big part of why the stock is cheap right now.
Why Volkswagen is cheap
As just about everyone in the world knows, VW found itself in a massive diesel-emissions cheating scandal in 2015. The consequences of that scandal, including recalls, fines, and litigation settlements, have cost the company billions over the last four years, putting dent after dent in its bottom line.
That's the bad news. The good news is that while there might still be one or two diesel-related shoes left to fall on Volkswagen, it's a good bet that most of the financial consequences are already known and settled.
Now, the company -- and investors -- can look ahead. VW is in the early stages of an aggressive move into battery-electric vehicles. Its first mass-market long-range BEV, the VW ID3, is about to go into production. Several more are expected to follow over the next few years, as the company ramps up to what it hopes will be annual sales of 3 million EVs per year by 2025.
In the meantime, it's making good profits on sales of SUVs and luxury vehicles. (Luxury-vehicle makers Audi and Porsche are Volkswagen subsidiaries.) With much of the cost of the diesel scandal in the rearview mirror, VW's margins are improving and its operating cash flow has been strong.
The bottom line for VW: The lingering effects of the diesel scandal are probably contributing to the low valuation, but VW's prospects for bottom-line growth over the next five to seven years look good.
What about dividends?
Like many German companies, Volkswagen pays a dividend once per year, after its annual meeting in May. This year's dividend on VW's "ordinary shares," or common stock, was 4.80 euros ($5.27), up from 3.90 euros in May 2018. That translates to a dividend yield of about 3.2% at current prices.
Note that VW's board takes the prior year's earnings into consideration when it sets the amount of the dividend, so it tends to change from year to year. Put another way, if VW's profit drops sharply during a recession, its dividend is likely to drop sharply as well.
Ford takes a different approach. The Blue Oval has paid a quarterly dividend of $0.15 per share since 2015. In 2016, 2017, and 2018, when profits were strong, it chose to pay an additional "supplemental" dividend in the first quarter, while keeping its regularly quarterly payment unchanged.
Ford kept the regular dividend constant for a reason: It wants its shareholders to be able to count on those regular quarterly payments "through the cycle," meaning through a recession when its profits will be squeezed.
Ford believes that between the steady income from its financial services subsidiary and its hefty cash reserve ($23.2 billion as of June 30), it will be able to comfortably fund its regular dividend through the next recession -- and that once it does, long-term investors (and Wall Street analysts) will understand that its dividend is reliable.
At current prices, that annual $0.60-per-share dividend works out to a dividend yield of right around 7%. If Ford really can maintain those payments through the cycle -- and I think it can, unless the next recession is unusually severe or protracted -- then it has the clear advantage here.
Which stock is the better buy now?
As we've seen, both companies look like decent bets to increase earnings over the next several years, assuming that the economy cooperates. Both have good management teams, reasonable debt loads, and strong presences in particularly profitable niches of the market (luxury for VW, pickups for Ford).
As seasoned auto investors know, a restructuring automaker can be a good investment if its plan is strong and its balance sheet is in good shape, and both of those are true of Ford. But as I see it, Ford's dividend is the key difference maker. Not only is it more generous than Volkswagen's right now, it's also more likely to be sustained through the next recession, whenever it arrives. I think an investor who buys Ford at current prices, with an expectation that they will reinvest the dividend and hold for five years or more, stands a good chance of outperforming the market over that time.