It seems counterintuitive to think that shares of major automakers have struggled in 2014, given the industry's rebound in recent years. But that's exactly the case, as shares of General Motors (NYSE:GM) have fallen some 23% on the year. Ford Motor Company (NYSE:F) stock is down 8% on the year and 16% in the past 12 months.
Meanwhile, the seasonally adjusted annual rate, or SAAR, for U.S. auto sales continues to approach levels not seen since before the Great Recession. After a brutal winter weighed on early 2014 sales, there were serious concerns about whether SAAR could exceed 16 million. That level is now in the rearview mirror, with investors wondering whether 17 million annual vehicle sales can be sustained.
The decline in General Motors isn't that surprising, given the company's massive recall debacle. The recalls, which have included more than 30 million cars, have resulted in more than $2.5 billion in charges.
Ford, on the other hand, has seen sales slip ahead of the release of its all-new F-150 truck. The truck is not just the top-selling vehicle for the company, but the best-selling auto in the entire country -- and has been for over 30 years. So with production going offline to prepare for the new aluminum-bodied version, the company will endure short-term pain.
In September, Ford also issued disappointing guidance, calling for pre-tax profit to fall to $6 billion in 2014, from the previous range of $7 billion-$8 billion. Currency issues in South America will cost the company $1 billion this year, and Europe is likely to remain unprofitable for longer than previously expected, at least through 2015.
On the plus side, although the currency swings hurt profits, it's not as bad as a profit dip involving an operational flaw or lower demand.
So what's the scoop?
Both Ford and General Motors pulled in over $1 billion in net income for the third quarter. While the global economy might be slowing somewhat, these two businesses are doing just fine in the United States and in their No. 2 market, China.
Both companies have given investors reasons to be unhappy. But for long-term investors looking to add shares on a pullback, or for investors who have been waiting for a drop in the stock price to initiate a long position, this looks like a good opportunity. Auto sales aren't declining and the U.S. isn't in a recession.
Yes, Ford and General Motors are cyclical companies. They would certainly endure some short-term and possibly intermediate-term setbacks if the overall U.S. economy slows. But until that happens -- which, with an improving labor market and increasing GDP, doesn't seem to be the case -- these automakers should be just fine.
Are the dividends safe?
Both companies' dividends appear safe. For Ford, we can use a relatively easy metric called the "payout ratio." The ratio divides the dividend (per share) by earnings per share. The result, expressed as a percentage, is preferred to be low. I personally like companies that have a payout ratio below 50%. A reading over 100% would indicate the company is paying out more in dividends than it generates in income.
Ford has a healthy payout ratio of 32% over the previous 12 months. In each of the past two years, the automaker has raised its dividend payout in January. Although the current yield of 3.5% is attractive, I would expect more capital to be returned to shareholders in January 2015. The payout ratio is low enough to warrant such a move.
Ford's $4.17 billion in free cash flow easily covered the $1.77 billion in dividend payments over the past 12 months.
But investors might be getting worried about General Motors' 3.9% dividend yield. Because GM has endured so many recall-related costs to its earnings per share, the current payout ratio doesn't reflect the true nature of the company, at least in the short term. Because its EPS is so small due to these one-time costs, it would appear as though GM engages in rather risky dividend payouts. This isn't the case, however. Once earnings reaccelerate, the payout ratio will be more reasonable, but until then we need to use a different resource.
Fortunately, GM generates enough free cash flow to cover its dividend. The company has paid a dividend to common shareholders for three quarters now. In that time, the total dividend payment has amounted to $1.78 billion.
Keep in mind that over the previous three quarters, General Motors has been absolutely plagued by recall costs. Still, the company has generated $1.8 billion in free cash flow, covering all of the dividend payouts in that period, albeit barely.
General Motors is going through a dark time, but the dividend does not appear threatened. The company generates enough free cash flow to cover its dividend, and if that were to change for some reason, its $21.3 billion in cash could cover the payments for some time.
The bottom line is that Ford and GM can handily cover the costs of a dividend. If investors are worried about the global economy, then perhaps buying Ford and General Motors isn't right for them. But these industry giants are not likely to cut their payouts soon. To me, these stocks seem like great long-term buying opportunities on the recent sell-off.
Bret Kenwell owns shares of Ford. The Motley Fool recommends Ford and General Motors. 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.