One of the best trades of the 1980’s could be relevant again today: we love Ford
Famous investor and manager of the Fidelity Magellan Fund Peter Lynch is best known for his “buy what you know” strategy. Though Lynch did a lot more than just go to malls and buy stock in the most popular stores, occasionally the best investment opportunities are right in front of you. We think investors will have a chance to replicate Lynch’s famous auto trade of the 1980’s today with shares of Ford inexplicably tumbling towards the single digits.
On a discounted cash-flow basis, we think Ford is worth $20 if we double dip into a second recession, $34 under the continued low-growth scenario, and $48—more than a five bagger—if the economy can make a significant recovery.
CEO Alan Mullaly is one of the best executives in America. He famously took every step necessary to avoid a bailout, by leveraging the company to the fullest extent. Over the past few years, Mullaly has reinvigorated a dying company into the leanest US automaker.
Shares of the leaner, meaner Ford have been beaten down by 40.5%. Under $10, Ford is trading at an insanely cheap forward P/E ratio just north of 5. In spite of macro-economic uncertainty, we think it’s pretty unbelievable that a company firing on all cylinders is trending downward like it’s selling typewriters. We see several catalysts looming that will help shares appreciate to fair levels.
Catalyst #1: An Avoided Auto Strike
Because the company has been successful thus far in 2011, we think the possibility of a UAW strike is causing investors to avoid Ford. Unlike General Motors (GM) and Chrysler (owned by Fiat), UAW is not barred from striking. It was announced on Thursday that the UAW plans to hold a strike authorization vote by September 2nd, which obviously would be awful for the company. The last thing Ford needs while it continues to reinvigorate its brand are unhappy or not-working employees.
Ultimately, we think UAW President Bob King is far too intelligent and pragmatic to let the situation come down to a strike. Though he has complained about CEO Allan Mullay’s enormous compensation in 2010, King seems focused on working with Ford and the rest of the auto industry on creating a long-term, viable contract. King knows the more successful the automakers are, the more of his men will be employed, and the more compensation they will receive. He seems very friendly to variable compensation that aligns workers compensation with creating value for shareholders.
Additionally, we think King will continue attempts to unionize domestic workers at foreign automakers, which would be a net-benefit to Ford and the other American companies. It would hurt foreign cost advantages and create a much more level wage playing field. However, this is a big-if, especially with these workers located mainly in union-hostile states and a weak job market that may make the idea of unionize unattractive to workers with stable jobs.
Catalyst #2: Lower gas prices (in the near term)
At first sight, this seems like a dream. No, the industry fundamentals do not match-up long-term at all. Currently, demand outpaces supply globally, and there’s a good chance it will be like this for a long time. However, gasoline switches to a cheaper blend in the fall, which will in itself cause prices at the pump to fall. Additionally, we think fears of inflation in China could provide a near-term catalyst to decrease the global demand for oil.
Regardless, if gas prices do remain low for even a short amount of time, it could be a great catalyst for strong Q3 and Q4 sales. A drop in gas prices could also spur demand for less-fuel efficient, but more profitable vehicles like the Ford F-Series, 500, and Expedition.
Catalyst #3: Ford steals market share
Without question, we think this is already well-under way and trending positively. Ford’s market share fell from 23.2% in 2000, until it bottomed in 2008 at 14.2%. Since then, Ford, while divesting non-core units, has continued to add additionally market share, with 16.7% so far in 2011.
The major driver, contrary to some ideas, is not the lack of a bailout. Certainly that may sway fans of small government, but we don’t think it really factors into the minds of many outside of the financial and political realm.
So what’s the real driver? People want Fords. It’s as simple as that. The company continues to impress with better vehicle offerings year after year. Sales of the Fiesta, a new value and fuel-efficient offering, were up 58% in July, and the new line-up of crossovers and fuel efficient vehicles have helped boost sales across the board. Year-to-date, sales of Ford brand vehicles are up nearly 18% in the United States.
Furthermore, Ford continues to provide customers with the highest selling light-truck offerings (Ford F-series has already sold over 300,000 vehicles to date) and SUVs (Escape up nearly 30%, Explorer up over 100% after a remodel). After eliminating the faltering Mercury brand and divesting Mazda, Jaguar, and Volvo, we think the leaner Ford can approach market share upwards of 17% within the next few years.
Catalyst #4: Credit upgrade
S&P recently downgraded the United States credit, but the same will not be said about Ford. Given its ability to generate free cash flow and consistent commitment to pay down automotive debt, we think Ford stands a chance to be upgraded, lowering their cost of borrowing, which automatically creates value for shareholders.
Additionally, Mullaly has suggested that once investment grade status is reached, Ford will resume paying a dividend. A dividend will likely cause multiple expansion in itself, especially if it enough to generate some decent income at a sustainable rate.
Catalyst #5: Pent-up demand surfaces
We think this scenario is inevitable and is being completely ignored and neglected by the market. Over the past thirty years, Americans have purchased less than 11 million cars just three times, all during recessions. In fact, the median number of cars purchased over the last thirty years is over 15 million units. This leaves a huge amount of growth from 11.7 million cars in 2010, and a projected 12.5-13 million units in 2011. Additionally, the huge drop-off in cars in 2008-2011 leaves the United States with an aged fleet due for replacement.
We doubt, short of a financial catastrophe, that Americans can buy fewer than 14 million cars in 2012, simply because older cars are beginning to falter and become far too expensive to repair. The sweet spot of car purchases between 1999 and 2002, which resulted in nearly 70 million units moved, is becoming increasingly obsolete and a good majority of these cars will need to be replaced.
Furthermore, we think a demographic shift from the northern states to the south and west also benefits vehicle sales. Almost no southern or western cities have sufficient infrastructure to transport its influx of northerners tired of the cold and immigrants coming from Latin America. According to the US census, population has boomed nearly 14% in the south over the past decade, while the Mid-West and Northeast have grown at less than 4%. People living in Arizona and Texas literally have to drive more than people in New York and Chicago.
If job growth accelerates, we wouldn’t be surprised by auto sales that top 16 or 17 million units. Even if it doesn’t, we are very confident Ford, as well as the entire industry, will be selling more cars than they are now.