Best idea portfolio member Ford Motor (F) has been on a tear lately. After bottoming at $9, shares have rallied up to over $12, until they pulled back modestly. In addition to third-quarter earnings, which were reported Wednesday, a few material events have happened, resulting in the shares rallying. Though none of them change our fair value estimate, they do strengthen our conviction in the idea.
Third-quarter results, so-so
Let’s get the bad news out of the way. The third quarter for Ford wasn’t a disaster, but it wasn’t great either. Improving sales trends continued, with volumes up 14% for the quarter and retail market share coming in at 13.9%. Additionally, the automotive business threw off $400 million in cash flow from operations, and the firm improved its net cash position by $10.7 billion versus a year ago.
Unfortunately, there was a lot of ugly too. First and foremost, the day before earnings were reported, Ford car quality rankings tumbled. Thankfully, this isn’t like the Pinto, but rather deals with poor software integration of the MyTouch technology and other peripherals. There are no exploding gas tanks, and Allan Mullaly claims the company has and continues to work aggressively to fix these issues. Consumer reports tend to be more important in cars than other products, since auto purchases tend to be both rarer and more expensive than most purchases. We think Ford should be able to work through these issues and improve customer satisfaction, but it could have a marginal effect on sales in the near term.
More immediately troubling, the loss in Europe doubled year-over-year, and the
Even though we find these events more troublesome, the market seemed more disappointed in the lack of a dividend. Mullaly went as far as to say there will be a dividend, “sooner rather than later,” but gave no specific timetable that many investors were looking for. A dividend would provide a catalyst to propel the stock upward, but we would rather management and the board wait until the economy stabilizes and Ford is able to pay down more debt before returning cash to shareholders. It will happen eventually, but it isn’t a major driver shareholder returns in our model.
Sigh of relief over the UAW agreement
It didn’t look good at all for a second. We couldn’t believe that shares stayed up as bad news just kept piling on with a factory in Michigan voting down the agreement narrowly, and the Chicago plant voting it down by a wide margin.
Other factories decided to vote with the plan, and ended up creating an easy victory for the agreement. We released a note earlier discussing our opinion on the new labor contract, concluding that this was one of those rare deals that benefited labor, shareholders, and management. The new agreement will result in a $280 million expense in Q4, but that’s a small price to pay to avoid a strike and keep employees satisfied.
Credit upgrade hits, but not investment grade
Moody’s and S&P upgraded Ford to their respective highest junk ratings, and an investment grade could be on the horizon. This was one of the substantial recent drivers in the stock’s share price, and we are excited about the lower debt costs that are inherent with an investment grade rating. Mullaly once said an investment grade would spark a dividend, and although he’s changed his mind, it certainly wouldn’t hurt.
Overall, results in the quarter were mixed, but the build-up of the Focus and release of the new Escape are among the events to look forward to in fourth quarter. We also hope to see an improvement in the operating margin in 2012, which will flow directly to the bottom line. The margin of safety isn’t quite as high as it was at our purchase price of $9.90, but $12 is just too cheap for this great business.