Ford (F): An Attractive Yield And Valuation, But Look Elsewhere For Steady Dividend Growth

When it comes to safe high dividend stocks, generally you want to stick to companies with numerous competitive advantages and operations in industries that consistently grow.

 

Thus automakers like Ford (F) are typically not where most investors look for such income investments.

 

However, with Ford shares now beaten down and offering an attractive 5.0% dividend yield, many income investors may yet be drawn to it.

 

Let’s take closer look at Ford to see why the market is so down on its stock and whether or not it could be a good fit for a diversified dividend growth portfolio.

 

Business Overview

Founded in 1903 in Dearborn, Michigan, Ford is the sixth largest automaker by vehicle sales with approximately 7.5% global market share today. It markets its cars and trucks under the Ford and Lincoln brands in North America, South America, Europe, the Middle East, Africa, and Asia.

 

 

Ford Financial Services is the company’s financing arm, designed to help customers finance the purchase of new vehicles.

 

Business Analysis

The automotive industry can be a brutal one to invest in, even more so for dividend growth investors. That’s because it allows for very few sustainable competitive advantages and is an extremely capital intensive and cyclical industry.

 

 

If volatile top line growth wasn’t bad enough, the constant need to refresh existing models (to maintain global market share) and also launch new ones (such as electric vehicles) means that Ford’s capital spending is highly lumpy, resulting in wild swings in margins and returns on investor capital.

 

 

Add to this Ford’s legacy costs, specifically its large pension obligations, and you get a company with below industry average profitability in an industry that’s hardly known for its rich shareholder returns.

 

Ford Trailing 12-Month Profitability

 

About the only good thing to say about Ford’s profitability is that the company’s free cash flow margin remains strong and currently secures the dividend.

 

Now in fairness to the company’s previous management, led by former CEOs Alan Mulally and Mark Fields, they did a remarkable job turning the company around after its near bankruptcy during the financial crisis.

 

For example, thanks to strong product launches (35 vehicles since 2013), as well as impressive cost cutting measures, Ford’s European operations have managed to claw their way back to profitability. That’s no easy feat given the high regulatory and labor costs of the continent.

 

 

In addition, the company has made great strides in simplifying and reducing the number of total product platforms its vehicles are built on, which provides immense cost savings and economies of scale (amortizing vehicle development costs across a much larger amount of sales).

 

For example, in 2007 99% of Ford’s sales were based on 27 vehicle platforms, across seven brands, but in 2016 it was just nine platforms across two brands, with management planning to eventually reduce that further to eight platforms.

 

Meanwhile, refreshed product offerings have greatly improved the brand reputation of Ford and Lincoln, thanks in large part to far better quality control.

 

 

For example, in 2007 JD Power’s initial quality study of new auto customers found that Ford’s cars had an average of 221 problems in the first year per 100 vehicles, slightly above the industry average of 216, but far below industry leaders such as Buick, Lexus, and Cadillac, which led the industry in reliability with 145, 145, and 162 problems, respectively.

 

However, by 2016 Ford had cut those problems by more than half, to just 102, better than the industry average of 105, and much closer to the industry reliability leaders Kia, Porsche, Hyundai, and Toyota which scored 83, 84, 92, and 93, respectively.

Another major improvement Ford made over the years is an increased emphasis on credit quality at its finance arm, whose average FICO scores to new lenders in Q2 of 2017 hit new all-time highs.

 

 

This is important to ensure that its financing arm, a crucial component of helping fuel sales, doesn’t go the way of General Motors’ (GM) GMAC financing, now spun off as Ally Financial (ALLY), which helped to bankrupt GM in 2009 thanks to massive subprime credit losses, including $5 billion in Q4 of 2009 alone.

 

Finally, Ford has shed itself of its massive medical liabilities when the big three U.S. automakers, as part of bankruptcy negotiations with the United Auto Workers (UAW), established a health trust (now operated by the UAW) with a one-time payment of $56.5 billion to cover $88 billion in future healthcare liabilities for 750,000 retirees and their dependents.

 

All told the turnaround effort led to steadily rising profits that hit record highs in 2015 and 2016, allowing the company to return more than $15 billion to shareholders in the form of regular and supplemental dividends and buybacks designed to offset executive share compensation.

 

 

In the next few years, Ford plans more aggressive capital investments that will see 2017 operating profits dip; however, once the new model launches bear fruit it expects 2018 to see a return to record profitability once more.

 

 

Meanwhile, the company’s long-term growth plan involves not just doubling down on its bread and butter cash cows (North American SUVs and crossovers), but also heavy investments into future technologies such as autonomous vehicles, elective vehicles ($4.5 billion in the next five years to launch 13 models), and ride sharing.

 

 

For example, according to Jim Hackett, Ford’s new CEO and former head of its Smart Mobility division, Vehicle Management as a Service (VMAAS), managing autonomous vehicle fleets could become a $400 billion a year global business, one that generates margins of “at least 20%.”

 

In other words, the Ford of today is nothing like the poorly managed and slow-moving dinosaur of the past. Rather management has a strong dedication to producing highly reliable and popular vehicles while also investing in the autonomous and clean vehicle fleets of tomorrow.

 

That being said, before you run out and buy Ford, be aware that there are plenty of risks that could still sink it as a high-yield dividend investment.

 

Key Risks

Ford has three major problems as it strives to adjust to a rapidly evolving industry that is currently being disrupted by revolutionary new technology.

 

First, while its global turnaround endeavors have been impressive, the fact remains that the company is highly reliant on its North American division for nearly all of its profits.

 

For example, in 2016 the company lost money in South America, the Middle East, and Africa, while Asian and European operations were barely profitable.

 

 

 

Worse yet, North American operations could have already peaked, with sales, market share, and margins all declining recently.

 

 

This is largely due to the fact that during the great recession auto sales fell off a cliff, as frightened and cash-strapped consumers held onto their older vehicles longer.

 

Once the crisis had passed, the economic recovery allowed a much needed replenishing of an aging vehicle fleet.

 

 

However now that tailwind is largely gone, resulting in falling auto sales that are expected to further deccelerate in the short-term.

 

 

Worse still, Ford Credit, while admirably sticking to very high underwriting standards (only lending to high credit score individuals), has seen six straight years of rising default and loan loss rates.

 

 

Now it’s important to note that even during the financial crisis, Ford Credit came nowhere near threatening the survival of the company, and it remains profitable today.

 

That being said, rising loan losses in the face of steady economic growth, accelerating real wage growth, and rising average FICO scores does potentially signal that even in these relatively good economic times, North American consumers are tapped out on debt.

 

If true, this bodes poorly for Ford’s short-term sales prospects and could put its longer-term growth guidance at risk.

 

Similarly, over the long-term Ford will have to compete with equally hungry rivals such as GM, which is also investing heavily into mobility, autonomous cars, and electric vehicles (EVs). And thus far at least, GM’s offerings look far superior to Ford’s.

 

For example, while Ford has been coming out with compliance EVs, sold mainly in California to meet that state’s zero emission requirements (and with ranges of about 100 miles on a charge), GM’s Chevy Bolt ($30,000 after the Federal Tax Credit and a 238 mile range) was the 2017 North American Car of the Year, and Car and Driver called it the best non-luxury EV in America.

 

Simply put, while Ford’s dividend is currently safe, its growth prospects appear meager at best, and its survival is far from assured.

 

Ford’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Ford has a Dividend Safety Score of 39, indicating a [potentially unsafe dividend, which isn’t surprising given the company’s unimpressive payout history.

 

 

In fact, since 1980 Ford has cut or suspended its dividend no less than four times, in 1980, 1991, 2002 and 2006. That’s thanks to the incredibly volatile nature of its earnings and free cash flow, courtesy of a cyclical industry in which sales can drop by as much as 30% or more in a year, which occurred in 1980 and 2009.

 

That being said, Ford management has instituted a variable hybrid dividend model in which it targets a 40% to 50% Adjusted EPS payout ratio, composed of a 60 cents per share annual regular dividend and annual supplemental payouts.

 

Ford has stress tested its business model and, thanks to its $20+ billion cash reserve (and large revolving credit lines), the CFO has stated that, based on the company’s stress tests (which simulate similar conditions to the Great Recession), the payout is expected to survive the next industry downturn.

 

 

Of course, there are ultimately two factors that most heavily determine a dividend’s security. First, strong and sustainable EPS and free cash flow payout ratios.

 

And indeed during times of record profits (2015 and 2016), Ford’s payout ratios do appear highly sustainable.

 

 

 

However, given that earnings and free cash flow can evaporate during a downturn, thanks to high fixed expenses and capital spending requirements, the long-term ability of Ford’s dividend to survive the next recession is likely to come down to whether or not its balance sheet can allow management to temporarily borrow to cover the cash shortfall.

 

At first glance Ford’s balance sheet appears to be massively overleveraged, with a net debt position of $106.9 billion.

 

However, in reality most of that is from Ford Credit and actually represents income-generating assets. The company’s corporate debt level is $43.0 billion, which while still high, is far more manageable.

 

 

 

That being said, in an extremely capital intensive and volatile industry such as this, a company’s true financial strength can only be determined by comparing its credit metrics to those of its peers.

 

Ford’s balance sheet is indeed highly levered, more so than even its peers, who themselves have high leverage ratios (Debt/EBITDA) of over 5.

 

 

 

While Ford’s current ratio (short-term assets/short-term liabilities) is comfortable above 1 and better than its rivals’, the fact remains that its interest coverage ratio, while manageable right now, doesn’t have much safety cushion should auto sales continue sliding as they are expected to.

 

In other words, if management’s guidance of a return to profit growth fails to materialize, Ford’s ability to borrow in order to maintain the dividend could be limited to just one or two years at most, lest its credit rating get downgraded to junk status and put the company at risk of higher future debt costs and limited financial flexibility.

 

In other words, management’s guidance of a safe dividend isn’t a promise. Only high-risk investors should consider it for their diversified portfolios.

 

Ford’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Ford has a Dividend Growth Score of 47, indicating potentially market average dividend growth in its future.

 

However, keep in mind that while management’s long-term growth plan (especially in autonomous vehicle fleet management) is promising, the company’s historical dividend growth indicates that those seeking steady dividend increases should look elsewhere.

 

 

After all, the rapidly changing and highly unpredictable nature of this industry’s profits means that dividend growth, if it comes at all, will be very lumpy, especially given Ford’s variable and hybrid dividend payout policy.

 

Valuation

Over the past year, Wall Street pessimism about peak U.S. auto sales have caused Ford to underperform the S&P 500 by about 15%.

 

This, combined with years of market underperformance, have left it looking like one of the cheapest stocks on Wall Street (though for justifiable reasons).

 

For example, Ford’s forward P/E ratio of 7.2 is far below the S&P 500’s 17.7, as well as the industry median of 17.5. It’s also less than the stock’s 13-year median value of 7.8.

 

Meanwhile, Ford’s dividend yield of 5.0% is more than double the S&P 500’s 1.9%, as well as the industry median of 2.0%, and is significantly greater than the stock’s historical 3.1% yield.

 

In fact, Ford has only offered a greater yield about 15% of the time over the past 22 years.

 

However, keep in mind that even if the company is able to deliver mid-single-digit dividend growth as some analysts expect, payout growth will likely be highly variable and lumpy, making Ford a less appropriate choice for those looking to fund their retirements purely through dividends.

 

Conclusion

Ford has made a truly remarkable turnaround since the dark days of the Great Recession, a fact not appreciated by Wall Street, which continues to punish the company’s shares with a low multiple.

 

That being said, Ford still leaves much to be desired as a high-yield investment, both in terms of dividend safety and predictable long-term dividend growth potential.

 

While Ford may look somewhat interesting for deep value, contrarian, high-risk investors, the stock probably isn’t the right choice for a conservative income portfolio.

 

Investors can read an in-depth review of Ford’s dividend safety, including the drivers behind its historical dividend cuts, here.