Monday, 1 February 2010

Company Focus – Ford Motor Co – Finally In the Black & Awaiting the US Fiesta Boost...But is it Presently Over-Bought?

FMC Stock Price (as of NYSE close 01.02.2010) -

The old Henry Ford saying that “an aeroplane takes off against the wind” surely must have been Alan Mulally's constant mantra since his appointment as CEO what now seems an age ago. He pledged much of Ford's major asset-base as collateral for a 18bn loan in 2006 that would underpin the liquidity needs of a global company requiring major turnaround under the ONEFORD initiative.

That decision to divest of PAG brand (the last of which was Volvo recently sold to China's Geely in late December) allied to a plan to 'globalise' the number of platforms / component-sets, create attractive vehicles and lead the way with UAW cost-cutting talks has proven undeniably effective. They were simple and obvious requirements that Ford has met.

Having got the fundamentals of the business model right, the market and balance sheet gains would in due course be achieved as Ford battled past less effective competition. But that competitive edge was supercharged by the fracturing and dissolution of GM & Chrysler; the cross-town foes seen to become effectively impotent as quick-track bankruptcy courts, government largesse and Italian optimism saved their skins as an increasing disillusioned customer base shopped elsewhere. The last bastion of a credible US autos player – that Saint Elsewhere for US loyalists – was FMC.

Perhaps not since the invention and popularisation of the Model T has Ford been so popular, but that has only really come thanks to the surrounding direct competitor flailing massively – to which we can obviously add the credibility loss at Toyota due to its defective accelerator problem.

Thus it has been a perfect storm of loss of competitor credibility and the consumer purchase surge of the CARS programme that has allowed FMC to recapture such a large slice of domestic market share in such a short time. Add the cost-savings put in place by ONEFORD and the recent frantic activity to renegotiate credit-lines and quietly issue new stock and the consequences drive straight to the P&L bottom line.

As a result, in Q409 Ford manages to stem its historic run of domestic losses, and across all divisions except Volvo posted positive results, leaving the Group with a Q4 PbT of £1.8bn. However, for FY09 whilst CARS and similar international schemes boosted Ford Credit's earnings, the regional vehicle divisions themselves continued as a mixed bag of performers at the PbT level. S. America shining in comparison, Europe just about creeping into the black, but N. America, Asia and Volvo varyingly in the red, with additional debt servicing and re-valuations pulling the total Automotive section performance down to $-1.4bn. This however demonstrates the size of losses at Ford diminishing in a continued bid to cultivate investor favour.

If we review FMC's stock-price over the last 9 months Ford has been perhaps a global performer. Discounted heavily along with GM in 2008/Q09, the General's entry into bankruptcy demonstrated Ford's glaring difference. Knocked down to just over $1 in February/March (stated by investment-auto-motives at the time), the company stock has charged back; but not simply in line with say the DJIA upturn, but well well beyond, today sitting at just over $11. Thus as that sole effective Detroit player, it attracted far more attention and perhaps speculative liquidity than it should have done rationally.

During a period when the US stock market desperately required financial rationality, how could the 'fundamentals perspective' of FMC have been driven so low, and now arguably too high? Companies simply do not feasibly grow their worth by approximately 1000% over 9 months even in the best of circumstances. A reasonable argument is that the heavy Q109 over-discounting has been rectified, and today the stock sits in line with growth from what should have been a higher base-line. On the surface this is justified, but amongst the hulla-baloo of the strong equities market up-tick, ineffectual autos-competition and FMC consumer gains (greatly boosted the Ford Credit division) it seems that the central concern of maintaining sensible sustainable traction in light of FMC's heavy debt-burden was, for a time forgotten.

That, as an issue, is now back on the table,. So FMC must be being seen to both service debt to its primary rolling credit-providers (GS and HSBC), its largely institutional bond-buyers and assortment of (new & old) stock, whilst critically keeping FMC P&L in the black.

What is of real concern to those fringe investors without collateral is the question of the innate value of those assets held by primary charges and the concern about the Federal Reserve's monetary policy. The assets were valued at 2006 prices which reflected near top-of-market conditions. Since then commercial real-estate, plant, tooling, vehicle inventory and proprietary retail space values have been heavily deflated under strict mark-to-market conditions.

Ford obviously continues to pay-down much of that original $18bn 'home improvement loan', and effectively replaces it and subsequent rolling-credit chunk by chunk with contingently raised capital instruments whilst it has access at historically low rates. The FY09 debt servicing itself cost $292m.

As for asset valuation, from preliminary FY09 reporting, FMC appears to have adjusted its asset-base valuation necessary to reflect market conditions, but at just $-6m for FY09 it begs the question as to whether the figures prescribed in the re-valuation of marked-to-market are truly reflective or whether they simply accord to the necessary accounting obligation? Although not privvy to private figures, let us remember that the $18bn loan in 2006 was very probably based upon the normative 80% ratio-rule for asset value – hence valuing FMC (tangibles + intangibles, such as the Blue Oval itself) at approximately $22.5bn. Thus to see only 3 years later, after the massive asset bubble deflation the US has incurred (say optimistically -20%), a discounting of only $-6m over the last 12 months does appear somewhat questionable to the critical investor, even if obviously within the bounds of accounting legality.

As the capital markets have noted, present FMC debt stands at $34.3bn, of which the vast majority of $32.3bn is directly attributable to the US.

[NB Theoretically, this 'circularity' should be great for the US economy as Ford draws in foreign earnings to pay-off homeland debt to largely homeland companies. But unfortunately this situation - of the country's only presently viable automaker taking ostensibly all its credit from US capital sources - only serves to undermine US foreign-trade policy standing relative to criticism about an implicit US-centrism. And in light of the Obama administration now prohibiting the “too big to fail” maxim in the banking sector, should it also not look also to its inter-related risk-exposure across commercial sectors? Or is the 'circularity' implicitly viewed as a much needed mechanism in the revival of the US economy's fortunes?].

Of that $34.3bn debt, 'only' 50% is presently secured asset-backed' debt from the original Mulally debt plan. This much reduced exposure from an estimated previous 80% could account for Ford's seeming ability to marginalise its asset value re-valuation and avoid the critical gaze of non-secured lenders, and re-valuations of greater measure could feasibly destabalise the whole apple cart. Understandably from Mulally's and Booth's perspective, they wish to smooth-away any possible investor concerns. Critically FMC is keen to highlight that against the $34.3bn debt, it holds $25.5bn in liquid cash and short-term convertibles. Add the $11bn or so market capitalisation figure stated in its EoY report – presumably taken from the recent market peak - and the very simplistic calculation that $25.5bn + $11bn = $36.5bn. Hence this figure meets the debt obligation with $2.2bn spare.
FMC hasn't but could, point out its option to re-mortgage the remaining 50% of assets to secure further liquidity, even if against the will of higher grade non-directly asset backed investors. To do so however, would appear foolhardy in all but the most severe of times.

However, given the still fragile economic environment, future investors recognising their place low down the ladder, should place ever harsher criteria against their investment decisions. Taken to investment stress-testing extremes, 50% of the current FMC cash-pile is asset-backed and so effectively not presently owned by FMC – it's liquidation of course realistically depending upon the remote case of default. But, as stated, those so in the lowest tranches must run worst case scenarios. So in turn a 'bare-bones' re-calculation strips out half the liquidity and adds the equity (MktCap) value. Therefore, $12.25bn + $11bn = $22.25bn. This then is about $8bn under the present debt level, yet of course excludes the remaining 'free' asset-base, which can theoretically be used to re-inject that $12.25bn.

But, could it actually raise that sum in this day and age given the very different conditions to Q306? The Volvo & SAAB deals, the latter especially made up of massive equity buy-in from the vendor, perhaps demonstrates the unease about automotive asset valuations at present. Such fragility is undoubtedly great for cash rich PE firms and trade buyers, but bodes less well for low order investors.

This is not to say FMC is a basket case, far from it since the ONEFORD progress and concomitant FY09 results demonstrate the level of structural progress made to date. But simply that regards timing of the investment sweet-spot may be well passed, both in terms of equities for the moment (having seen its mega rally) and in terms of fixed income instruments, given the 'top-up' needs of the company prior to what appears to be a period of future partially internally generated self-funding – in part from Ford Credit revenues.

The new Fiesta is being introduced in North America now, but until May and the model's production ramp-up in Mexico, the cars will be shipped from Germany to ensure quality. This of course means initial unit margins will be low, indeed possibly negative, given the very low margins provided from German manufacture, the reduced but still sizable US$ : Euro FX differential and of course the relative inelasticity of US retail pricing vis a vis Japanese and Korean peers.

Until Mexico produces the Fiesta en mass, probably from Q3 2010 onwards, FMC will not be able to seize the small car opportunity. Whilst in other regions, as the stimulus spending that gave Fiesta such a boost diminishes, so either capacity or unit margins will come under pressure. Fiesta is perhaps Ford's prime global player and its role should not be under-estimated especially in Europe but as it slowly melds into the normative competitive background and competition grows with new launches (eg new Opel Corsa, Renault Clio4, Peugeot 209, Mini Countryman etc) so increasingly Ford will rely upon US and Chinese markets, with only the former of these arguably generating initial large volumes for the model without the profit slice removed, as obviously demanded by its Chinese JV partner Changan (CFMA).

Thus whilst Ford's health has undeniably improved, as Mulally himself points out 2010 will still be a tough year with an expectation to become solidly profitable, but no guarantee. For that reason and those mentioned previously about “arriving late to the show” investors must show caution for their own and FMC's own medium term good.