Ford Investors Are Missing the Big Picture
Ford Motor Company shares have been slammed this week after the automaker revised its 2014 earnings guidance down by about 20%. Ford also pointed to long-term cost pressure that may keep its North American margins below the levels investors have enjoyed in the last few years.
By the end of Tuesday, Ford shares had fallen to $14.79, after beginning the week at $16.33. (The stock began September even higher, above $17.50.) Yet Ford investors seem to be missing the forest for the trees.
While its earnings will be down in 2014, Ford is primed for a big bounce-back year in 2015. Furthermore, it has significant ongoing catalysts that should keep earnings growing in the next five years. The recent dip is a great opportunity for long-term investors to put some money to work in Ford stock.
Near-term outlook is under pressure
It's true that Ford's near-term guidance update was disappointing. The company had originally expected to generate a $7 billion to $8 billion pre-tax profit this year. That was already a decline from the $8.6 billion pre-tax profit it earned in 2013.
On Monday, Ford slashed its 2014 pre-tax profit estimate to $6 billion. As my Foolish colleague Daniel Miller describes, the three big factors impacting Ford's 2014 forecast are higher warranty accruals -- mainly for older vehicles -- a sharp downturn in South America, and weakness in Russia. Those factors total a $2.2 billion negative impact.
That said, many of these issues are short-term in nature. Weak results in South America and Russia were caused by geopolitical issues: e.g., economic sanctions related to Russia's support for Ukrainian separatists, Argentina's default and the related litigation with U.S. hedge funds, and Venezuela's currency woes. These problems will eventually recede -- and if they don't, Ford will cut capacity to match the new demand environment.
Meanwhile, the $1 billion in higher warranty costs is a one-time adjustment primarily related to some recent recalls. However, Ford actually showed that warranty costs and quality issues have been on the decline in recent years, despite some well-publicized recalls.
On the flip side, general business conditions have been better than Ford projected late last year. Auto industry sales volumes have been equal to or better than its initial expectations in most major markets, including U.S., Europe, and China. In short, Ford's weaker 2014 performance is not indicative of serious long-term problems.
Earnings will start to rebound in 2015
In fact, Ford's profitability is likely to rebound strongly in 2015. In North America, the new 2015 Ford F-150 will hit dealer lots later this year. Its innovative aluminum body will enable better hauling and towing capacity as well as lower fuel consumption. This should drive strong demand for Ford's most valuable product line.
Meanwhile, Ford will bring several new manufacturing plants online in China in the second half of 2014 and in 2015. This will nearly double its annual production capacity in China to 1.9 million units. This will support the launch of new models like the Ford Escort, which has been designed specifically for China to complement the Ford Focus in the compact car segment.
Just as important, Ford expects to dramatically cut its losses in the problem regions of Europe and South America. In Europe, Ford expects to reduce its loss by roughly $1 billion compared to the $1.2 billion loss projected for 2014, largely because of the impending closure of its Genk, Belgium, factory. Losses in South America should also moderate because of a few key product launches.
In total, Ford projects that pre-tax profit will reach $8.5 billion to $9.5 billion in 2015. That's not quite as good as the $10.6 billion pre-tax profit many analysts were expecting. Still, at the midpoint of the range, that would represent a record adjusted profit.
More profit growth levers ahead
The new Ford Escort is just one of 19 product launches planned for Ford's Asia-Pacific region in 2015. The automaker also has an unusually high number of product launches scheduled for 2015 in Europe. These new products will power Ford's long-term growth, but in the short term, launch costs will depress 2015 profitability.
The 2015 F-150 launch will also continue to constrain profitability in 2015. The Kansas City Assembly Plant -- one of two that build the F-150 -- will be closed for six weeks in early 2015 as it retools to produce the new models. Thus, Ford will only reach full production capacity of its most profitable model in Q2 next year. It won't have a full year of production of the new F-150 until 2016.
2016 will also be the first full year that Ford benefits from its increased production capacity in China. Another milestone scheduled for 2016 is the end of local production in Australia as Ford consolidates its operations to larger, more efficient, and cheaper factories in Asia.
On top of all these individual profit drivers, Ford expects to benefit from gradual worldwide economic improvement. Ford even hopes to revitalize its stodgy Lincoln nameplate as a small but solidly profitable luxury brand. All of these factors will drive earnings significantly higher by 2020.
The long-term outlook is bright
Looking at Ford's 2020 outlook, it's easy to be bullish about the company. Ford expects to grow automotive revenue at a compound annual growth rate of at least 5% between now and 2020. That would put automotive revenue at perhaps $190 billion to $200 billion by then, up from $139.4 billion last year.
Ford also expects its automotive operating margin to reach approximately 8% by 2020 as it finishes the implementation of its "One Ford" plan by moving virtually all of its vehicles to one of eight global platforms. This would imply automotive operating profit could reach $15 billion to $16 billion by the end of the decade.
Including profit from the Ford Credit division, which is already nearly $2 billion annually, Ford hopes to reach $18 billion in pre-tax profit by 2020. Assuming that the company's tax rate and share count remain similar to where they are today, that would boost EPS to about $3. Even with a below-average earnings multiple, Ford stock could be worth $40 by 2020 in that scenario.
Risks ahead -- but the potential rewards are bigger
All of these projections are just that: projections. Less than a year ago, Ford expected to earn $7 billion to $8 billion before tax in 2014 -- now it expects to earn just $6 billion. This serves as a good reminder to investors that projections are not guarantees of future performance.
That said, it would be wrong to presume that Ford is bound to miss its future targets just because it cut its 2014 guidance. In the short run, there's nothing Ford can do about global economic conditions. In the long run, it can adapt -- just as it has dramatically cut costs in North America and Europe in the last seven years in order to better match capacity to demand.
Furthermore, Ford's long-term outlook doesn't involve a lot of "heroic assumptions." It does expect to more than double sales in the Asia-Pacific region, but this is fully supported by its recent growth trajectory. Meanwhile, it's now projecting very modest earnings from Europe, with an operating margin of just 3% to 5% in 2020.
Ford may fall short of its 2020 targets. However, with the stock now trading for less than $15, there's a big margin of safety for investors even if its EPS can't reach $3 by 2020. In the meantime, Ford investors should stop worrying and enjoy the company's nice 3.4% dividend yield while they wait for the stock to recover.
The article Ford Investors Are Missing the Big Picture originally appeared on Fool.com.Adam Levine-Weinberg is short December 2014 $15 puts on Ford. The Motley Fool recommends and 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.
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