We see a number of takeaways from the rating upgrade. Perhaps most obvious is that this is a big statement from an agency regarding Ford’s future. Moody’s believes that the company has the ability to endure macro downturns and given the muted global growth outlook, that is a testament to Ford’s capitalization and liquidity position. We think that for an auto OEM (original equipment manufacturer) to be upgraded to investment grade is indicative of a the observed recovery for the sector since the lows of early 2009. Another takeaway is that this Ford no longer needs to post collateral for its secured revolver and lenders from the Department of Energy, leaving most of Ford’s balance sheet unencumbered. However, with all these positives, we still would not expect any capital deployment for shareholders through share repurchases or dividends. After all, Ford is still reckoning with its pesky pensions.
From a product portfolio standpoint, Ford has the highest refresh rate among OEMs (four model years out), which we believe will translate into market share increases. Ford has been relentless since ’08 in reorganizing and optimizing its products. This has resulted in an impressive turnaround that will continue into the future as the company continues to have a high product replacement rate. From a structural standpoint, Ford has been equally successful in producing results. The profitability of Ford Motor even in difficult years, debt paydown of over $20 billion in the last couple of years, and US market share gains are all highlights of the discipline that Ford has employed, which we think will contribute to the company’s continued success moving forward. Record Q1 profits speak for themselves with strength in North America and a surprisingly high cash conversion rate.
However, Ford still lags behind General Motors (NYSE: GM) in the lucrative Chinese market. But GM trails Ford in the credit ratings world. Moody’s confirmed GM’s credit rating at Ba1 but noted that its rating could be restored to investment grade in the next twelve months. Toyota (NYSE: TM), too, has relatively low exposure to China (12% of retail sales for CY 2011). However the Toyota Group has a “~40% to 50% market share in ASEAN (covers Southeast Asian),” which we view very favorably. Though it’s only a matter of time before the likes of Volkswagen and Hyundai enter the market, TM’s existing presence in this market will prove valuable.
The troubling Europe market shows just how important the international diversification is in a high growth area like Asia. Rising gas prices and a challenging environment in South America have compressed Ford’s profit margins. And there are no shortage of bears talking about another global downturn but valuation is compelling and leave room for upticks in Asia, Europe, and North American pickup truck mix.
The investment grade upgrade supports a higher multiple than the depressed ~7.3x 2012 P/E as we feel cyclicality can be balanced out by international growth and a reduction in the remaining legacy liabilities. If Ford trades up to 10.0x 2012 P/E, which we think is fair, that yields a per share value of approximately $15. We note that 10.0x is above the company’s historical trading range but given its phase of recovery, we think it is warranted. Not to mention that the stock should get a little bump when Ford and Ford Motor Credit are included in the investment grade index at the end of May. Though Europe remains an overhang, we expect strong performance in North America and positive long-term company fundamentals to prevail. Ford is still our favorite pick in auto industry. We should note that billionaires David Einhorn and Warren Buffett think GM is a better pick than Ford.