Tuesday, October 26, 2010

Bookkeeping: Starting Ford (F) on Impressive Quarter

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I continue to believe Americans are not appreciating the massive restructuring that has happened in the auto sector.  To this end I've been using a few auto suppliers for exposure to the sector, but today - upon further reflection and an impressive quarter - I am adding Ford (F).  Take a step back and think who - outside of a handful of young tech companies - have had the best prospects the past few quarters.  It is multinational companies who can arbitrage labor costs, sell to fast growing economies overseas, and benefit from government stimulus programs; either directly (Cash for Clunkers) or indirectly (U.S. government now providing 1 in 5.5 dollars of income for the average American, countless American households living in houses they don't bother to pay a mortgage on).  [Oct 20, 2010: Eaton's Combination of Domestic Cost Cutting and Foreign Sales Display the Power of Multinational Industrials] [Oct 21, 2010: Caterpillar Scores with Now Redundant Playbook - Slash Domestic Labor + Emerging Market Growth = Mad Money] Ford and General Motors embody those trends.

What is different in this space is that that this sector has been behind the rest of corporate America in making the migration to the 'new normal'.  Going into the Great Recession the percent of profits that went to capital (versus labor) in America was already at all time highs.  I imagine it has only continued the past 2 years but don't have the data in front of me.  Obviously with the union movement, this was *not* the case in the auto sector, especially the domestics and their largest suppliers.  But as I outlined in this piece on why GM will be a very attractive IPO - this has changed. [Jun 16, 2010: What to Expect from a General Motors IPO Indeed it was changing even before the Great Recession as the union had agreed to tiered wages - that is paying new hires just above Walmart wages.  Now, it will take many years (and retirements) to transition over to this lower cost level but effectively this is akin to the outsourcing labor arbitrage seen in many multinational peers in other industries - only it is being done inside the country and of course not to the low level of salaries that other companies can get away with, because much of the labor is still in the States.  However, quite a bit is in Mexico [Sep 10, 2010: Bloomberg - As Wage Differentials Narrow Can Mexico Regain Some Outsourcing versus China?]

But there is a secret weapon for the Big 3 - in 2007, along with these new wage contracts came an agreement to offload part of the most damaging cost to American companies: healthcare - to the union.  Whereas once these companies were paying for retiree healthcare benefits, that is no longer going to be the case.  This line item, which in many corporations rises 8-12% a year is going to be the worry of another entity altogether.  Can you imagine the benefit to Boeing (BA) or General Electric (GE) or any multinational if they could have a 3rd party (in this case the union but in other countries the central government) be responsible for this cost?  Profits would boom to the stratosphere.  But the auto companies pulled it off, and I don't think the market appreciates this.

Again, as I do in any auto related piece I need to stress how profitable these companies have become with depression like auto sales of 10, 11M-ish a year.  The U.S. peaked over 16M when half of America was using their house ATM to buy cars.   Probably a more realistic level of non credit binge level is 13M, but the U.S. - despite a "great recovery" in the economy - is nowhere near that.  Plus of course Ford, and especially General Motors has a booming emerging markets component.  Hence, coming into the recession these auto companies were just beginning to act like global multinationals after being a decade+ behind the rest of our largest corporations in hollowing out the middle class.  But now it is on full throttle, and by one measure (healthcare) the cost structure of the auto makers might be 'best in class'.  (please note the auto suppliers do not have this huge benefit)

In short, many of the same trends decimating much of the labor force in America are creating a boon for profits and corporations, especially of the multinational kind.  I opined in the early days of this website whether we may be in a new era where a small strand of society, especially of the corporate kind, does well - while the rest takes many bullets.  [Jul 27, 2010: NYT - Industries Find Surging Profits in Deeper Cuts [Oct 20, 2009: WSJ - Slump Prods Firms to to Seek New Compact with Workers] This appears to be happening but much like the house ATM glossed it over the past decade, the new ATM (the government + Federal Reserve versions) is covering it up now.  Therefore objects in your rear view mirror may appear more green shooty than they truly are.

But as stock speculators all we can care about is the bottom line and Ford, amongst others, seem to be in the driver's seat (pun intended).

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Specific to Ford (F) the chart looks excellent....



And the results speak for themselves; a 10 cent beat. Pay attention to the "VEBA" which is the entity aka healthcare.  I started with a 1% exposure today just to get my feet wet.  If the market were not so overextended I'd probably go larger to begin.

Near term risks are obvious - the Fed and U.S. government stop sacrificing the saver class to benefit the debtor class; government handouts to Americans drop under a GOP Congress, emerging markets slow, and Bernanke's printing press causes the type of commodity inflation that truly hammers profit margins (already well on the way on this one)

Via AP:
  • Ford Motor Co.'s third-quarter net income rose 68 percent as it grabbed a bigger share of the U.S. auto market and buyers paid more for its highly-rated cars and trucks. It was Ford's sixth straight quarterly profit and the company's best third-quarter performance since at least 1990.
  • Ford's earnings of $1.7 billion, or 43 cents per share, beat Wall Street estimates. Without one-time items, which included a $102 million charge related to Ford's sale of Volvo, Ford would have earned 48 cents per share. Analysts polled by Thomson Reuters had forecast earnings of 38 cents per share. 
  • In the same quarter a year earlier, Ford earned $1 billion, or 26 cents per share.
  • Ford CEO Alan Mulally said popular new cars, and aggressive cost-cutting helped the company make money despite lower global sales.
  • Ford's quarterly revenues fell $1 billion, or 3 percent, to $29 billion for the quarter. But Ford said if Volvo's 2009 revenues were excluded, revenues rose $1.7 billion.

Debt picture improving
  • The automaker said it expects to end the year with as much cash as it has debt, a year earlier than it had previously forecast. Ford, which four years ago mortgaged its factories, blue oval logo and other assets to fund a huge restructuring, said it paid off $2 billion in debt in the third quarter and expects to pay off an additional $3.6 billion for retiree health care on Friday. Ford's debt will stand at $22.8 billion after those two actions. It has $20.3 billion in cash.
  • When Ford pays its debt to the United Auto Workers health care trust, it will no longer owe the trust any money. The UAW agreed to the trust in 2007, and it began paying health care benefits for 195,000 retirees and spouses in January. The automaker was paying a 9 percent annual interest rate on its obligation to the trust.
  • Schloss said once Ford repays the UAW trust, it will have reduced debt this year by $10.8 billion, saving roughly $800 million in annual interest costs. 

Commodity costs are rising ....
  • Booth also said raw material costs have risen $1 billion this year over last, about what the company expected.

Of course pensions are still underfunded, but with the Federal Reserve now manipulating asset prices higher than they should be, with enough QE's in the coming years, all these problems go away.  (Dow 36,000 should coincide with QE5).
  • A Credit Suisse analyst wrote last month that the automaker's global pension funds were $12 billion underfunded at the end of last year, and that could worsen to $17.5 billion by the end of this year.
  • Ford has said it will make around $1.5 billion in pension payments this year and next, and it doesn't expect the payments to significantly affect earnings.

Long Ford in fund; no personal position

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