The Ford Motor Company (F, Financial) has proven itself to be exceptionally resilient in the face of market challenges. Indeed, it was the only one of the “Big Three” automakers to survive the 2008 financial crisis and Great Recession without resorting to bankruptcy protection and massive government bailout.
That is not to say that Ford eschewed government largesse entirely. It lobbied for, and received, a $9 billion line of credit from the government in case of a prolonged economic downturn, as well as a $5.9 billion loan to cover the costs of updating its manufacturing facilities in order to build more fuel-efficient vehicles. While not nothing, it was still far less than the $80 billion the US government shelled out to save the broader auto industry, which included the nationalization of General Motors (GM, Financial).
Ford has always prided itself on its fiscal prudence, hoarding cash in the event of downturns and crisis, as well as to guarantee the company’s healthy dividend payments. The company was sitting on a cash cushion amounting to just over $25 billion at the end of second quarter 2018. Careful financial management and long-term planning have allowed Ford to grow and prosper during the current long economic expansion.
But things have started to turn against Ford and other automakers sooner than they expected. Ford anticipated that 2018 would be another good year for itself and the auto industry. That has not quite been the case.
2018 fails to deliver on its promise
Fears over trade wars have spooked markets, and rising tariffs have damaged opportunities in several foreign markets, as well as dampening demand in the domestic market.
China has been a particular stumbling block for Ford. The company forecasted considerable growth and profits from the Chinese market, but retaliatory tariffs have damaged the American auto industry’s competitiveness in the region.
The unexpected headwinds have already weighed on Ford’s earnings. In second quarter 2018, the company missed on earnings, posting $0.27 per share versus the analyst consensus estimate of 31 cents per share. Ford also revised its earnings per share guidance downward, guiding for full-year earnings per share of $1.30-$1.50. Even the high end of Ford’s guidance is below the prior consensus estimate of $1.52 per share.
Fears over continued soft earnings has led to another concern: that Ford might cut its dividend.
Warning sirens sounding
Closing at $9.55 per share on Aug. 17, Ford’s stock is down 24% from the start of the year. That has resulted in Ford’s dividend now yielding over 6%. That is a fat dividend in its own right, and that has led some analysts to express concern that it may be unsustainable – or at least prudent to trim given the troubling economic storm clouds gathering on the horizon.
Analysts from Berenberg and Morgan Stanley have both signaled their expectation that Ford will cut its dividend. Berenberg projects a cut by a third, from 15 cents per quarter to 10 cents per quarter starting in 2019. The perceived need for the cut is the product of the Chinese market where tariffs may bite deep into Ford’s earnings. A major downturn in Chinese revenues could certainly cause serious problems, given that earnings from its Chinese business covered about 60% of the dividend in 2017.
The US market is not perfect either. Despite significant domestic economic growth, vehicle purchases have been anemic compared to forecasts from 2017. Preserving capital is important, especially if another down cycle commences. Trimming the dividend in 2019 could be a means of securing the company’s finances in the event that the ominous clouds on the horizon turn into a full-blown storm.
Keeping promises
Ford has pledged that it will maintain its dividend. CFO Bob Shanks had this to say at Ford’s 2016 Investor Day presentation:
Our capital allocation continues to be disciplined and to deliver strong returns, and we are fully prepared for a downturn. As a result, we plan to offer a secure regular dividend through the business cycle with an option for upside on investments to keep our core business strong and to win in emerging opportunities.
In other words, Ford was confident it could maintain its dividend even in the teeth of a recession. But does the company still have that same level of confidence after an unexpectedly weak 2018? That is the big question facing current and would-be Ford investors.
Much has changed since 2016. Certainly no one expected a trade war with China, complete with retaliatory tariffs targeting the automotive industry. Yet here we are. But where is Ford?
Ford stands firm
In the face of analyst skepticism, Ford continues to insist that its dividend is ironclad. In a recent interview, CFO Shanks was asked whether the promises of 2016 should be considered operative despite the unexpected economic headwinds of 2018:
It's extremely operative. It's an important foundation of our entire strategy around the balance sheet, around shareholder distributions and the way in which we provide them. It's also about the consistency that we hope to provide, and to demonstrate through – whenever the next downturn is – around the regular dividend.
This has been a core tenet of Ford’s financial strategy since the Great Recession. A regular dividend is a sweetener for shareholders as well as a proof of fiscal strength.
Of course, a company can get into a lot of trouble paying dividends it cannot afford; just ask Kinder Morgan (KMI, Financial), which is still being punished by the market for slashing its dividend when oil prices collapsed. Ford could face an ugly market reaction were it to cut its dividend after guaranteeing its status.
So how does Ford plan to pay for it even as the China market gets ugly?
Ford Credit to the rescue
According to Shanks, the answer lies in the Ford Credit division, which he describes as a cash-printing machine just gearing up for action. It is hardly a small thing at present, delivering $2.3 billion in pre-tax income to Ford’s coffers in 2017. But Shanks sees its growth and steady cash generation as a firm guarantor that Ford’s dividend will be paid:
What that means is we should be able to expect that will send back to Ford, in general, about $1.6-1.7 billion every year, which is that 11% on the $15 billion – and the $15 billion will grow. That pays for around 70% of the dividend on its own.
So I've got the stable dividend and I've got the stable distribution coming from Ford Credit. It doesn't totally match up but it certainly pays a huge chunk of it.
In other words, Ford Credit can more than make up for the shortfalls in China – and can do so even during an economic downturn.
Verdict
Recessions can strike fast and hard. Preparation is important, especially for a business with the size and complexity of Ford. A 6% dividend yield is nothing to slouch at, and that yield would only improve in the event of market forces depressing stocks.
Ford looks well placed to weather whatever storms lie ahead, and should be able to do so without compromising on its dividend. Fundamentally, Ford is still a family business in many ways, and the descendants of Henry Ford continue to carry an attitude of proprietary stewardship that results in a conservative and long-term view. The company’s managers are clearly immersed in that same culture.
As the world economy continues to be roiled and our capital markets continue to enjoy a veritable bull market in everything, it is worth looking to companies like Ford that can offer stable income opportunities and potential capital appreciation if and when capital flows to safety.
Disclosure: I/We own no stocks discussed in this article.
