Raising estimates and PO; Ford should keep motoring As part of our sector review (please see our recent note,Changing lanes – still accelerating) we are raising our Ford EPS estimates in 4Q10e from $0.45 to $0.48, in 2011 from $2.25 to $2.40, and in 2012 from $2.40 to $2.55. We are also increasing our price objective from $20 to $24, which is based on a P/E of 10X our 2011e. In our view, Ford’s stock should continue to outperform for a number of reasons, including, strong management, solid operating results, a consistently improving balance sheet, industry-leading product, and recovery in the U.S. sales cycle.
Solid results should continue
Ford’s financial performance over the past year has been impressive, with LTM EPS of $2.05 and automotive cash flow generation of ~$6.5bn. We expect the company to continue generating solid pre-tax profits in North America and in Ford Motor Credit, and stable/improving international performances to bolster results.
Balance sheet getting stronger each quarter
Ford has made meaningful progress in shoring up its balance sheet, and we expect further improvement ahead. Our current estimates imply that Ford will be comfortably net cash positive in 2011 and FMCC remains significantly over capitalized, which should drive higher value for shareholders.
Product sweet spot and common platform leverage ahead
We believe Ford is entering the sweet spot of its product cadence in MY11-MY14 (please see Car Wars 2011-2014 for further detail). We are forecasting an annual U.S. replacement rate of ~30% for Ford during this timeframe, and expect greater use of common platforms/parts to drive significantly lower engineering costs.
Solid leadership at the top
It is difficult to measure the short-term success of a management team in the automotive industry, as so much is dependant upon the economic cycle. However, we believe Alan Mulally has led Ford through what is likely the worst of
␣the downturn, and has positioned the company for success as volumes recover.
Initiating with an Outperform. We are initiating coverage of General Motors with an Outperform rating and 12-month price target of $43. After a quick stint in bankruptcy, the primary outcome of which was a balance-sheet cleansing and the installation of new management and Board, we think GM offers an attractive 12-18 month investment opportunity.
■ A Deep Discount to Ford. Even after pushing up the issue price, GM still came to market at a deep discount to Ford. GM is currently trading at 3.9 times 2011 EBITDAP vs. Ford at 5.5 times.
■ Valuation Gap Should Close as We Approach 2012. We introduce a new analysis in this report that helps us map company fundamentals to valuation multiples for global automakers. Based on this equation, we think GM’s current discount to Ford is justified, but that the gap will close materially in 2012 as GM’s product cycle hits its stride and Ford’s shifts to a lower gear.
■ 2011 Won’t Be Easy. While we recommend investors build positions ahead of the expected 2012 re-rating, we recognize that 2011 will be a difficult year. GM has limited new product coming to market this year and faces difficult production comparisons versus 2010, when the company was re-stocking depleted truck inventories.
■ Pension Is Both Risk and Opportunity. We would be remiss to not dedicate at least one bullet point to pensions. On the risk side, we note that GM’s pension plans remain under-funded by more than $20 billion globally, and thus will consume significant cash contributions over the next two years. On the opportunity side, we note that normalization of record-low interest rates could shrink GM’s liability, potentially freeing up significant value for equity holders.
Finally, GM can worry about revenues, not costs.
GM has the chance to translate competitive costs and a strong balance sheet into something it hasn’t been able to do in 50 years – take risk on the top line. Sustainable success beyond 2015 depends on new management and new product. Nearer-term, despite a product line not yet firing on all cylinders, we expect GM to generate $10bn or more of free cash flow for each of the next 5 years. We forecast GM to generate nearly $40mm of free cash flow per day over the next 5 years, driving our $50 price target and Overweight rating.
GM is poised for 10% EBIT margins by 2013 and 53% revenue growth by 2015. On our calculations, GM’s balance sheet is set for dramatic improvement from today’s already-strong levels. We forecast GM’s net cash improves to more than $22bn by the end of 2011 despite making a $6.1bn contribution to US pensions with net cash rising to approximately $71bn by 2015. Key drivers of our cash flow assumptions include:
1. N. America. GM holds share stable in a US market recovery to 14mm units in 2011 and 15mm in 2012. N. America generates 6x more FCF than China JVs.
2. Non-China Emerging Markets. We estimate these areas generate 2x-3x more FCF than China.
3. Europe. We believe Opel structurally burns $0.5bn of cash per year and is worth negative $5bn.
We believe GM can sustain a 5% EBIT margin (ex China) with fully taxed normalized earnings power of more than $4 per share. We can pay up to $30 per GM share on a 5-year LBO valuation of the core auto business (ex China) run at a 35% tax rate. To this, we add the value of the NOLs ($9 per share), Chinese JVs ($6 per share), AmeriCredit ($2 per share), Delphi and Ally stakes ($3 per share), taking our price target to $50.
Bottom line: GM is designed to be very profitable in a bad market and is an out-of-the-money call option on new product and management. GM shares offer slightly more upside than Ford, albeit at higher risk.