Ford Should Drive Your Portfolio

Ford (NYSE: F) managed to ride out the great recession without a government bailout. But General Motors (NYSE: GM) simply could not survive on its own. Nobody knows whether the U.S. will ever get its money back from the GM bailout, but at least the new, publicly-traded version of GM is a more viable business. Should you invest in the car company that survived on its own or the one that the U.S. bailed out?

GM failed for six reasons that serve as a warning for all businesses. As I wrote in 2009, GM took a $19 billion bailout from the U.S. that ended its 101 year existence. And it failed due to six management weaknesses:

• Bad financial policies. By 2006, GM's liabilities exceeded its assets and it was using its vehicles as loss-leaders to issue more profitable car loans;
• Uncompetitive vehicles. Compared to its toughest competitors -- like Toyota Motor Co. (NYSE: TM) -- GM's cars were poorly designed and built, took too long to manufacture at costs that were too high, and as a result, fewer people bought them, leaving GM with excess production capacity.
• Ignoring competition. GM has been ignoring competition -- with a brief interruption (Saturn in the 1980s) -- for about 50 years. At its peak, in 1954, GM controlled 54% of the North American vehicle market. By 2008, that figure had tumbled to 19%.
• Failure to innovate. Since GM was focused on profiting from finance, it did not really care that much about building better vehicles. GM's management failed to adapt GM to changes in customer needs, upstart competitors, and new technologies.
• Managing in the bubble. GM managers got promoted by toeing the CEO's line and ignoring external changes. What looked stupid from the perspective of customer and competitors was smart for those bucking for promotions.

Meanwhile, Ford managed through the same competitive environment in much better shape. Under CEO Alan Mulally, formerly a Boeing (NYSE: BA) executive, Ford borrowed billions that gave it the cash to survive the Great Recession.

But beyond that, Mulally is a great problem-solver. According to Stan Sorscher, a former Boeing employee and current union official I interviewed for an August 2009 story, Mulally would invite people from all levels of the business to share information and work toward solutions that are in the best interests of Boeing.

And before its second quarter financial report on Wednesday, Ford was expected to report EPS of $0.45 per share with revenues seen rising 11.9% to $29.86 billion. Its actual results were a penny higher than expected -- $0.46 while Ford's revenues rose much faster than analysts had forecast -- 14.1%.


Ford is also enjoying the benefits of a successful negotiation with the United Auto Workers and credit rating upgrades. Due to Ford's free cash flow and automotive profits S&P raised its rating while Fitch did the same on Ford's strong financial performance and efforts to reduce debt. Moreover, in September, demand for Ford's fuel-efficient automobiles led to a strong sales report.

For its part, GM reported a great second quarter but its stock fell when it predicted a weaker second half. Specifically, its Q2 2011 net income of $2.52 billion was 90% above the year before and its EPS of $1.54 was 32 cents above the average estimate of 13 analysts surveyed by Bloomberg. GM's 19% sales increase to $39.4 billion was $3 billion higher than estimated.

But the most interesting part of this report was that GM customers are willing to pay higher prices. For example, GM's Cruze is selling for $4,200 more than the Chevrolet Cobalt car that it replaced; the new Buick LaCrosse is fetching $7,000 more than its predecessor and its Chevrolet Equinox sport-utility vehicle gets $3,800 more than it did in 2009.
 
Should you buy GM and Ford stock?

• Ford: Solid growth, decent margins; hard-to-value stock. Ford sales were up 10.9% in the past 12 months to $131 billion while net income jumped 142% to $6.8 billion – yielding a 5.22% net profit margin. Its PEG is undefined (where a PEG of 1.0 is considered fairly priced) because at a P/E of 7.1 its earnings are expected to fall 5.71% to $1.77 in 2012. However, if it can continue its earnings growth at the pace of the last 12 months, the stock is screamingly cheap. 
• GM: Good sales growth, but falling profit and small margins; hard-to-value stock. Revenue for GM was up 29.6% in the past 12 months to $146 billion while net income dropped 95.5% to $7.9 billion – yielding a 4.77% net profit margin. Its PEG is also undefined on a P/E of 5.22 and earnings expected to decline 1.64% to $4.20 in 2012.

Analysts seem convinced that neither Ford nor GM can grow earnings in 2012. But if I was going to gamble, I would say that GM has a better chance of beating expectations based on its higher prices and cost controls.