Historical Results and Commentary
November 11, 2002
Holdings
|
|
Nov-02 |
|
1 |
F |
|
2 |
NBG |
|
3 |
YHOO |
|
4 |
NKE |
|
5 |
BA |
|
6 |
VRSN |
|
7 |
JDSU |
|
8 |
CAT |
|
9 |
JNJ |
|
10 |
NSM |
|
11 |
CA |
|
12 |
FNF |
|
13 |
MSFT |
|
14 |
TKC |
|
15 |
HMC |
|
16 |
WMT |
|
17 |
X |
|
18 |
AAPL |
|
19 |
COP |
|
20 |
WB |
Performance of Individual Stocks For last 3 months:
|
Nov-02 |
|
|
FNF |
0.20% |
|
COP |
-6.40% |
|
CAT |
-6.13% |
|
NKE |
-2.17% |
|
BA |
-23.48% |
|
VRSN |
40.60% |
|
JDSU |
-1.28% |
|
YHOO |
24.75% |
|
JNJ |
10.47% |
|
NSM |
-22.56% |
|
CA |
50.28% |
|
PFE |
2.36% |
|
MSFT |
11.93% |
|
TKC |
24.70% |
|
HMC |
-18.62% |
|
WMT |
7.87% |
|
X |
-20.76% |
|
AAPL |
1.07% |
|
NBG |
-15.42% |
|
WB |
-8.04% |
Total Increase (Decrease) since last quarter: 2.47%
Additions: F
Subtractions: PFE
Commentary:
Can One afFORD FORD?
I have just added F to the portfolio in a timing play that is described in this commentary. Ford is in what I believe to be a cyclical downturn, and the following is my justification for purchasing Ford right now. First, one of the most attractive things about Ford right now is its dividend payment, which is currently 10 cents a quarter, or 40 cents a year. With a stock price of about 8 ½, this represents a dividend payout ratio of 4.7 percent. Not too bad. Also, Ford is a leading company in the automotive sector, with a long and successful track record. If there ever were a blue-blooded American company, Ford would be it.
Although the dividend payout and the reputation of the company are major strengths, the main impetus behind the purchase is that, well, it seems like a gamble with a much higher upside than downside. Essentially, Ford is a company with $285 billion in assets and no equity. This means that just a slight improvement in its ROA will result in a tremendous increase in its ROE. Now, it is also true that Ford is essentially an automotive manufacturer grafted to a financial firm, and the ROA on financial firms engaged in consumer lending tend to be constrained by lending spreads, which restrict the upward movement of the ROA of Ford’s financial assets. However, let’s make a conservative projection for the eventual after-tax ROA level sometime over the next 5-7 years of 2% for the automotive division and 0.5% for the financial division. That means the company would be earning just under $3 billion. If things go really well, and the after-tax ROA for the automotive section rises to a reasonable 4%, and the financial ROA rises to 1%, then we would be looking at annual earnings of $6 billion. Now, Ford currently has a market capitalization of $15 billion. If we assume Ford’s equilibrium PE is somewhere around 12 (a somewhat conservative estimate), then in the first scenario of $3 billion annual earnings, we would see a market cap of $36 billion, and in the second scenario, we would see a market cap of $72 billion. Also, from a net asset value perspective, in either case, Ford would quickly build its book value of equity, which would push its P/BV towards 1 in a static situation. In the dynamic world, we would expect the price to rise to avoid a contraction of the P/BV ratio to 1 or below. Also, even if Ford could make $1.25 billion a year, it would be properly priced at a PE of 12 where it is now.
But, all is not well in the state of Ford. The company is currently losing money. According to the latest quarterly report1 Ford lost $850 million in the 9 months ending September 30th, 2002, compared with losses of $385 million in the nine months ending September 30th 2001. However, this loss of $850 million includes a one-off accounting charge of $1.002 billion. So, depending on your point of view, Ford is actually doing better than last year. Also, sales in the core automotive business are up by about $2.5 billion, and the operating income from the core automotive business is improved from a loss of $1.187 billion to a loss of $306 million in this last 9 month period of the one ending September 30th 2001.
However,
Ford still has two major problems. First
is its competitive position. Let’s face it, Honda and
Second, Ford has a really weird capital structure. The company is divided into two divisions: Automotive and financial. The automotive sector has gross assets of $100.1 billion. Taking out goodwill and intangibles, this is $94.6 billion. This segment also has $99 billion in liabilities, giving it a net equity of -$4.4 billion. Oh boy, that is not good from a margin of safety perspective. The financial segment has gross assets of $185.5 billion, and gross liabilities of $171.0 billion, giving it a net of $14.5 billion in equity. But…there is also this little thing called “Company-obligated mandatorily redeemable preferred and mandatorily redeemable convertible preferred securities of subsidiary trusts holding solely junior subordinated debentures of the Company” which cost Ford $5.6 billion in the last 9 months (ending September 30th 2002). To tell the truth, I don’t understand Ford’s capital structure. Its financial arm currently has $143 billion in debt. Given low interest rates, if any time is an acceptable time to be mired in debt, now is. However, the problem with this is that if repayment obligations rise or the cost of funding increases for rolled-over debt, things can get difficult.
So,
to recap, Ford is a risky company right now, primarily because of its highly
leveraged position. I believe cyclical
factors are causing it to be temporarily unprofitable. However, I could be wrong, and Ford could go
the way of Penn Central or Enron. So,
how can one make a decision in a situation like this? I am going to use a basic game theory
approach to show why I have decided to purchase Ford.
I made a conservative model with the following assumptions:
The following shows 10 possible scenarios for Ford. The first (bankruptcy) has a 50 percent chance of occurring, and each of the others has a 5 percent chance of occurring:
|
|
Scenario
1 |
Scenario
2 |
Scenario
3 |
Scenario
4 |
Scenario
5 |
Scenario
6 |
Scenario
7 |
Scenario
8 |
Scenario
9 |
Scenario
10 |
|
|
|
Automotive |
BANKRUPTCY |
|
|
|
|
|
|
|
|
|
|
|
|
After Tax
ROA |
BANKRUPTCY |
0.5 |
1 |
1.5 |
2 |
2.5 |
3 |
3.5 |
4 |
4.5 |
|
|
|
Segment
Earnings ($bn) |
BANKRUPTCY |
0.5 |
1 |
1.5 |
2 |
2.5 |
3 |
3.5 |
4 |
4.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial |
BANKRUPTCY |
|
|
|
|
|
|
|
|
|
|
|
|
After Tax ROA |
BANKRUPTCY |
0.25 |
0.5 |
0.75 |
1 |
1.25 |
1.5 |
1.75 |
2 |
2.25 |
|
|
|
Segment
Earnings ($bn) |
BANKRUPTCY |
0.4625 |
0.925 |
1.3875 |
1.85 |
2.3125 |
2.775 |
3.2375 |
3.7 |
4.1625 |
|
|
|
|
BANKRUPTCY |
|
|
|
|
|
|
|
|
|
|
|
|
Net
Earnings ($bn) |
BANKRUPTCY |
0.9625 |
1.925 |
2.8875 |
3.85 |
4.8125 |
5.775 |
6.7375 |
7.7 |
8.6625 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market
Cap at PE=12 |
|
11.55 |
23.1 |
34.65 |
46.2 |
57.75 |
69.3 |
80.85 |
92.4 |
103.95 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
# of Years To End of Scenario |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Scenario
1 |
Scenario
2 |
Scenario
3 |
Scenario
4 |
Scenario
5 |
Scenario
6 |
Scenario
7 |
Scenario
8 |
Scenario
9 |
Scenario
10 |
|
|
|
1 |
-95.30% |
-18.30% |
58.70% |
135.70% |
212.70% |
289.70% |
366.70% |
443.70% |
520.70% |
597.70% |
Expected ROI |
144.85% |
|
2 |
-90.60% |
-13.60% |
63.40% |
140.40% |
217.40% |
294.40% |
371.40% |
448.40% |
525.40% |
602.40% |
|
73.60% |
|
3 |
-85.90% |
-8.90% |
68.10% |
145.10% |
222.10% |
299.10% |
376.10% |
453.10% |
530.10% |
607.10% |
|
49.85% |
|
4 |
-81.20% |
-4.20% |
72.80% |
149.80% |
226.80% |
303.80% |
380.80% |
457.80% |
534.80% |
611.80% |
|
37.98% |
|
5 |
-76.50% |
0.50% |
77.50% |
154.50% |
231.50% |
308.50% |
385.50% |
462.50% |
539.50% |
616.50% |
|
30.85% |
|
6 |
-71.80% |
5.20% |
82.20% |
159.20% |
236.20% |
313.20% |
390.20% |
467.20% |
544.20% |
621.20% |
|
26.10% |
|
7 |
-67.10% |
9.90% |
86.90% |
163.90% |
240.90% |
317.90% |
394.90% |
471.90% |
548.90% |
625.90% |
|
22.71% |
|
8 |
-62.40% |
14.60% |
91.60% |
168.60% |
245.60% |
322.60% |
399.60% |
476.60% |
553.60% |
630.60% |
|
20.16% |
|
9 |
-57.70% |
19.30% |
96.30% |
173.30% |
250.30% |
327.30% |
404.30% |
481.30% |
558.30% |
635.30% |
|
18.18% |
|
10 |
-53.00% |
24.00% |
101.00% |
178.00% |
255.00% |
332.00% |
409.00% |
486.00% |
563.00% |
640.00% |
|
16.60% |
The game scenario is played as follows: Ford is allowed to grow for up to 10 years until its earnings stabilize or until it goes bankrupt. The table above (the part below the title in red) shows the results given a few different variables. The rows show years until stabilization, and the columns show the return on the initial investment in Ford given a range of different equilibrium ROAs and corresponding yearly earnings. The rightmost column gives the expected return at a given year assuming bankruptcy has a 50 percent chance of occurring and each of the other outcomes has a 5 percent chance of occurring in each year examined.
Of course, there are several other variables that are ignored. Ford could reach an equilibrium PE of over 12, or its ROA’s could be higher than they are here. Additionally, there are lots of other combinations of mixtures of ROAs from the financial and automotive segments that are not considered. Finally, Ford could have a greater or less than 50 percent chance of going bankrupt. However, given that this conservative model yields an expected value of at worst 16.6 percent per year, F represents a good bet.2
110-Q released on November 14th, 2002
2Ford is a good bet for an individual investor worried about absolute returns on an initial investment, but not necessarily for the portfolio! This is because the portfolio is rebalanced every quarter (whereas my personal portfolio is not). Therefore, if Ford declines into eventual bankruptcy, such losses will be amplified by reinvestments into F. If this were a portfolio in the real world, I would not rebalance F. If you happen to be copying this portfolio, I recommend that you do not rebalance F, unless you run a similar model and conclude F represents a good investment at future time periods.
Back to Quarterly Commentaries
Historical Results and Commentary