In the corner offices of the nation's major airlines, industry executives are still beaming about the "great re-rating of 2013."
It's a move I suspected might happen back in 2011, while Delta Airlines (NYSE: DAL) was trading for less than five times trailing earnings. At the time, I thought investors would eventually award a higher multiple as business grew more predictable. If shares simply traded up to eight times projected 2012 profits, then DAL would double in value to $16, I figured.
Shares now trade for around $30, or around 11.5 times forward earnings and around seven times projected 2014 EBITDA. In effect, the whole airline group has benefited from a trend toward higher P/E multiples -- to a much greater extent than I had anticipated.
Investors no longer fear a deep downturn for airline industry profits. In a similar vein, investors can stop worrying about the nation's top automakers.
Like the airlines, automakers now sport their strongest balance sheets in memory and can easily handle whatever the economy throws them. And like the airlines, they throw off a ton of cash flow. As a result, look for Ford (NYSE: F) and GM (NYSE: GM) to benefit from a "re-rating" in the next 12 to 24 months as well.
|© 2014 The Ford Motor Company|
|Ford plans to release 16 new models in North America this year, and the full-year sales impact should be felt in 2015.|
Though I'm also a fan of GM, let's take a closer look at Ford to see why shares remain quite undervalued and should benefit from an eventually higher multiple.
Shares of Ford have fallen nearly 20% from the 52-week high and now trade near eight-month lows, and its market value now stands at around $58 billion, a drop of roughly $13 billion from the peak.
The question is: Does the current market value represent a fair price for future cash flows? And if not, what is fair value?
To get a sense of that, I am using Merrill Lynch's financial projections, as they are largely in line with the consensus view. Ford's 2014 sales are expected to be flat, largely because the company is in a transition phase of model changeovers. Ford plans to release 16 new models in North America this year, and the full-year sales impact should be felt in 2015.
Ford's Powerful Cash Flow
As noted earlier, Ford's market value stands at $58 billion, but if you back out the net cash position of $20.7 billion that Merrill forecasts by the end of 2015, then the enterprise value drops to around $37 billion. (Ford has other major debts on its balance sheet, but those are all tied to assets such as factories.)
Also note that Ford's 2015 EBITDA should approach $17 billion while free cash flow is expected to exceed $7 billion. What is an appropriate EBITDA multiple, in the context of enterprise value? The current 2.2 multiple seems awfully low. If Ford trades for three times 2015 EBITDA, then its enterprise value would move up to $51 billion, or $14 billion higher than current levels. Adding such a figure to the current market value equates to an $18 share price.
But Ford deserves more. As investors come to understand that the current auto industry upturn (which is hardly a boom) won't be followed by a bust, then an EBITDA multiple of 4 looks even more justified. The puts the enterprise value at $68 billion, and the projected market value at $88 billion. That works out to be a $21.50 share price, fully 50% above current levels.
In recent quarters, Ford has begun to lavish a lot more attention on its dividend, which now yields 3.4%. Frankly, Ford could easily boost the dividend by 100% without making a dent in its balance sheet. But I'd prefer to see share buybacks, which are the preferred path whenever a stock sports low multiples.
Risks to Consider: Ford has had great recent success in China, but any downturn in that country would create a drag on global operations, just as Ford of Europe has in recent years.
Action to Take --> Shares of Ford have been on a wild ride, surging to $20 in early 2011, slumping below $10 in the summer of 2012 and rebounding toward the $20 mark again this past summer, only to pull back below $15 in recent sessions. Yet all the while, Ford's operations have been gaining strength. The company's successful moves in China, its declining losses in Europe, and its solid presence in North America (which again should benefit from 16 new model launches this year) are creating a powerful global platform. Wall Street, judging by the latest pullback, remains skittish about the company's prospects, but the financial statements are undeniably impressive. This truly a buy-and-hold stock, which stands to deliver very strong cash flows in coming years.