Many investors, such as retirees, prefer to invest in higher-yielding stocks. This is quite reasonable as high-yield stocks provide a return even when the markets are moving sideways or downward, while at the same time even modest share price increases result in compelling total returns once the dividend yield is added into the equation.
Investors should, however, also consider the stability of the dividend. In cases where companies pay out high dividend yields, there is also a risk that the dividend could be cut if the economy goes into recession.
Ford Motor Co. (F, Financial) is among the highest-yielding stocks in the S&P 500 Index, which is why many income-focused investors own this stock. While Ford's dividend of 6.5% is attractive, investors should not ignore the risks with this stock. A possible recession in the U.S. or further trade war escalation with China or the European Union could hurt the carmaker to a significant degree, which is why we don’t see the stock as a sleep-well-at-night investment.
Company overview, recent results and growth outlook
Ford’s history dates back more than 100 years. Over time, Ford has become one of the largest automobile companies in the world, and the number two player in the United States. Its model lineup is weighted towards SUVs and to pickup trucks, at least in the U.S. In other markets, where pickups hold a much lower market share, Ford is selling a larger amount of passenger cars.
Ford reported its most recent quarterly results in July, where the company announced results that were relatively in line with what it had reported for the prior-year quarter.
The company did not generate high profits during the quarter, yet it still managed to eke out some marginal gains year over year when it comes to earnings per share. Earnings before interest and taxes and free cash flows rose substantially year over year, though, and Ford’s cash balance of more than $23 billion was above management’s target at the end of the quarter. This would be a major positive during a recession, as Ford is less likely to run out of money if its cash balance stands at a high level before entering a recession.
Revenues were flat year over year, despite the fact that sales volumes dropped by 9%. Through improved pricing and a more favorable sales mix with a higher portion of high-priced SUVs and pickup trucks, Ford was able to keep its revenues flat year over year. The improved sales toward higher-margin vehicles also explains how Ford was able to grow its EBIT and cash flow while its revenue did not increase.
Ford generates almost all of its profits in the North American market, as its operations in Europe and China are just breaking even. This can be explained by U.S. consumers’ strong demand for pickups, which allows Ford to sell higher-priced, higher-margin vehicles that generate higher profits. In foreign markets, the sales mix is less favorable as the company’s margins on its lower-priced passenger cars are much lower than those for its more expensive, bigger models.
This situation means Ford is highly dependent on U.S. consumers’ demand for automobiles for its profits, which can be a positive as well as a negative. Right now, the U.S. economy is growing at a faster pace than that of most European countries, for example, which is beneficial for Ford since it relies on strong consumer spending in its core market. Should the U.S. go into a recession, however, the automaker would be hit quite hard since it is not able to generate meaningful profits in other geographic markets.
Ford is working on growing its profitability by closing down factories that are not needed right now, mainly in Europe, while also stopping production of non-profitable passenger cars. This should bring down Ford’s fixed costs and increase its capital efficiency, which is highly positive, especially if the state of the global economy would worsen further.
Ford’s dividend yield is high, but vulnerable if economic conditions worsen
Ford’s shares offer a dividend of 60 cents per year, which results in a dividend yield of 6.5% at current prices. This is more than three times the broad market’s dividend yield, which is quite remarkable. Based on results that Ford generated during 2018, and based on what it guides for in 2019, the dividend looks quite reasonable. Management is guiding for earnings per share of $1.20 to $1.35, which means the dividend payout ratio in 2019 is somewhere between 44% and 50%.
Usually, investors don’t have to worry about dividend cuts if a company pays out only half of its profits, but in Ford’s case, its earnings per share could decline substantially in the future if a recession hits the U.S. During the last financial crisis, which was a very harsh recession, Ford did not only stop generating any profits for a whole year in 2009, but was also forced to cut its dividend by 40% before eliminating it completely one year later. It is unlikely that the U.S. will be hit by an extreme recession in the near future, but even a more benign downturn would likely damage Ford’s profitability meaningfully.
Due to other factors, such as trade war issues, and the need to invest heavily into self-driving technology and e-mobility, Ford could be more vulnerable right now compared to how it was positioned before the last financial crisis. This can also be seen by the fact that its earnings per share are much lower right now compared to where they were 10 years ago – the company earned $3.13 per share in 2008, versus a little bit more than one-third of that right now.
Final thoughts
The risk of a dividend cut is not extremely high right now, we believe, and it is not at all a sure bet that the U.S. will be hit by a recession anytime soon, but investors should nevertheless keep in mind that Ford’s dividend is not the safest they can get. Due to its heavy exposure to consumer spending trends, Ford is a company with above-average cyclicality and, therefore, also has above-average risk for a dividend cut. The fact that the automobile industry is subject to massive change over the coming years poses some additional risks as well. Ford had to cut its dividend significantly during the Great Recession, so because it is a highly cyclical business, is not a stable stock to own if another recession occurs.
Disclosure: No positions.
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