Pat Dorsey: Hi, I'm Pat Dorsey, Director of Equity Research at Morningstar. I'd find one of the hardest things as an investor is managing the tension between having a defined point of view of the world, having an investment discipline of sorts without which I don't think you have any prayer of beating the market and changing your mind once in a while.
It's very easy to anchor on out-dated assumptions, stick to your knitting even though the knitting has changed, so to speak, and have a point of view about a company or industry that is frankly not reflective of current information. I thought about this a lot over the past month or so, as I have actually been spending a lot of time looking at Ford shares. I never thought I would actually be excited about recommending and even investing in an automaker.
It's a little bit like the old quote that Warren Buffett gave some years ago after his failed – well, not failed, he broke-even investment in USAir when he said that he carries an 800 number around in his pocket and whenever he gets the urge to invest in an airline, he calls airline investors anonymous and has somebody talk him out of it. I kind of felt like that when I started looking at Ford maybe.
But the world does change, and it's interesting to look at the automakers right now, especially Ford and there is one point of view that says, gosh, it's a capital-intensive business, selling into a mature market. It's a company that's been losing market share for years, et cetera, et cetera, et cetera, but then if you take a fresh view of things, you realize that Ford is going to be saving about $1 billion per year in cash costs after transferring its healthcare obligations for retirees to what's called a VEBA, or Voluntary Employees Benefit Association.
So that's $1 billion a year in cash outlays that Ford no longer has to spend. It's a cost structure has come down materially over the past few years as it's basically rationalized the number of options that it has on its cars. It's consolidated to some types of car onto a single global platform, which streamlines and makes the manufacturing process much, much more efficient.
And then finally and most importantly, it's actually making cars people want to buy, which is kind of a new thing and if compared to the old days of the Ford Tempo, when Ford meant fix or repair daily. Ford models are now beating some flagship, Honda and Toyota models in initial quality surveys. Ford is actually getting pricing increases on a lot of its cars. Pricing is up year-over-year this year. So the story today is frankly different than it was, say 5, 10 or 15 years ago.
I think as an investor you have to recognize when the fundamentals of an industry or a company do change even though they may have been awful at one point, they are good now or they may have been good at one point and they are awful now.
With Ford I think the story has materially changed. You look at the kind of margins the Company can generate going forward. We think earnings per share could be in the neighborhood of $2.50 to $3.00 within a few years time, which actually makes the current $12.50, $13 quote look pretty cheap. Even if you put a pretty low multiple on, say, $2.50 in earnings, you get a share price that's quite a bit higher than $13 per share. In fact, our fair value estimate on Ford is $20 per share.
So adding some of the behavioral elements, which is that I think a lot of investors have exactly the impression of Ford that I have had for a long time, which is that, this is an automaker, you never invest in American automakers. You might trade them a little bit, but they are never going to make money over the long haul, and a lot of people have been burnt investing in these companies over time. So, gosh, just don't worry about them, don't buy them.
So that's one behavioral element I think leading to the mispricing thesis. And the other is that operational leverage is almost always underestimated by the market. I have seen this a lot in my career as an investor. Morningstar saw when we initiated coverage on Visa and MasterCard and CME that were very mispriced out of the gate because we thought margins would be a lot higher than the Street did and we were right about that, and we saw it on the bad side, where we did not see, say, the operating deleverage in the newspaper companies, where margins collapsed much faster than we had thought and then in fact the market thought as well.
I think the same thing is going to happen with Ford. I think the market is probably underestimating the operating leverage in Ford's business. Ford is making money even at a fairly low amount of any auto sales right now. So if you see some pent-up demand coming back into the market and those auto sales in North America really head higher, you could have even upside to that $20 fair value estimate and operating leverage typically is mispriced by the market.
So bottom line, I am Pat Dorsey and I am recommending an auto stock, never thought I'd be in this position, but I think it's worth a look.
I'm Pat Dorsey, and thanks for watching.