Ford Motor Co. (F) slumped 4% after its latest earnings release. As a result, the stock is now offering a 6.7% dividend yield which makes it a high-yield stock.
High-yield stocks are certainly attractive for income investors on the surface, but sustainability of the dividend (particularly during a recession) must also be an important consideration before buying the stock.
Ford is a highly cyclical company whose profits are sensitive to the broader economy. There are specific risks that call the sustainability of Ford’s dividend into question, including the trade war and a potential global economic slowdown.
As a result, while Ford’s high yield is appealing for income investors such as retirees, the big question is how safe this dividend is if another recession were to occur.
While Ford is a large multinational automaker, it generates essentially all its earnings in North America. To provide a perspective, in the most recent quarter, the company reported earnings before interest and taxes (EBIT) of $2.0 billion in North America and negative EBIT of approximately $683 million in all the other regions combined.
The auto maker faces intense competition from its peers in Europe while it is also affected by costly regulatory issues in this region. That’s why it is going through a major restructuring in this division. This restructuring is taking its toll on Ford’s near-term results, its outcome is doubtful. Moreover, Ford is facing strong headwinds from a slowing auto market in China. Despite the efforts of the Chinese government to prop up its auto market, Chinese auto sales have decreased in 15 of the last 16 months. Ford’s sales in China fell 30% in the third quarter.
As Ford is profitable only in North America, it is highly exposed to any headwind that will show up in the U.S. auto market. Unfortunately, this market has decelerated after several years of strong growth. In the third quarter, Ford’s U.S. sales fell 4.9%. Due to all these business headwinds and higher incentives in North America in the fourth quarter, Ford lowered its full-year operating income guidance, from $7.0-$7.5 billion to $6.5-$7.0 billion and its adjusted earnings per share guidance from $1.20-$1.35 to $1.20-$1.32. Consequently, the stock fell 4% after its October 23rd third-quarter earnings release.
Behavior in recessions
The auto industry is characterized by extreme cyclicality and fierce competition. Auto manufacturers have to spend enormous amounts on capital expenses year after year in order to produce new models and remain relevant. As a result, they tend to post poor free cash flows and accumulate excessive amounts of debt. Consequently, when a recession shows up, automakers often see their profits evaporate, as auto sales slump during rough economic periods.
For example, in the Great Recession of 2007-2009, General Motors (GM) went bankrupt and Ford saw its earnings evaporate, as its earnings per share plunged from $3.13 in 2008 to $0.00 in 2009. As a recession has not shown up in the U.S. for a whole decade, this is an important risk factor to keep in mind before investing in Ford. Income-oriented investors should be aware that the dividend of Ford could be cut in a recession.
As mentioned above, Ford currently has an exceptional 6.7% dividend yield. Given the mid-point of its revised guidance, Ford also has a decent payout ratio of 48%. This payout ratio might signal that the dividend is absolutely safe in other sectors, but this is not the case in the highly cyclical auto industry. In the absence of a recession, Ford is not likely to cut its dividend—but the dividend will come under great pressure if and when the next downturn arrives.
Moreover, the automaker carries an excessive level of debt. As per its latest report, its net debt stands at $121.0 billion, which is almost 25 times the annual earnings of the company, while interest expense consumes 36% of operating income. Due to Ford’s high debt, its deteriorating business outlook, and its prolonged restructuring program (which will extend for several more years and will cost $11 billion), Moody’s recently cut Ford’s credit rating from Baa3 to Ba1. Overall, the high leverage of Ford adds to the thesis that the dividend is at risk in the next downturn.
Ford’s 6.7% dividend yield may entice many income-oriented investors, given the decent payout ratio and low prevailing interest rates.
However, the company is facing strong headwinds in most of its markets. It is also going through a prolonged restructuring program while carrying a high amount of debt. As a result, Ford’s dividend is likely not sustainable in a severe recession.
Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.
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