David Whiston: GM and Ford show up on dividend investors' radar screens with dividend yields of over 4% and 6% respectively. Ford also pays a supplemental dividend once a year, which--when added to its regular quarterly dividend--comes out to an annual yield of 7.7%, using the most recent special dividend of $0.13 per share paid in March. Yields this high, especially in Ford's case, suggest the market is fearing a dividend cut, but I think both are safe because the market still does not believe that GM and Ford are different than how they or their legacy firm, Old GM, operated prior to the great recession. I do stress to clients however, that I don't expect dividend growth from either firm anytime soon, most likely not until after the next recession. Both management teams want a dividend that is sustainable throughout a cycle, so that is why both dividends have remained flat for a few years now.
Let's talk about Ford first since its yield is higher. The company ended the second quarter with $25.2 billion of cash and investments outside of its finance arm, with 86% of that held in the U.S. Ford also has about $11 billion available on credit lines. Given that the annual regular dividend is about $2.4 billion, we see this liquidity as more than sufficient to keep the dividend safe, but we do think the firm could take a break paying a special dividend when a downturn occurs.
The question, of course, is can Ford keep the regular dividend in a recession while also paying out at least $7 billion in cash restructuring over the next three to five years per its July earnings release. We think it can, because the company's liquidity excluding Ford Credit is already over $6 billion above the firm's long-term target of $30 billion, which gives it a buffer to burn cash in a recession. More cost savings are coming via further platform reductions down to five modules from nine platforms presently; there's $25.5 billion of cost cuts identified through 2022 primarily in materials, engineering, and marketing, as part of CEO Jim Hackett's emphasis on making Ford more physically fit; and the company's U.S. product lineup is finally getting updated soon.
Next year and in 2020, new generations of high volume profitable light-truck models such as the Escape, Explorer, and F-150 launch and Ford enters new segments such as a compact off-road vehicle to rival Jeep and also brings back the Bronco. These moves and others will bring Ford's U.S. portfolio average age down to 3.3 years by 2020 from 5.7 this year. Concentrating more dollars where it makes the most profits in light trucks should help results over time and help Ford maintain its dividend.
There's two other reasons we think Ford's dividend is safe. One is a practical one in that we feel the Ford family, which always has 40% voting power through supervoting shares, wants its dividend as do many outside shareholders. The second reason is the captive finance arm, Ford Motor Credit. CFO Bob Shanks this year in interviews and on earnings calls has said the credit arm's June 30 managed receivable balance of $151 billion is nearing a ceiling management that has for the division of $155 billion. This means the captive is in a position to make distributions back to the parent. This year the captive expects to pay Ford about $2.5 billion compared with $406 million last year, and Shanks is guiding to a typical annual payout of about $1.6 billion to $1.7 billion. That payout alone is nearly 70% of the regular dividend each year. So, we think even in a downturn, Ford's regular dividend is safe, but I would not be surprised to see the supplemental dividend cut or eliminated in a downturn.
Now despite Ford's higher dividend yield relative to GM's, I like GM stock more than Ford. Ford's stock is slightly cheaper on a price to fair value basis, but until management better articulates its strategy, I think the market will remain frustrated with Ford stock even though I think it's quite cheap, so investors will likely be waiting a while. GM on the other hand is in the midst of a $14 billion buyback program which we like a lot because we think the stock is cheap, it is ahead of Ford in autonomous vehicle launch targets by two years, and it just started launching its new full-size pickup platforms.
This platform is GM's most profitable vehicles because it also is used for full-size SUVs, a segment GM dominates with about two thirds of the market via offerings such as Escalade and Yukon. New generations of pickups and SUVs, with GM competing in more pickup areas than it used to with re-entry into medium duty, and the new Silverado offering three new trim packages in high volume and off-road segments, and a crossover lineup just updated last year leaves GM in our view with a very attractive product lineup right when American consumers are now buying nearly 70% light truck models every month.
As for the dividend, we think that's safe, too. GM keeps the vast majority of its cash in the U.S. The annual dividend totals about $2.1 billion, and GM has total automotive liquidity at June 30 of $32.1 billion, including $14.1 billion on credit lines. In a two-year recession with a 25% U.S. industry sales decline over two years (for perspective the great recession was a 35% decline for 2009 versus 2007) management guides to a free cash flow burn over two years of $1 billion to $5 billion, which is inline with our own projections.
We see a lot of upside still coming to GM that the market ignores for now because we are late in the economic cycle, but we think in a recession the market will realize management isn't kidding when it says GM North America can break even at 2009 industry sales levels, which were really a depression for the auto industry in our view and not likely to repeat.
Both GM and Ford offer attractive dividend yields, but we like the GM story more than the Ford story right now. If GM can prove to the skeptics that it is a different company, then we see P/E multiple expansion after the next downturn higher than the roughly 6 times the stock trades at now. If that expansion occurs, then something in our view like 8 or 9 times forward earnings is not unrealistic, which at a conservative EPS of $6 per share means about 45% upside to where GM trades today.
Editor's note: All figures are in U.S. dollars.
