The U.S. auto stocks have not performed well to start 2016, particularly Ford Motor Co. (NYSE: F). Shares of the auto giant are down 21% in the past one year. This decline comes as the company racked up record profits last year. Ford is benefiting from several tailwinds in the U.S., including low gas prices, low interest rates and an improving economy.
But investors aren’t convinced that Ford’s impressive performance is sustainable. The fear is that higher interest rates are right around the corner, which could hurt auto sales.
While there are significant concerns facing Ford, the company remains highly profitable and is a strong brand in the U.S. Going forward, it can offset weakening performance in the U.S. with international growth.
Ford Revs Up its Profits and Dividends
Ford stock currently pays $0.60 per year in dividends, which comes out to a 5% dividend yield based on Ford stock’s recent closing price of $12 per share. That is a very high level of dividend income. By contrast, stocks in the S&P 500 Index have an average dividend yield of 2%.
Not only that, but Ford also declared a $0.25 per share special dividend earlier this year. That means Ford shareholders collected $0.85 per share in dividend income this year, which represents a 7% yield based on the current share price.
Ford’s special dividend cost $1 billion, but the company is able to pay such hefty dividends because it is seeing record profits. Total car sales in the U.S. rose by 5% last year. This drove record pretax profit last year, of $10.8 billion. Ford’s hugely popular F-Series pickup truck has been America’s best-selling vehicle for the past 34 years.
Ford is off to a good start to 2016 as well. Despite higher interest rates this year, Ford still produced $3 billion of adjusted pretax profit last quarter. Earnings per share declined 3.7% from the same quarter last year, but the company still earned $0.52 per share. This is more than enough to cover its quarterly dividend of $0.15 per share.
Vehicle Sales are Accelerating
Ford’s strong earnings are due to solid sales results, particularly in the international markets. Ford’s China sales increased 24% last month. Sales through the first nine months of 2016 rose 11%, compared with the same period last year. Furthermore, Ford’s Europe sales increased 7% through the first nine months of the year.
In addition to its sales growth, Ford is improving its profit margins. Automotive segment operating margin was 7.7% last quarter, and Ford is rapidly improving its profitability across its geographic segments. Ford’s European segment posted $467 million in pretax profit last quarter, which set a company record. Ford also realized record pretax profits in North America through the first six months of 2016.
Overall, total profit is up 33% through the first six months of the year.
Going forward, Ford is targeting additional markets around the world to drive further growth. For example, Ford invested over $3 billion to boost its production capacity in Mexico and South Africa.
Why Ford Stock Could Drive Significant Gains
Ford stock is very cheap. Shares trade for a price-to-earnings ratio of just 6. This compares with a price-to-earnings ratio of 24 for the S&P 500 Index. Such a low P/E is indicative of the high level of investor pessimism.
As the Fed is set to raise interest rates again over the next few months, it is true that higher rates may raise the cost of borrowing. This could lead to lower demand in the U.S. But thanks to its international growth, Ford’s earnings and valuation multiple could expand from here. At its current valuation, Ford stock has a 16.7% earnings yield.
Plus, the 5% dividend makes the total return potential attractive. And Ford management has indicated it is not opposed to more special dividends in the future, if its profits allow.
As a result, Ford stock could be a good buying opportunity for value and income investors.
Disclosure: The author is long F.