Ford And The Importance Of Signaling

Today shares of Ford Motor had an impressive mid-day rally as the stock popped from $10.70 to $11.10 in just minutes after the auto manufacturer announced it will initiate a 5-cent dividend at the end of January, its first dividend payout in five years.

Booming '90s

In the late '90s, when Ford's stock still traded at $30 a share, shareholders were spoiled with a quarterly dividend of $0.50. When the recession of 2001 hit hard, Ford was forced to slash its fat dividend to just 10 cents a quarter from 2003 onwards. The stock price moved in tandem with the dividends, with the stock trading in the high-single-digits.

Troubles of 2006

Despite a recovery of the economy, fierce competition from foreign competitors combined with rapidly rising labor costs (as a result of the mighty auto unions) Ford came in serious financial difficulties in 2006. In the same year rating agencies cut its credit to junk and Ford decided to skip its dividend payments. In that year Alan Mulally was hired as new CEO of the firm. Under his command the company laid-off thousands of workers, closed factories and sold well-known brands including Land Rover, Volvo and Jaguar.

Recession of 2008

Thanks to the measures taken by Mulally Ford entered the 2008 recession in reasonable shape and was not forced to accept a government bail-out, something which Chrysler and General Motors could not avoid.

Improved operating performances leading to positive operational cash flows and years of divestment allowed the company to pay back large parts of it debt. Long term-debt was cut from $170 billion to $105 billion in a period of just four years, a remarkable achievement given the circumstances.

Turnaround

The year 2009 started off badly for Ford's shareholders, who were more worried about the state of the economy than impressed with Mulally's actions. The stock traded $1.50 at the beginning of the year. With economic signs turning green and improvements becoming more visible, the stock started a two-year lasting rally closing at $19 in the beginning of 2011. In the period 2007-2010 Ford managed to reduce its long term debt by some $60 billion to roughly $105 billion, thereby significantly strengthening its balance sheet.

Signaling

This year Ford's shareholders have not much to cheer for, with the stock down 35% year to date, hovering around $11. The timing of the dividend announcement acts as a main signaling factor in Ford's case.

• While a 5 cent dividend might be lower than analysts have expected (expectations were about 8 cents) the payment is ahead of schedule as major rating agencies have not rated Ford's credit investment-grade yet.
• Ford explicitly mentions to be cautious, as it does not want to skip or cut a dividend when economic headwinds might arrive. The new dividend policy is geared towards much more stable dividends tied to long-term performance.
• Bondholders are cheering pushing the 2021 8.875% notes up 2.5 point to 105 cents on the dollar. This shows that both equity and credit investors have trust in the company. Remember that higher dividends normally worsen the bondholders risk-return profile.
• The announcement comes just weeks after the four-year agreement with labor union UAW during which costs will rise 1% per annum giving much greater visibility on future profits and cash flows.

Shareholders should applaud Ford's move. While a 2% yield per annum is not spectacular, there is room for upside surprise, as under the lead of Alan Mulally, Ford has chosen a much more conservative and long-term financial strategy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.