If the stock market were a race, Ford Motor Co (F.N) appears to be lagging behind, but it may be ready to start closing the gap with General Motors Co (GM.N).

Ford's stock has risen 5.6% this year, slightly less than GM's 30% gain and the S&P 500's 16% gain. The gap between the two U.S. automakers is not huge. Both are growing sales. Ford is expected to generate about $22 billion in operating profits in 2024 and 2025, while GM is expected to generate $26 billion. Both are outperforming the market average in terms of growth in electric vehicle sales.

The main difference between the two is their plans to return capital to shareholders. GM has announced or completed about $16 billion in stock buybacks, or about 30% of its total market value, since it first announced a $10 billion buyback plan on Nov. 29. Ford has stuck with its dividend, paying 15 cents a quarter and an 18-cent special dividend in March.

It's not often that one of the two largest U.S. automakers underperforms relative to the other. When it does, the underperformer usually closes the gap, Morgan Stanley analyst Adam Jonas noted in a recent report. It just takes a catalyst. For Ford, the catalyst is simple: spend less on electric vehicles, improve quality and focus on shareholder returns.

“We think Ford has an opportunity to close the gap by moving toward capital controls,” wrote Jonas, who has a buy rating on the stock with a $17 price target, which represents 32% upside from Wednesday’s close of $12.87.

Mike Ward, an analyst at Liberty Capital Markets, said don't expect Ford to do a stock buyback like GM. The Ford family still controls 40% of the voting rights of the company's stock, and Bill Ford Junior is the executive chairman of the board. The Ford family likes to get dividends. Ford's current plan is to distribute 40% to 50% of its free cash flow each year as a special dividend.

More special dividends should be coming. Ford will generate $21 billion in free cash flow over the next three years. Paying out 50% of that would equate to an extra $2.60 per share, or 20% of the current share price. That money is in addition to the 15-cent quarterly dividend. Still, the stock market doesn't seem to be buying it. Ford shares are down 16% in the past 12 months. Ward remains hopeful, saying the company is more focused on overall shareholder returns.

In the past, management bonuses were based on a combination of stock performance, return on capital, profit margins and free cash flow targets. Improved operating results, however, don't always translate into higher stock prices. Ford's operating margins have improved by about four percentage points over the past decade compared with the decade before. The result of all that effort? Ford's stock price has reached 1987 levels. Now, management is compensated for total shareholder return, Chief Financial Officer John Lawler said at an investor conference in June.

Ford needs to do more than just pay dividends and buy back shares, though. Ford's profit margins have lagged behind GM's, and the company plans to turn that around by cutting $2 billion in costs. Part of the cost improvements starts with quality. Ford spends about 3.5% of sales annually on warranties, higher than GM's 3% and Toyota Motor Corp's 1%. Improving to rival levels could mean an additional $1 billion to $2 billion in annual operating profits, a big deal for a company that expects to make $11 billion in profits by 2024. Ford CEO Jim Farley acknowledged the importance of quality to Ford in April, noting that quality in 2023 was a 10% improvement over 2022 and another 10% improvement over the current model year.

Then there's the FordPro business, which is everything the other businesses aren't. The unit, which sells and services trucks, cars and vans for businesses, had an operating margin of 16.7% in the first quarter. The performance raised questions on Wall Street about how Ford could monetize the unit, either through a spinoff or an initial public offering. None of that is likely. What Ford Pro can do is help investors believe that profits won't evaporate in a downturn.

But the biggest improvement in free cash flow has to come from Ford's EV business. Ford's electric vehicle division (Modele) lost $1.3 billion despite a combined profit of $3.9 billion from the traditional automotive business and Ford Pro. Modele has not yet reached the scale or cost structure to generate sustained profits. Ford is not giving up on EVs, but it has to narrow those losses. That means spending less on EVs. When it released its first-quarter earnings, Ford lowered the upper limit of its 2024 capital spending guidance to $8 billion to $9 billion, down from the previous range of $8 billion to $9.5 billion. That may not have gone unnoticed, but it amounts to a slowdown in spending on EVs.

Ford could also get help from a stronger auto market. Americans are expected to buy 16 million new vehicles in 2024, up slightly from about 15.5 million in 2023. John Murphy, an analyst at Bank of America Securities, thinks industry sales will peak at 17 million to 18 million vehicles in 2028. Murphy thinks Ford will gain market share in the interim. His $21 price target reflects more than 60% upside for the stock.

All that said, cutting the capital budget may be the best sign yet that Ford is serious about its stock price.

The article is forwarded from: Jinshi Data