Ford Motor Company (F) has an interesting value argument; is it worth the risk?

September 24, 2018

Ford Motor Company (F) has an interesting value argument; is it worth the risk?

Nothing has kept the market more on edge this year than trade tensions and the threat of a trade war between the U.S. and its trade partners. Things only seem to get more intense this week, as the Trump administration is set to impose new 10% tariffs on $200 billion of Chinese goods on Monday. China is promising to retaliate with its own set of 5% to 10% duties on $60 billion of U.S. goods. This second set of U.S. tariffs will cover about half of the total goods China sells to the U.S., with President Trump saying that he’s ready to impose another $267 billion worth of tariffs that would cover pretty much everything else China imports to the U.S. 

All of this is in addition to tariffs the U.S. is also imposing on its other most important trading partners, including steel and aluminum on the European Union and auto-related tariffs on Mexico and Canada. Even the recent agreement between the U.S. and Mexico to rework their two sides of the long-standing NAFTA agreement have yet to remove tariffs on that country, and Canada is still yet to agree to join its neighbors back at the drawing board. U.S. and international businesses seem to finally be showing some of the effects tariffs have been expected to impose in the form of higher costs, although to what extent that effect will continue remains to be seen.

For some investors, automotive stocks may seem like a risky place to put their money in the current geopolitical climate; and I think it’s true that if you’re willing to make an investment in this space, you have to be willing to accept that the prices of most of the stocks in the industry are likely to remain under pressure for as long as trade tensions remain in force. The industry is down more than 16% since early January, with the largest portion of that drop – about 10% – coming in just the last three months. If the industry is under so much pressure, and there doesn’t seem to be much relief in sight in the near future, why not stay away from the industry altogether?



To be an effective value investor, I’ve found that you have to be willing to move against the grain of the broad market; to me, that means that when everybody else says “stay away” from a certain industry the smarter thing is to actually go ahead and take a long look. If you want to find some of the best bargains in the marketplace at any given time, you’re going to be more likely to find them in deeply discounted stocks in depressed industries. That’s one of the biggest reasons that I think Ford Motor Company (F) could be an interesting stock to think about right now.

Over the last few weeks, I’ve seen a few reports that have suggested that, as extended as the current bull market is, it could still continue to go even higher. One interesting argument points out that while the market has recovered all of the losses its incurred at the beginning of the year, the length of that recovery created a technical pattern of consolidation that could see the S&P 500 push well above 3,000 by the end of the year. Another one follows a similar train of thought to point out that most of the stocks that have been pushing the market higher lately haven’t been the traditional high-flyers that were already trading at or near all-time highs; instead, they’ve been stocks in out-of-favor industries; think financial stocks like Citigroup (C) and JP Morgan (JPM), or industrial stocks like Caterpillar (CAT). That’s what amounts to a broad market rotation from growth stocks into value, which means that the best, and highest-probability investments are likely to come from stocks that right now are trading at significant discounts.

I do think it’s true that auto stocks are starting to show some of the effects of tariffs, and I think you’ll agree that is the case. Another element that I think plays into the favor of the auto industry, however is the fact that even if the economy does actually turn negative, the Trump administration – which has been saying all along that its trade policy is intended to help U.S. industries like steel and autos in the long run – is likely to fall back on the “too big to fail” logic that the last two presidential administrations used during the Great Recession ten years ago to bail out Ford, GM and Chrysler Motors. A bailout may not be necessary this time around – the fundamentals for Ford in particular are far better than they were ten years ago – but the “too big to fail” logic is likely to mean the long-term risk in any of the big three auto companies is actually pretty low.



Fundamental and Value Profile

Ford Motor Company is a global automotive and mobility company. The Company’s business includes designing, manufacturing, marketing, and servicing a full line of Ford cars, trucks, and sport utility vehicles (SUVs), as well as Lincoln luxury vehicles. The Company operates in four segments: Automotive, Financial Services, Ford Smart Mobility LLC, and Central Treasury Operations. The Automotive segment primarily includes the sale of Ford and Lincoln brand vehicles, service parts, and accessories across the world. The Financial Services segment primarily includes its vehicle-related financing and leasing activities at Ford Motor Credit Company LLC. Ford Smart Mobility LLC is a subsidiary formed to design, build, grow, and invest in emerging mobility services. The Central Treasury Operations segment is primarily engaged in decision making for investments, risk management activities, and providing financing for the Automotive segment. F’s current market cap is $38.6 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings decreased by almost 52% while sales were mostly flat, declining by only about 2%. That’s a trend that has forced the company to adjust its production strategy, as it has announced plans to cut production of all sedans in the U.S. except the Ford Mustang, and to see shift its focus to SUVs, crossover vehicles and pickup trucks by 2022. The company operates with a narrow margin profile that saw Net Income at 4.2% of Revenues over the last twelve months, and decreased to only about 2.7% in the last quarter. I’m reading that contraction as an indication of the effect of rising materials costs, which is attributable, at least in part to tariffs and the threat they could persist for the foreseeable future.
  • Free Cash Flow: F’s free cash flow is quite healthy, at more than $9.1 billion over the last twelve months. That translates to a Free Cash Flow Yield of 23.5%, which is extremely attractive.
  • Debt to Equity: F has a debt/equity ratio of 2.8. High debt/equity ratios aren’t unusual for automotive stocks, however it should be noted that F’s debt/equity is the highest among the Big Three auto companies. The company’s balance sheet demonstrates their operating profits are sufficient to service their debt, with healthy liquidity to make up any potential difference if that changes.
  • Dividend: F pays an annual dividend of $.60 per share, which translates to a very impressive yield of more than 6% per year; the fat dividend is a compelling argument for why F could be a good place to park a portion of your investing capital and simply draw passive income while you wait for the stock’s price to increase.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for F is $9.18 per share and translates to a Price/Book ratio of 1.07 at the stock’s current price. Their historical average Price/Book ratio is 2.12, which suggests the stock is trading right now at a discount of more than 97%, and that puts the stock’s long-term target at about $19.46 per share, which is far above the stock’s 52-week high around $13, and a level the stock hasn’t approached since 2013. If you prefer to work with a more conservative target, the stock is also trading about 60% below its historical Price/Cash Flow ratio, which provides a target price a little below $16 per share.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from January of this year to its low, reached just a few trading days ago at around $9 per share; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock appears to be staging a short-term bullish reversal right now, but is very near to resistance from recent pivot highs right around $10 per share, with additional resistance not far away from that point at $10.85 as shown by the 38.2% retracement line. In order to develop any kind of sustainable bullish trend, the stock would need to break above that second resistance level.
  • Near-term Keys: The strength of the stock’s downward trend this year makes placing any kind of short-term bullish trade on F extremely speculative right now; the only signal that a short-term trader should look for to justify any kind of momentum or swing-based trade with call options, or by buying the stock is a rally to at least $11 per share. A break below $9 would mark a re-confirmation of the downward trend’s overriding strength and could be taken as a good signal to short the stock or work with put options. If, on the other hand, you don’t mind the idea of buying a stock with a very good balance sheet, a fat dividend, and a terrific long-term value proposition, and you’re willing to tolerate some near-term price volatility, the bargain opportunity looks very attractive right now.