STLA - Ford: Path To Ruin When Opportunity Abounds

2023-09-17 09:00:00 ET

Summary

• Ford faces a UAW strike against the Big 3 auto manufacturers due to demands for large pay and benefit increases.
• The auto giant is already threatened by competition from startup EV manufacturers with cheaper labor costs and high costs from investing in EVs.
• The stock is cheap at 6x earnings with EPS upside potential, but an extensive strike and excessive pay requirements could lead to financial ruin.

Whether investors support union workers or not, the UAW strike against the auto manufacturers aren't helped by a lengthy strike. Ford Motor ( F ) is highly profitable now, but the company faces major pressures from startup electric vehicle manufacturers with cheaper labor costs once scaled. My investment thesis is tepidly cheap on the stock due to the valuation and opportunity ahead in EVs and self-driving cars, but Ford has a limited margin of safety and excess spending due to union costs places them on a path to ruin.

Costly Union Strikes

On Friday, the United Auto Workers, or UAW, union agreed to strike against the 3 major auto manufacturers in the U.S. Ford, General Motors ( GM ) and Stellantis ( STLA ) face various plants shut down partially impacting the ability to make new vehicles requiring Ford to immediately lay off 600 employees.

Back in 2019, these companies faced strikes and had to hike wages by $1 billion. According to research at the time, the 3 automakers faced the following hourly labor costs by 2023 with Ford up to a $69 per hour all-in cost.

According to the WSJ , the unions are demanding over a 40% pay hike over 4 years and increased benefits, including a work week reduction to only 32-hours due to other industries obtaining far higher wage hikes since 2019. Industries from construction to food services have seen pay increases from over 20% to over 30% during this period.

The biggest problem with this logic is that workers from food services to retail were making far less than auto manufacturers. Walmart ( WMT ) just pulled back on starting pay to only $14/hr for all employees, a far cry from the autoworkers. The retail giant has increased hourly pay for workers to catch up with jobs in other industries to help retain workers.

The Ford CEO went on CNBC, claiming the new union demands would push average worker costs to $300K for a 4-day work week. This amount appears excessive, but the large demands could wipe out a lot of the profits of the business that is currently investing aggressively in EVs.

In late August, Ford made an original proposal to hike pay by up to 15%. The company outlined wages and benefits amounting to $130,000 when including $38,000 in benefits.

The amounts don't appear to match the $300K suggestion by the CEO, but Ford would have substantial costs meeting the demand for a 40%+ pay hike along with a 32-hour work week. The auto manufacturer would have to replace the lost production with additional workers.

Investing In The Future

The major path to ruin comes from the union bargaining, mainly related to additional wages and benefits for employees. The contact negotiations have nothing to do with making Ford more competitive in an increasingly global auto market.

While the union and pro-union people claim the company has plenty of profits to pay more to workers, Ford only produced $1.9 billion in net income during Q2'23. The company only had a 4.3% income margin, leaving very little margin of safety in a very competitive auto market.

The biggest problem is that Ford needs to continue investing in EVs, costing the company $1.1 billion in EBIT in Q2 alone. The legacy Ford business is highly profitable, but the company needs to invest in the future to remain competitive.

At some point in the next few years, Ford will eliminate these large EBIT losses and the EV business will contribute to the $4.7 billion in EBIT produced by the Blue and Pro segments. A plan where employees share more in the profits of the business would better align the unions with the company and shareholders.

Already, Ford faces a scenario where Tesla (TSLA) and Rivian Automotive ( RIVN ) combined have revenue targets of over $135 billion in 2024. Both EV companies have lower worker costs being non-union, and both companies now have very competitive EV trucks on the market to compete with the Ford truck line.

Analysts forecast Tesla topping $180 billion in sales by 2026. Ford will quickly lose any control over the domestic market, with the company far behind Tesla in the future of autos.

Ford can't continue paying up to $20/hr in higher wages and benefits to workers compared to EV competitors. The company needs to invest in the future and work with employees towards competitive solutions that don't put the company out of business.

The stock is probably a buy here, trading at 6x EPS targets of $2. Ford has a $3 EPS potential from just eliminating the losses on the EV business, making the stock extremely cheap at $12.

A long strike will have the impact of lowering inventories similar to during Covid, leading to higher short-term profits from elevated prices, but this is the path to ultimate ruin. Ford might generate some short-term profits, but the competition isn't slowing down.

Both Tesla and Rivian will continue pushing full-speed ahead to increasing EV production. Not to mention, China leads the world in EV production, making the country a long-term threat to replace the domestic auto industry.

The best path for shareholders is a scenario where a short strike lowers inventories, but Ford does agree to large union demands for wage hikes and shorter work weeks. The auto manufacturer has the potential to build on the already large profits by turning the EV segment into a profit contributor, but the path has to be helped by the unions.

Takeaway

The key investor takeaway is that Ford Motor is cheap at $12, but the company faces a ruinous path due to union wage demands. The biggest worry is that a lengthy strike provides more power to Tesla and Rivian, and the stock continues down the path of a value trap. For now, Ford is interesting with a nearly 5% dividend yield and large cash flows, but this could quickly end, if union demands remain excessive.

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