PEUGF - Ford: Why UAW-Driven Bankruptcy Concerns Are Overblown

2023-09-29 15:05:47 ET

Summary

• Ford Motor Company is better prepared to avoid bankruptcy than shrill headlines surrounding the UAW strikes would suggest.
• Finding opportunities for alpha rarely involve buying opportunities that feel risk-free, but overly negative sentiment is a great opportunity.
• Identifying and countertrading the crowd's false assumptions and beliefs can be a way to find alpha in the market.
• Very little has changed yet about Ford's long-term plans, and the UAW's demands may be more in line with what Wall Street analysts would like to see than you would think!

Everyone has the brainpower to make money in stocks. Not everyone has the stomach.

~ Peter Lynch

One of the biggest market stories this week has been the headline-grabbing United Auto Workers ("UAW") strike. In decades past, the powerful labor union would target one of Detroit's Big Three at a time, but in an unprecedented and aggressive move under the leadership of Shawn Fain, it is now striking at all three. The new leader appears to be a true believer and is known for unpredictable behavior; some might even say theatrics. For example, he is said to have actually torn up a proposed Chrysler contract.

Here is the current state of the strike.

• On September 15, the United Autoworkers had 13,000 members stop work at three plants from the Big 3 manufacturers: Ford Motor Company (F), General Motors (GM), and Stellantis ( STLA ) (Chrysler).
• The initial strikes targeted some of the companies' most profitable internal combustion engine models, including the Ford Bronco, Chevrolet trucks, and the Jeep Wrangler.
• After a week of striking, the UAW expanded strikes to dozens of Stellantis and GM facilities but spared Ford further labor actions. Its leader said the Ford was "serious" in reaching an amenable solution.
• Today's deadline brought an expansion of strikes against Ford and GM, while Stellantis was spared. This may indicate a prolonged "good-cop/bad-cop" strategy. The most profitable pickup trucks have not been targeted yet.
• The UAW has excited both rhetoric and action. It has full coffers to weather an extended strike if necessary. Cross-allegations blame each other for violence on the picket line between management and the union.
• President Joe Biden became the first sitting U.S. President to join striking workers on a picket line.
• The UAW's core demands include a 36% raise over the next four years, abolishing the two-tiered wage system, better pension benefits, restoring a cost of living adjustment, and some measures to ensure they aren't sidelined in the electric vehicle ("EV") transition.
• Economic losses are so far about $1.6 billion . However, the UAW could amp up the pain on the automakers in the coming weeks. Watch particularly if they strike at the respective engine plants as evidence things are getting bad.

It seems the sky is falling from much of the coverage. A strike? During this inflation? Of course, the purposely performative tenor taken on by Mr. Fain (certainly not entirely without cause ) is made easier to analyze when the strike appears to have become the first significant skirmish between President Biden and former President Trump in the 2024 election. However, there's more than meets the eye to this, and it's an issue where both sides are prone to disregarding thoughtful analysis for pre-existing notions and ideologically informed beliefs.

One term that keeps arising in the analysis is bankruptcy, the bane of shareholders. It's always important to remember that equities are junior in the capital structure, so shareholders are entirely wiped out when bankruptcy happens. This is one of the reasons legacy automakers have lower P/E ratios. The capital intensity and cyclicality of the auto manufacturing business make them generally prone to bankruptcy. Many commentators point out that UAW's upward pressure on wages makes non-union manufacturers blush and may ultimately make the automaker so uncompetitive as to render them bankrupt.

The conclusions on who is best suited to survive bankruptcy are different than you might think, as you can see above. As you can see, GM has a probability that would make Big Tech blush. Apple's (AAPL) probability of bankruptcy is 1.8% in the same model. But the exciting thing is the probability of critical competitors Tesla ( TSLA ) and Ford.

As you can see, Tesla and Ford's chances of bankruptcy are nearly the same, but Ford has a slight edge! When looking at discounted cash flow valuations, Ford is dramatically undervalued. Long-term shareholders should let the dividend do its work and buy Ford on the undue hysteria around its demise.

Remember, Ford has been playing the natural state of auto industry bankruptcy dodgeball longer than all the others. It has a more considerable hoard of cash than many rivals. There are certainly contradictions in EV policy, and the transition will be difficult. Still, when you hear a repeated narrative repeatedly, it can sometimes be a setup for a significant correction in antiquated thinking. The hidden upshot to current UAW negotiations is that they may actually make Ford more sustainable by giving the company a plausible reason to amp up reliance on the more profitable internal combustion engine ("ICE") models.

Red Scare: The Crowd's Understanding of the UAW Strikes

If you believe others will stop at the first step of reasoning, it is rational for you to stop at the second.

Richard Thaler.

While I understand the tempting allure of this narrative, particularly for those who love the ideas of Milton Friedman, I think it rests on faulty assumptions. Detroit's past bankruptcies should not be laid squarely at the feet of the unions. That seems the convenient narrative of sloppy and profligate management that stopped innovating and failed in quality control. You can't blame inflation on unions when their membership has declined precipitously over the past decades, but in the 1970s, that may have been a more sound argument.

Unions were part of the competitiveness problem in past industry failures. Still, I think this element of events is generally overstated. They were a convenient scapegoat, partially because of the confirmation bias involved with the core ideas of one of Wall Street's most cherished thinkers, Mr. Milton Friedman. His thoughts on unions making companies uncompetitive are core to many people's understanding of the current situation. However, the role of unions in the economy has dramatically changed since our last great fight against inflation. Also, remember Ford's core ICE business is still planned to be accretive for the foreseeable future.

But this time is very different for a significant reason. The legacy automakers are not sitting stagnant in the face of innovating competitors; even if they haven't caught up, they have made bold plans. And despite preconceived notions and social cues about labor unions, the interests of the UAW and Big Three shareholders might be more aligned than you would think.

For example, while the UAW will not admit publicly that it is opposed to the breadth of Ford's EV transition if you read between the lines in a lot of its demands, it is clear that it wants more ICE production in the short and medium term than the company is planning for. This goal aligns with what many Wall Street analysts would like to see the company do, albeit for different reasons. EV production is less labor-intensive than ICE production, so despite social cues and preconceived notions, Wall Street and the UAW are de-factor allies, even if they both don't know it. What a world!

There is definitely reason to consider the implications of the UAW's new-found aggressiveness. But it's important to consider that Mr. Fain's campaign has already achieved a symbolic victory for labor of a scale not seen for decades. Remember, too, that Mr. Fain has a lot of limitations. While his strike fund is considerable, it becomes less considerable the further and longer he expands the price. And while he is surfing a wave of favorable media sentiment, too aggressive a posture that starts closing suppliers and hurting regional economies threatens to undo the considerable progress in public relations and visibility he has achieved.

Freak Out About a Catalyst. Collect Yourself. Buy. Reinvest Dividends. Repeat.

I am convinced this will ultimately be an opportunity to buy an auto manufacturer or two. I am an existing and long-term Ford shareholder, so I will make larger purchases than my regular ones if there is further price weakness. There is a high likelihood that Ford will not be exempt from further escalations of the strike. If this occurs, I will buy on the weakness. Ultimately, if Ford goes bankrupt because of the UAW or EVs, it will be far into the future.

I've always liked the title of this website, Seeking Alpha. It is short and to the point. It sums up everything we are attempting to do as investors with beautiful brevity: outperform the competition to achieve a superior return. You can take the less arduous road and buy an S&P 500 ETF ( SPY ); frankly, you'd have much of the best thinking man has to offer on your side.

And, of course, the weight of recent evidence would support your decision. You'll sleep sounder than us poor souls condemned to a life of seeking alpha. The above is how hedge funds perform versus the market. The average investor does considerably worse. But for some of us, there is an urge to direct our exertions to seek greater than the market's return, however statistically improbable our odds at success may be.

Like Sisyphus, we often do achieve outperformance. Our confidence surges, and often, in our hubris, we will depart from the process that got us that performance in the first place. Or our luck runs out. Then, that proverbial performance globe rolls back down the hill again. There are a lot of ways to get alpha. The sell-side and fundamental analysts know companies inside and out, and they can get into the weeds and see insights by analyzing details that many of us miss. Their approach would be considered bottom-up.

Top-down analysts take a different approach, and they essentially use economic data and macro analysis to orient themselves in the cycle more accurately than the competition. Quantitative analysts use various tools, from natural language processing and other data analysis methods to advanced mathematics; they try to use advanced analysis to attain an edge. All of these ways require considerable investment of time and resources. One of the easiest ways to identify alpha is to identify the crowd's predictable and natural false assumptions and beliefs and countertrade them.

Of course, This isn't easy, but it's certainly easier than the three methods I mentioned. Furthermore, this is where the stomach comes in, which Mr. Lynch refers to in his under-used quotation at the beginning of this article. It is not as simple as simply doing the opposite of what the Wall Street crowd is doing. However, when the Wall Street crowd agrees about something, I think it is always wise to consider at least that counter-trading them may be a wiser option than following them. When the catalyst is emotional and dominates headlines, the rule is twofold.

Thus, I think the UAW strike is an opportunity for long-term shareholders in the auto companies. If you're swing trading, by all means, you may want to avoid them until there is more clarity. However, there are a lot of people who hold large positions in Ford, myself included. I intend to use any price weakness around the strikes to accumulate more. Generally, I am encouraged by the relatively more productive relationship Ford has been shown to have with the UAW in the past. Even the seemingly fanatical Mr. Fain has so far shown deference to Ford's commitment to its workers.

Sometimes, family management can be a liability, but when your family invented welfare capitalism and the assembly line, it could pay off during a strike. General Motors is in a less enviable position than Ford, and its history with the UAW has been far more problematic. Furthermore, they are behind Ford in EV auto sales despite some impressive strides by the stalwart firm under CEO Mary Barra. That's why Ford is my pick to take advantage of what I think is overly negative sentiment on the current strikes.

Risks and Where I Could Be Wrong

I am not dismissing the many valid concerns over the UAW's aggressive posture. However, many Americans don't realize that these tactics in labor negotiations were common in the past. Mr. Fain is purposely heightening the performative nature of his actions when the threats of potential bankruptcy and economic damage seem credible. If they don't seem credible, he is less likely to get his desired threshold for victory.

Still, I could be wrong. Maybe Mr. Fain is unreasonable and is simply trying to cause as much hurt and attention to the Big Three and his demands as possible. If this is the case, I could be wrong about buying Ford, and those prophesizing bankruptcy could be correct. Ultimately, though, despite the truculence of Mr. Fain's actions, he knows where his bread is buttered, and the viability of his hosts is as essential to his survival as it is theirs.

Of course, the EV transition was already fraught with peril outside the UAW issue. Ford is losing a considerable amount per model, and if the current course can't right this losing economic proposition, obviously, the company will eventually fail. That's not new info.

However, I'm giving CEO Jim Farley the benefit of the doubt. I think his passion for the product will ultimately deliver. From a brand and market penetration perspective, Ford is still nipping at Tesla's heels more than competitors despite grand future plans. Other risks are stalking the economy as well:

• Escalation in Ukraine or Taiwan.
• Fed Policy Error.
• Banking Issues Worsen.
• Return of Inflation.
• CRE meltdown.
• Write-downs of Private Assets.

And then the industry is highly cyclical. If a recession manifests or any of the above risks become more acute in the short term, then the fortunes of Ford will naturally decline with the economy. Of course, the company's massive credit operation is also exposed to a consumer slowdown. So, risks abound, but I'm sticking with Ford and using price weakness to lower my cost basis and boost my effective yield.

Conclusion

Over a many-year period, they [UAW] were asking for more, but we’re the ones who gave it. But then when we got into a really tough period, I sat down with [UAW President Ron Gettlefinger] and I said, ‘Ron you have to help me save the Ford Motor company’ so we didn’t have to go through bankruptcy, so we didn’t have to get a Federal bailout and he did that.

-Bill Ford talking about avoiding bankruptcy in 2009.

Ford Motor Company ( F ) is one of two major auto manufacturers that has never gone bankrupt. The other company is Tesla . Many Americans may not be aware of the circumstances that led to Ford narrowly avoiding bankruptcy when General Motors did not back in 2008. While I wasn't there, from my research, it appears a critical element of Ford's staying in business was its dedication to compromising with the UAW; Bill Ford famously relayed that he asked then UAW President Ron Gettlefinger to save Ford Motor Company from bankruptcy.

This history is important because not having gone bankrupt over more than a century of operations does mean something to creditors. While competitors that have gone through bankruptcy more recently may enjoy the benefits of having been streamlined under the gun, they are still often looked at by many investors in debt markets with a more wary eye. This is why, of the Big Three, I am most inclined to buy Ford. I am a long-term shareholder, so I give this recommendation with full realization the UAW situation might get worse, even far worse. If it does, I will buy more shares and use them to lower my cost basis.

Headline hysteria is always a risk, but despite the difficult transition that the world's original auto company is undergoing, the safety margin is much higher than shrill headlines about an aggressive strike would suggest. Ultimately, being the historic teacher's pet of the UAW relative to the other two Big Three shouldn't hurt either!

The crowd is nearly certain the UAW issues will cause bankruptcy. Anyone with a Tesla will tell you that this proves Ford's irrelevance. Many Wall Street analysts love an opportunity to demonstrate their affinity for free market principles and the idea that shareholder interests should trump those of labor. However, their confidence in Ford's supposed imminent demise only makes me more confident that I should use price weakness on this catalyst to buy more of this American industrial pioneer.

As you can see above, there are widening divergences in expectations for next year's earnings. The shrill headlines regarding the labor issue and the confirmation bias often involved in the pronouncements are when paired with this, diverging expectations and inherent opportunity for alpha. It is a high-risk but high-reward bet on Ford, but I am willing to make it.

I suspect the rewards for Ford long-term shareholders down the road will prove this UAW-driven angst a capital buying opportunity! Betting on great companies at moments of maximum doubt is where many fortunes have been made in the stock market.

For further details see: