2023-10-30 09:46:37 ET
Summary
- Ford's stock has lost close to 30% since a "Sell" thesis was assigned, compared to a 6% decline in the market.
- Ford's Q3 results were disappointing, with a substantial loss in its Model e electric vehicle unit.
- The tentative labor deal with the UAW, featuring substantial pay raises, is expected to cost Ford about $6.2 billion over the contract period.
- Ford stock continues to offer investors no equity upside; And I maintain a "Sell" rating.
Back in June I previously wrote an article about Ford Motor Company (F), arguing a clear "Sell" thesis. It was an early Sell, when most of the Street and Seeking Alpha analysts were still bullish on Ford, likely because the stock was in an uptrend.
In a nutshell, I defended the thesis that Ford stock is clearly overvalued, with an EV/EBIT ratio for FY 2024 at around 15x, compared to the industry median of 12x. Moreover, I pointed out that Ford's ambitious targets for EV production and market share appear optimistic, especially considering its lagging position in EV technology and profitability. In that context, the company's collaboration with Tesla (TSLA) on charging networks highlighted a weakness, not a strength, underscoring the company's broad lag in Mobility as a Service (M.a.a.S). Lastly, I also voiced concerns about Ford's underperforming margins vs. peers.
The article has not been well-received, attracting more than a 100 bullish-skewed comments, and only 8 article likes. But investing is not a popularity contest. Since assigning a "Sell" thesis on Ford, the company's stock has lost close to 30% in value, compared to a loss of only 6% for the broad market, S&P 500 (SP500)
Today, as I reiterate my "Sell" rating conviction, I ask: Do you believe me now?
Ford Weak Q3 Strengthens Sell Conviction
Ford delivered a very disappointing set of Q3 results , missing analyst consensus on both top- and bottom-line: During the period from June to end of September, Ford generated about $41.18 billion of revenues, up 11% YoY, but underperforming analyst estimates by about $1.3 billion (according to data collected by Refinitv).
With regard to profitability, Ford only generated about $1.2 billion of profits (a meager 3% profit margin), missing consensus by about 20%. Ford's profit for the quarter was carried by Ford's traditional businesses including Ford Blue and Ford Pro, which generated profits of $1.72 billion and $1.65 billion, respectively. Ford's "growth vertical" and electric vehicle venture, Model e, took a hit with a staggering $1.33 billion loss.
More Uncertainty For The EV Business
Reflecting on the disappointing performance for Model e, Lawler acknowledged that -- although the transition to EVs is happening -- the change is slower than initially believed. While the underperformance may be partly attributed to rising raw material and labor costs for building EVs, there is certainly also heightened competitive pressure from EV giant Tesla, which is cutting prices aggressively in a push for volume.
On this though, Lawler has decided to pump the brakes on about $12 billion worth of planned investments in EVs, including delaying the construction of an electric vehicle battery plant in Kentucky. While this may help ease CAPEX pressure through 2025, the back-and-forth in Ford's EV strategy is creating a level of uncertainty that investors likely won't appreciate.
Moreover, investors should consider that a slower than initially expected ramp up in EV volumes also implies a slower margin expansion in the Model e business, mostly as a function of a slowing economies of scale ramp up.
Taking A Hit From Inside -- The Employees
While Ford is fighting macro headwinds and competitive industry pressures, the company has also been forced to take a hit coming from the inside of the company -- the employees. The strike has been loudly broadcasted by the media. But now, with an end in sight, it looks like Ford has lost.
UAW Wins The Negotiation
On October 27th, Ford has tentatively struck a labor deal with the UAW, pending approval by Ford union members. This agreement comes with a hefty 25% pay raise over a four and a half year period, including an initial bump of 11%. In total, these raises and added perks will bring the top wage to over $40 an hour, suggesting a 68% increase for starting wages to over $28 an hour. Moreover, the deal also promises the return of cost-of-living adjustments, a maximum three-year path to reaching the top wage, according to a UBS research note ( Ford reaches tentative deal with UAW, dated 25 October ). In exchange for this, Ford will be able to recall around 20,000 employees and restart work at idle factories.
Projecting The Earnings Headwinds On Preliminary Estimates
J.P. Morgan estimated that the ~40 day strike strike has cost Ford about $1.1 billion in earnings, with the majority of the headwind only expected to materialize in and 4Q, with ~$930 million ( J.P. Morgan research note: 2023 UAW Negotiations Update, dated 26 October ). That's quite a significant headwinds, but looks like peanuts compared to the expected future headwind on the backdrop of a 25% wage hike for employees.
Although CFO Lawler declined to put a price tag on the new four-and-a-half-year labor deal, the equity analysts at Deutsche Bank did it for him, estimating that the company will likely suffer a $6.2 billion earnings loss over the contract period ( Deutsche Bank: Automotive industry equity research note, dated 26 October ).
On an annualized basis, Deutsche Bank's estimates would suggest that Ford may suffer about $1.3-1.4 billion in incremental costs, amounting to ~17% of the company's FY 2022 EBIT. Needless to say, to counter such a spike in costs, Ford would need to find some impossible cost-cutting opportunities in the company's operating structure.
Previously, the company had provided guidance for full-year adjusted EBIT of $11-12 billion, compared to a consensus estimate of $10.761 billion. Total company adjusted free cash flow was expected to be around $6.5 billion to $7 billion (around $6.75 billion at the midpoint), compared to a consensus estimate of $6.1 billion. Now, following the tentative agreement with the UAW, Ford has chosen to withdraw its full-year 2023 guidance.
Valuation Offers No Support
I have previously argued that investors should think the following way about Ford's valuation:
Reflecting on Ford's laggard position in electrification and M.a.a.S, paired with a clouded macro outlook (remember, the automotive industry is highly cyclical), I would propose a ~x8 EV/EBIT as more appropriate, implying an enterprise value of approximately $100-$110 billion. And with Ford's net debt at $111 billion, I see little room for equity investors to make money here. Or in other words, aligning my commentary with CEO Farley's statement (emphasis added)...
Now, post-Q3 and UAW deal, I maintain my valuation framework, but update the numbers: I continue to view a ~x8 EV/EBIT as appropriate when pricing Ford stock. But while my structural EBIT estimate for Ford was close to $13 billion before the UAW deal, I cut this metric by roughly 12%, to $11.5 billion. This would suggest an implied enterprise value of about $92 billion, against a net debt position as of Q3 2023 of $113.7 billion. As sorry as I am to make this conclusion, the implied market capitalization is actually negative here.
Investor Takeaway
My June "Sell" recommendation for Ford has been validated as the stock plummeted nearly 30% since then, compared to a 6% market decline. Recent Q3 results were disappointing, with Ford's Model e electric vehicle unit posting a substantial $1.33 billion loss, on a more challenging EV environment than previously assumed. Moreover, the tentative labor deal with the UAW, featuring substantial pay raises, is expected to cost Ford about $6.2 billion over the contract period. Consequently, the company withdrew its full-year 2023 guidance, and its financial outlook has become less certain.
I maintain that Ford's valuation should be around ~x8 EV/EBIT, implying an enterprise value of approximately $100-$110 billion. Given Ford's significant net debt position as of Q3 2023 at $113.7 billion, there continues to be little room for equity investors to realize any gains. Thus, my "Sell" rating on Ford's stock stands.
For further details see:
Ford: Do You Trust The 'Sell' Thesis Now?