Thinking to buy Ford Motor Company stock on its recent strength, think again.
- Non-Opec Countries joining the party have to be bullish for energy prices. Gasoline prices will follow crude eventually.
- November US sales were impressive but these numbers are only really off the back of investment in previous quarters.
- Huge investment has been earmarked for autonomous. Does Ford really have the balance sheet to compete over the long term?
Ford (NYSE:F) is a stock that is affected meaningfully by macro events especially within the US which is by far its biggest market. Last week Fed announced that it will not only raise interest rates for the first time in 2016 but also is planning to hike 3 times instead of 2 next year. This resulted in the S&P 500 (INDX:SPAL) dropping 18 handles as well as the bond market continuing its upward trajectory. However, the real asset class that caught a bid yesterday was the U.S dollar which now is approaching parity with the euro. In my opinion, many investors are going to take this sustained upward movement in the dollar as a sign of US economic strength. However, the only reason why rates are expected to rise so quickly is because inflation has really spiked in the US since the summer. Currently, the consumer price index stands at 1.7% in November up by 0.2%. Ford stock is up over $1 since its November lows mainly because of its impressive November numbers and a perceived strength in the US economy. Furthermore, as we enter the final week of 2016 many investment banks and hedge funds will be closing out their existing positions and moving their capital into stocks that are perceived strong and which also pay a high yield. Ford looks like it will be a major beneficiary. However, I believe it will be a false dawn and here are three reasons why.
Energy Prices Are Going Higher
Firstly, with non-OPEC countries now teaming up with OPEC for a production cut in 2017, this has to be bullish for crude oil prices going forward and bearish for Ford. Gasoline prices always sooner rather than later follow crude oil prices which have to be bearish for Ford's high margin models such as its F-series Super Duty trucks and Lincoln models. Besides the inflation trend, I believe the main reason why Ford stock is down 11% year-to-date is because commodities have rallied meaningfully this year. In fact, the CRB index which is a commodity futures price index representing a basket of commodities such as gasoline, crude oil, and aluminum looks like it is about to break out to new 2016 highs. Higher commodity prices will mean that Ford's raw materials which it uses to make its products are going to be more expensive. Moreover, the cheap gas that has fuelled Ford's huge sales growth in recent years is going to become much more expensive at the pumps in the near term. (See Also: Why Ford Motor Company Is Not A Buy Going Into 2017 )
November Sales Were Strong Due To Incentives & Launches
I just believe that investors are reading too much into the November numbers which although were encouraging still only portray a short-term trend. In fact, if we go back to the company's third-quarter earnings we can see that automotive operating margins fell to 5% when we exclude the return of door latches. Moreover, pre-tax income slipped by 56% which was primarily because of launch costs for the super duty and higher commodity costs as discussed. It will be relatively easy to report a strong fourth quarter after a relatively poor third quarter where costs were highly elevated. What I am reading into the bullish expectations for next quarter is that it will only be a short-term occurrence. The 10% increase in retail sales in November along with the 11% spike in F-series truck sales for me is down to two temporary metrics. First is the launch of the brand new super duty series trucks and the second is the strong incentives Ford has been offering for purchases before year-end.
Can Ford's Balance Sheet Keep Up With The Competition Over The Long Term?
Ford, though not a dividend aristocrat, is a well-recognized dividend option due to its high yield and the special dividend. The stock with its present 4.8% yield and over $12 billion in free cash flow on a trailing 12-month average are big calling cards for dividend investors. However, it always amuses me why investors do not study historic fundamentals. For example in 2008 free cash flow levels reached -$6.8 billion. Moreover, from 2007 to 2010 there was huge negative equity on the balance sheet and the company also had an average of $120 billion in long-term debt. Equity balances in auto companies such as Ford are just not stable which is why any contractions in the global economy could easily wipe out the company's equity in a matter of a few quarters. Long-term investors should definitely be wary of the huge investment levels that have been targeted for the autonomous area over the next few years. Although Ford is one of the frontrunners in this space at present, it does not have the strength in its balance sheet to compete against its competitors if autonomous spending needs to remain elevated over time.
Therefore investors need to take the upcoming 4th quarter results with a pinch of salt. They are going to be impressive but they will not necessarily mean that earnings will remain elevated. Inflation and commodity strength are worrying headwinds which should be monitored closely.
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