- Subprime auto loans continue to rise. JP Morgan has recently stated that a bubble could be on the horizon.
- The inventory to sales ratio continues to rise which means second-hand cars are getting cheaper.
- Ford could still lose money on their operating leases even if debtors pay off their leases in full.
Sentiment is getting pessimistic on Ford Motor Company (NYSE:F) stock at the moment which might mean that a rally may be not very far away. However, the impending rally may be short lived as Ford's May numbers were not all that impressive. Industry sales fell by over 6% despite the SAAR (Seasonally Adjusted Annual Rate) metric remaining stable. There is a reason why Wall Street is not valuing Ford stock higher and I believe it ties into the cyclical nature of this industry. In fact, if we are witnessing the US market leveling off, then meaningful growth will be hard to come by for Ford as the US by far is its biggest market. Furthermore, oil prices have been on the rise meaningfully and one would have to believe that if oil keeps rallying, Ford's "Utilities" division would come under pressure due to higher gas consumption.
Trucks and vans are keeping the company moving forward and the Lincoln brand also managed to report growth in the company's recent quarter. However, if the US job downward trend continues along with higher gas prices, it will be difficult for Ford to beat previous earnings numbers. Investors should remember that Ford's recent earnings have reported many beats on the top and bottom line but the numbers still weren't able to move the stock. This is why I see more downside risk than upside in Ford and here are more strong reasons why.
Even though "Ford Credit" goes to great lengths (see chart) to demonstrate that this side of the business is structurally sound, one still has to take into account the risks in this area especially when we see the growth of subprime auto loans. I believe it actually came to a head last week when the CEO of JP Morgan Chase confirmed the debt risk in this area that many are oblivious to. Ford bulls state that as more contracts have been written over the past few years, delinquencies have actually declined.
Furthermore, Ford constantly states that its lofty "Ford Credit" debt balance is self-liquidating. What this means is that the balance would naturally decline if sales slowed as less contracts would be handed out. However, what management fails to state is how much of current leases would come under pressure if sales all of a sudden came to an abrupt halt. The "receivables" metric on Ford's balance sheet is shown as an asset (and definitely is when customers make good on their debt) but history has shown us that car lease is one of the first expenses to go when money gets tight in any household.
I've been looking for a top in US auto Sales for a few quarters now and recent numbers are illustrating to me that we might have hit a top. The inventory to sales ratio (see chart) has been rising meaningfully which means that used car prices are slipping and if this trend continues, then dealers are going to be left with no option but to reduce the price of second-hand cars. This is economics 101. If the market changes, dealers simply have to cut their prices in order to stay afloat. This will have huge ramifications mainly for new vehicles in the sense that sales would have to drop meaningfully until dealers "inventory" gets cleared.
Now, here is the thing that nobody is talking about. Imagine a customer who took out a lease on a ford recently. These leases can last anything up to 7 years which is another symptom of this cracked up auto boom. Now if what I am projecting comes true and quality second cars (many of them coming off lease) come onto the market at very cheap prices in the near term, will this person continue to pay his long-term lease or hand back his keys ? All I know is this. What happens in the housing sector can also happen in this sector. This is why the powers to be will do everything possible to keep credit lines going in order to pretend all is healthy.
Furthermore, the other problem with a huge amount of vehicles coming off lease (in a down-moving market) is that Ford will have to sell those cars at a big discounted price to keep cash flow levels ticking over. This is what investors are missing in my opinion. Even if Ford doesn't have a lot of defaulters, it still can be hurt badly from having to sell automobiles at big discounts once they come off lease. Therefore, dismiss claims that Ford Credit's customers are good for their debt as that's only one piece of the argument here. The real problem I see is if the supply of second-hand automobiles spikes, which will cripple prices in the second-hand cars market
To sum up, I believe the market has priced in a top in new auto sales which is why Ford stock is finding it difficult to move higher. I would urge investors to do their homework on the stock and especially study the fundamentals over a long period and observe what happens to companies when the cycle changes. If inventory levels continue to expand in the US, I can't see the share price remaining above $13 for long.