- Commodity prices (such as steel, copper and aluminium) have been a tailwind for Ford over the last 4 years.
- Some commodities have risen sharply over the last six weeks. Will the industrials follow suit?
- The Chinese market although only a small part of Ford's revenue illustrates that the world is slowing down.
- Europe still hasn't recovered in terms of car deliveries since 2006 and is only growing fractionally because of government incentives and tax cuts.
- The US is crucial for Ford. If the job numbers every month continue to be revised downward, it stands to reason that people will have less money to buy cars - especially first time buyers
Ford Motor (NYSE:F) is definitely peeking interest among investors for a variety of reasons. The car manufacturer reported excellent auto deliveries in September which has many analysts bullish on the stock. Industry sales increased by almost 16% (year over year) and retail channel volume rose 23% which made September of this year the best retail month the company has enjoyed since 2004. Low gas prices, cheap credit from financial institutions and better technology in its cars all seemed to be responsible for the company's bumper sales. However the question must be asked - why is the share price lagging? Ford's share price is down almost 5% year to date despite the strong delivery numbers.
This is why you see many analysts pushing this stock because they believe the share price should be substantially higher because of the numbers the company is currently generating. I wouldn't be so bullish at this juncture though. The stock price is lagging for fundamental reasons. The car industry is extremely cyclical and many bulls believe there is ample roadway for this sector to grow because of the huge slump the industry recently came out of. I'm not so sure, which is why I would recommend caution at this juncture. Let me explain the reasons why..
Firstly we have to look at the commodity cycle, as raw materials can generally make up more than 45% of the vehicle's production cost. One has to say that since 2011, commodity prices have definitely aided Ford as the whole complex has been in a big slump. It is my firm belief that commodities bottomed at the end of August. Commodities such as Silver, Corn and oil are all up substantially since then (see chart)
Aluminium and copper have not rallied like the rest of the commodity complex (still trading near their lows) and as these are two of the main commodities used in car manufacturing, their low prices have provided a respite for Ford's business in terms of margins. If industrial commodity prices remain low, it will be a clear signal that China is slowing down rapidly. Furthermore we can see this slowdown clearly with China's PMI figures which currently has a figure of less than 50 which shown manufacturing is declining in the country.
China currently is doing everything it can to revive its economy (and auto industry) but up to now its easing measures, interest rate cuts and discounts on smaller vehicles are still not having the desired effect (see chart). Nevertheless Ford seems to be bucking the trend with pre-tax profits of $192 million in Q2 of this year (in the Asian-Pacific Region) but I cant see this trend continuing if car sales growth continues to decline in the east.
I live in Europe and I don't think this market either is going to provide the growth Ford is looking for. The company has already reported over $4 billion in losses in Europe since 2012 due to lower sales across the board. Although sales actually rose in 2014 for the first time in seven years, I don't see this trend continuing. Sales were up because car dealerships were offering exceptional value on second hand cars because of government incentives and tax breaks across the board. Through ruthlessly cutting costs and evolving its brand, Ford surprisingly has done quite well in Europe this year.
Sales are up 10% already this year compared to the first 8 months last year and its new SUV offerings should increase market share even more once they are introduced to the region. However we have to look at the facts here. Ford is gaining market share in a region where because of the incentives and tax breaks, margins are much less than previous years. It is gaining market share yes (compared to its competitors) but in a declining overall market. Where I live, these government incentives have continued year on year despite the warnings of them being stopped which is a sign in itself.
Furthermore when you look at recent economic figures in the US, it doesn't bode that well for Ford and other car manufacturers. The US up to now has been the one shining light in the world economy in terms of economic growth but things are starting to slip. Job growth has definitely been muted over the last few months which is bearish for auto sales as first time car buyers is one of the most important customer segment for auto sales. Bulls will no doubt dispute my argument by saying that unemployment is still very low and auto loan delinquency rates also have never been lower in a decade. However I believe the delinquency rates will eventually rise especially when you see the huge increase in subprime auto loans. These loans are growing at a staggering rate (130% since the financial crisis) which again illustrates that American families are not as well off as recent economic numbers would tell you. Therefore if the US economy continues to weaken here, you would have to believe that its record profits in the US would come under pressure. It is easy deliver cars when lending conditions are not strict enough and we definitely have an element of this in the US.
Ford Valuations Aren't All That Attractive
To sum up, Ford is definitely a bright spot in the auto sector with net income up 44% and operating related cash flows reaching $1.9 billion. It is paying out a nice 4% dividend yield which will definitely interest income investors due to its low current P/E ratio of 15. However North America is crucial to Ford's success going forward with revenues surpassing $23 billion in Q2 of this year. I see a downward trend in the US which will overtime affect consumer spending habits and new car sales accordingly.