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Ford - Back to Reality

Psalm Chapter 33 verses 4-5 state, "For the word of the Lord is right and true; he is faithful in all he does. The Lord loves righteousness and justice; the earth is full of his unfailing love."


It's interesting to read these verses as the statement the Lord loves righteousness and justice should be no surprise as the Lord is perfectly righteous and just. Sin cannot exist with God. He is faithful in all that he does as God loves us all the same as our creator. God's word is right and true as it transcends human ancient civilization to the present, it cannot be destroyed or eliminated. The earth is full of His unfailing love as it is His creation too, and His presence and mark is everywhere.


As I think of the words righteousness and justice with respect to the stock market, it's not quite as straight forward. There really is no ultimatum because every company is created and run by imperfect people. Any company can and will either go bankrupt or be acquired over time. Most importantly, market and consumer sentiment can change any company's trajectory. Human emotion is one of the biggest factors in investing. As such, I like to add some degree of stability through monitoring and tracking progress, determined by what a company says, how it executes, and what the tangible results are.


Ford Motor Company (F) reported their earnings this past week, and the SP sold off. Ford definitely has gotten ahead of itself as Morgan Stanley has used the tailwinds of Tesla, Inc. (TSLA) and new comers like Lucid Group, Inc. (LCID) and Rivian Automotive, Inc. (RIVN) to pump both Ford and General Motors Company (GM) as potential electric vehicle, EV leaders. I don't buy it, and Morgan Stanley has already moved on to ironically, Rivian and Ferrari (RACE).


The conviction to invest in companies like Tesla, Lucid, or Rivian is predicated on the fact that these companies are developing leading and cutting edge EV technologies, while at the same time, are creating entirely new brands, supply chain models, and direct-to-consumer value (part of the brand experience), among other facets. This is in stark contrast for companies like Ford and GM that will be looking to cannibalize their top selling brands, while managing multiple supply chain needs (legacy and new), and transitioning to direct-to-consumer models, while figuring out how to deal with less relevant dealership space, among others challenging items.


Ford and GM are not competing against only Tesla, Lucid, and Rivian as the clear EV vertically integrated leaders, but they are also competing against Carvana, Inc. (CVNA) and Vroom, Inc. (VRM), and Lyft, Inc. (LYFT) and Uber Technologies, Inc. (UBER), and most importantly, themselves. Both companies will be hard-pressed to meet all the standards that current customers desire with respect to EVs. For Ford, this means that the F-150 Lightning EV will need to perform to a high standard. Knowing this clearly, I would be surprised if Ford will be getting the EV Lightning out on schedule as the F-Series is the most important part of Ford's business.


A major red flag on the horizon I see is Ford's continued public statements regarding their EV prowess. Both Ford and GM have become leading EV expectation cheerleaders much more so than Tesla, Lucid, and Rivian. Some would say they have no other choice, but this continued and increasing expectation setting will come back to bite them both in my opinion. A clear example of this is Ford's February monthly U.S. sales report. In this report title Ford has the audacity to state:

Ford Begins 2022 With Record Electrified and SUV Sales Momentum; Electrified Vehicle Sales Expand At Almost 4 Times Rate Of Overall Industry Segment; F-Series Hits 40 Millionth Sale; January New Retail Vehicle Orders Hit 90,000 – A New Record

I'm sorry, but why in the world would a company like Ford highlight that its EV sales expanded at almost 4 times faster than the industry? Let's put this into perspective, during January 2021, Ford sold 238 Mustang Mach-Es, and in January 2022, this amount increased to 2,370. This type of comment is like Ford saying in 2021 the Mustang Mach-E increased sales by 905,000% because it only sold 6 vehicles in 2020. The next month will be the first apples-to-apples true comparison for Ford. Additionally, the average Mustang Mach-E sales, February through December last year averaged 2,446, so January 2022 was 3% below this level. This is a great example of where a company like Rivian is not concerned with hundreds to thousands of percent performance from immaterial scale, but rather is focused on the hundreds of thousands of vehicles that will be delivered in the near future.


With the subjective posturing regarding the EV transition for Ford, let's take a closer look at the financials.

For now, my financial model is not accounting for substantial growth based on EV cannibalization. Investors should remember that Ford's Revenue peaked in 2018 at $160 billion. I am forecasting that by 2023, Ford will have finally returned back to this level. From there, I am not going to make superfluous estimates assuming unproven EV expectations, namely increased Revenue and Cash Flow per EV unit, irrespective of volume accomplishments. Ford will need to prove that it can do two key things 1) sustain its top models annual sales with EVs, and 2) make the balance to EV-based supply chains.


While the Mustang Mach-E has underperformed last years apples-to-apples average, the non-EV Mustang January 2022 numbers were up 30% above the 2021 average. The Mustang Mach-E clearly was not an equivalent EV transition, and I will be very interested to see if the Mach-E is sustainable. If not, this will be Ford's first failure, and this question is highly important if Ford is to succeed for its most prized F-Series models. Once Ford does begin selling the EV Lightning, a similar non-EV to EV assessment will need to be strictly adhered to.


To the second point, Ford will be partnering on battery development and production for its supply chain needs. Ford will be spending massive amounts of capital to develop this, something the company hasn't been accustomed to for a long time. The EV Revolution has placed every company equally at a starting point, exception being Tesla, and I do believe those who spend most aggressively and pursue human capital talent the strongest will come out on top. I am not confident that Ford will be capable of fine tuning its supply chain partnerships within five years, ten is a better bet, which puts them that much further behind the curve versus EV vertically integrated leaders. At the same time, I am also not confident that having a few key executives will build momentum towards completely shifting the dynamic of human capital talent at a company like Ford, or GM for that matter.


As for the current business model, Ford has witnessed a return to reality with respect to Cash Flow performance. During 2020 Ford's OCF inflated substantially due to pandemic inconsistencies to 19%. For 2021, this has dropped significantly back to 11.5%. Revenue also got back on track with 7% growth after consecutive year declines totaling over 21%. During 2021, Ford saw volume weakness across its Americas and Europe markets, while China and its International Markets groups saw growth. Offsetting the Americas and Europe markets weakness was substantially improved vehicle pricing, with the China market being the stark contrast to this.


Supply chain issues remain a key factor, but most expect vehicle pricing to remain strong allowing for continued improvement in Revenue performance. Valuation remains very disconnected with respect to EV vertically integrated leaders, and the recent plunge is a constant reminder that Ford will have much to prove before the company can justify any significant expansion in valuation. Recent discussions have revolved around Ford's increasing capital expenditure plans, as well as some initial talk about Ford potentially spinning off its EV segment.


I wouldn't be surprised if Ford did indeed spin-off the EV business. I'm not sure if this would really fundamentally improve the company's situation and risks to pivot, but it could immediately create a clear separation of EV versus legacy supply chain needs and operations, and unlock value accordingly. I view a spin-off as the best case scenario for a company like Ford, as well as GM. In the event no spin-off occurs, I view this as negative in that the required risk taking element is not there.


Ultimately, Ford is in the same boat as Lucid and Rivian, with a modest lead via the Mach-E. Of course if Ford can truly provide all its customers needs with the EV Lightning, then the company will be on the right track to continue leading the "charge". However, I still believe there is a lot of risk, which continues to be placed more on companies like Lucid and Rivian, when Ford and GM have equal, and in many ways, greater risk to succeed.


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