Ford Stock: The Yield Curve Says It All
We have argued for a while now that Ford (NYSE:F) the stock is set for a downturn. We got it wrong initially and got quite a bit of a stick from readers. However, over time, our analysis came to fruition.
As Ford stock hits multi-year lows, many investors may be looking to buy into the dip, but we would like to reiterate that past price is not an indicator of future price when considered in isolation. We expect Ford stock to experience further declines before reaching a tradable level; Here’s why.
Economic headwinds for durable goods
I will base my economic inferences on the yield curve and the spread between long-term and short-term Treasuries.
First, the upward slope of the yield curve shows implied interest rates above 3%. Whether or not the rates materialize is debatable. Moreover, the spread between the 10-year and the 1-year is very close to equilibrium, implying an unequal distribution between long-term and short-term rates.
Essentially what the yield curve is telling us is that there is likely to be tight monetary policy in the near term, which could send us into major economic trouble, subsequently necessitating lower interest rates .
If the yield curve and the spread unfold, we may see some headwinds popping up in the durable goods space. Durable goods with life cycles beyond three years are not essential to our daily standard of living. Thus, a declining economy leads to cyclicality in the durable goods space, such as vehicles.
In addition, Ford is selling a financed product. With interest rates potentially rising, financed durable goods will likely take a back seat among consumers for years to come.
Now that I’ve covered my economic outlook, I’d like to associate it with Ford stocks. Ford’s May report shows its U.S. sales fell by 4.5%. I’m aware that its e-vehicle sales jumped 2.22x year-over-year, but the secular growth we’re seeing in that department still can’t be justified. For context, Ford’s latest 8-K report indicates that electric vehicles represent only 4.05% of its sales in North America.
Do not mistake yourself. I love the new F-150 Lightning. However, for Ford to move from an internal combustion vehicle business to an EV, it would likely require a lot of restructuring costs, and it would require a lot of consumer adoption of EVs. Plus, I certainly don’t see the latter happening in the current economic environment.
I will not speculate on how Ford $5.4 billion Rivian (NASDAQ:SHORE) the loss can be recovered. The observation I would like to focus on relates to industry maturity – Ford’s portion of a mature industry with little growth (except for EV segments). The company’s Rivian investment was a sign of the company’s strategy of investing outward to support growth. This is a typical decision of mature companies, as the maturity phase is usually characterized by a phase of disorganization, which leads many mature companies to invest in alternative industries or refinance to expand horizontally.
I’m not saying it’s a bad thing for Ford to invest outside. Instead, I argue that his stock is not consistently backed and the start of his external investment process is questionable.
Relative valuation exists to compare a stock to its peers or alternatively to its historical value. I decided to hedge historical value here because it takes cyclicality into account. Thus, we will observe things on a normalized basis.
At first glance, Ford looks excellent with a price-to-sales ratio below 1.00 and a price-to-earnings ratio well below that of the S&P 500 (22.4x). However, it is only when we consider company-specific cyclicality that this becomes clearer.
First, Ford’s P/E ratio is trading at a 47.59% premium to its 5-year average, suggesting it is in cyclical surplus. Additionally, the company’s price-to-sales ratio looks glamorous in isolation, but a normalized surplus of 36.55% suggests otherwise.
Finally, the company’s price-to-book ratio can be considered as such, since it is a threshold-based measure. The famous financial academic, Eugene Fama discovered in 1993 that value stocks offer the best risk/return prospects. Fama said stocks are considered valuable when they have book values below the market average. Thus, Ford’s price-to-book ratio above 1.00exceeds the threshold and is deemed overvalued.
A potential bull case
The graph below shows Ford’s market share in North America only. I couldn’t find any credible source for its global market share. Nonetheless, using the company’s North American market share provides a strong indication of its large-scale operations.
Ford could persevere in an economic downturn because its strong market share gives it bargaining power over its suppliers and pricing power in the market, which renders my bearish assertion obsolete.
Additionally, Ford’s stock price is something to watch. This high quality company has lost more than 35% of its market value since the beginning of the year. Thus, we could say that the stock price has bottomed out and we may soon see a recovery.
Cyclicality will likely get the better of Ford for now. The company holds a strong position in the market, and there’s a fair argument that Ford shares could be oversold. However, the yield curve and relative valuation metrics suggest going long on Ford is a bad idea at this point.
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