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The market made a big mistake, in my opinion, in its overreaction to Ford’s (NYSE:F) results for the third quarter on Friday. Shares of the car brand slumped more than 12%, falling to their lowest level since January 2021, after Ford withdrew its adjusted EBIT guidance for FY 2023… for the most short term reason ever: the company warned that the United Auto Workers’ tentative labor deal was causing uncertainty about its earnings prospects.
However, a labor strike/agreement is never really a good reason for long term investors to doubt the validity of an investment thesis. Even with a softening electric vehicle market, persistent losses in the EV division as well as a withdrawn guidance for FY 2023, I believe Ford makes an attractive value proposition on the drop. Ford has its strongest electric vehicle line-up in years and shares, due to the market’s overreaction on Friday, are now truly cheap!
Previous rating
I downgraded Ford to hold after the car brand released second-quarter results, chiefly because of slowing electric vehicle adoption and larger than expected losses in the EV division: Why I Am Down-Grading To Hold.
One positive take-away from the second-quarter earnings release, however, was that Ford raised its FY 2023 outlook with regards to its adjusted EBIT… which rose from a range of $9-11B to $11-12B. Ford withdrew its guidance in the third-quarter due to continual negotiations with the United Auto Workers union. I am upgrading Ford to strong buy because the market is widely overreacting to this short term event.
Mixed earnings results, Ford missed on revenues and earnings
Ford reported mixed earnings for the third-quarter and failed to meet expectations: the car brand fell short of revenue estimates by $1.34B and missed consensus EPS estimates by $0.06 per-share, in part due to growing losses in the EV segment.
Source: Seeking Alpha
Growing losses in the electric vehicle business
Slowing EV adoption has become a bit of a concern for investors as of late and Tesla’s (TSLA) Q3’23 earnings report was widely seen as a warning that growth in the electric vehicle market was set for further headwinds… which caused selling pressure not just for EV companies, but also for legacy car brands like Ford and General Motors (GM).
Although Tesla is suffering from deteriorating margins in the electric vehicle sector, largely due to growing price competition, I believe Tesla is a solid hold for investors as Tesla is launching new products which generate a catalyst for delivery, revenue and free cash flow growth: Overreaction to Cybertruck Comments Creates Long-Term Opportunity.
But back to Ford.
Ford’s electric vehicle business continued to lose a lot of money in the third-quarter and it reported a total adjusted EBIT loss of $1.3B compared to a Q2’23 EBIT loss of $1.1B. Year-to-date, total losses in the electric vehicle division amounted to a $3.7B and the segment posted a negative EBIT margin of 72.8%, so Ford is losing a lot of money on each electric vehicle sold. As far as the timeline is concerned, I believe Ford will post EV losses of a significant nature at least until FY 2026, but Ford’s growing scale and increasing delivery volumes should help the company narrow its losses over time. I estimate that Ford could become profitable, in the EV division, by FY 2026 or FY 2027.
However, over time I expect Ford’s electric vehicle-specific losses to diminish and Ford itself has said that it follows a long term EV strategy that targets an annual production volume of 2M units by FY 2026… which then should translate to an 8% adjusted EBIT margin.
Due to growing headwinds in the EV business, largely due to pricing pressure, Ford said that it will delay approximately $12B in EV-related investment spending as well. Expanding losses in the electric vehicle segment contributed to Ford’s 12% sell-off on Friday, together with a withdrawn FY 2023 EBIT guidance.
Source: Ford
Ford’s tentative labor agreement and guidance withdrawal for FY 2023
The biggest take-away from Ford’s earnings release was that the car company withdrew its EBIT guidance for the current fiscal year: last week Ford agreed with the UAW to a generous 25% pay increase for auto workers as well as cost-of-living adjustments.
Ford did not lower its guidance, but just withdrew the existing one, signaling that the car brand can currently not provide a reliable estimate for its FY 2023 adjusted EBIT. In the first three quarters of the year, Ford generated approximately $9.4B in adjusted EBIT. While the union agreement will cost Ford a lot more money in labor costs, the car brand nonetheless confirmed that demand for its products, including its electric vehicles, remained strong in the third-quarter.
With the strongest product line-up in years — the Mustang Mach-E in the SUV segment, the e-Transit in commercial vans and the F-150 Lightning truck in the pick-up segment — I believe Ford is well-positioned to execute its long term EV strategy and gradually work towards lowering its losses in the electric vehicle division. The labor agreement should not taint, in my opinion, Ford’s long term earnings prospects in the auto market as the company will likely pass on higher labor costs to consumers.
Ford’s valuation
Ford’s earnings potential was not especially expensive before the Q3’23 earnings-related drop, but it sure is a lot cheaper now.
Shares of Ford are trading at a P/E ratio of 5.6X (an 18% earnings yield!) and 17% below their 1-year average P/E ratio. I believe Ford could reasonably be valued at 10X forward earnings once EV division losses narrow (which is currently a weight on Ford’s valuation).
With $1.80 per-share expected in earnings next year, Ford could have a fair value closer to $18. With shares dropping below $10 on Friday, Ford is an unbeatable bargain right now, in my opinion. My FV estimate is driven by the assumption of low-to-mid single digit EPS growth going forward and a 10X multiplier seems appropriate for a company that is growing its business and generating a ton of free cash flow. A 10X multiplier also seems appropriate for a cyclical car brand which is dealing with a top line contraction during a recession.
Risks with Ford
The labor agreement with United Auto Workers is expensive and will result in higher labor costs for Ford going forward. This may dent the short term earnings trajectory a little bit, but ultimately, I believe, Ford will just pass those costs on to the consumer, thereby restoring its long term earnings prospects. Besides the labor agreement, I believe a recession could impact the value proposition as a decline in consumer spending would most likely lead to lower wholesale volumes and retail auto sales. Higher-for-longer EV division losses may also be a headwind for Ford’s valuation.
Final thoughts
Share price drops like the one from Friday are, on one hand, infuriating because the market is overly impressed with a decline in short term earnings. On the other hand, it is moments like this, when the market hopelessly overreacts to a short term event such as a labor strike/labor agreement, that creates new investment opportunities for long term investors. My previous rating on Ford was hold, but I am upgrading to strong buy as I believe that Friday’s market reaction was overdone and that Ford’s long term value proposition has not been significantly impaired. In fact, with shares trading below $10, I believe Ford is significantly undervalued and has a very favorable risk profile!
