What Ford’s Q2 Earnings Call Failed To Do
The purpose of this review is to boost current investor confidence, something Ford’s Q2 earnings call failed to do. I say this respectfully of course and will be focusing on several topics that I believe bolster the bullish case.
Profits are driven by wholesales, not retail sales. While sales for Ford remain relatively stable in 2018, there’s a considerable amount of volatility in wholesales. As you can see from the chart below, wholesales fell by 24% due to the Meridian supplier fire in May of 2018.
However, there was a far more significant drop in wholesales during the month of July in 2017 due to production cuts in response to a considerable slowdown in sales. The production outlook for 2018 is better, and I estimate (my margin of error on Ford wholesale estimates is about 1%) an 11% y/y increase in wholesales for the month of July.
From a product offering standpoint, I think there is far too much focus on what’s being lost and not enough on what’s being gained. Ford’s decision to end production of their fuel-efficient sedans at a time when gasoline prices are rising has been hotly debated. Some investors are concerned that higher fuel prices will shift consumer demand away from profitable trucks and SUVs to less profitable sedans. This is a valid concern because it has happened before. However, before we can assume that it will happen again, we have to ask ourselves if all of the variables are the same today. One variable I think is being overlooked at the moment is the significant improvement in the fuel economy of trucks and SUVs since the last time higher gasoline prices shifted consumer preference. The following illustration compares the fuel economy of a new Ford F-150, Explorer, Escape and Fusion in 2009 versus the same vehicles in 2018.
This illustration also provides the annual fuel cost for each vehicle with 15,000 miles driven at current fuel prices. As you can see, the difference between the monthly fuel cost for an F-150 or Explorer compared to a Fusion was far more significant in 2009 than it is in 2018. It’s also important to note that in this example, the difference in fuel cost between a 2009 Fusion and a 2018 F-150 is only $11 per month. For this reason, I don’t think that fuel prices today pose the same threat to truck and SUV sales as they have in the past.
Soon to replace the less profitable sedans will be a very important new addition to Ford’s model lineup, the 2019 Ranger.
To give you an idea of how important the mid-size truck segment is, consider 2017’s sales figures from Ford’s competitors.
Ford has also been very proactive in managing the wave of off-lease vehicles, and their efforts are proving to be successful.
Used vehicle values were up significantly in Q2 and are expected to finish the year 1% higher than the prior year (mix adjusted). This improvement is very positive from a consumer purchasing power standpoint.
If you agree that the fundamentals look good going forward, then the next logical step is to figure out if the stock is fairly valued. As you can see in the chart below, Ford is trading closer to book value than it has in years.
On an earnings basis, I think it’s hard to argue with a good company that trades with a P/E ratio below 6 - nevermind the near 6% dividend yield.
Though I prefer to focus on fundamentals and valuation, Ford also has an attractive long-term technical setup. In my opinion, Ford has been in a corrective pullback (retracement) since the strong impulse from 2008-2010 ended. I believe the correction is at (downward trend line support and .5 retracement) or near (long-term trendline support and .618 retracement) an end before a significant move up.
So what could trigger the next leg up?
Autonomous Driving Technology
Autonomous technology geared toward consumer applications is very promising and could be very profitable. However, I think the adoption of this technology by consumers is going to be a slower process than some investors might expect. While there will undoubtedly be early adopters, the bulk of consumers will likely take a wait-and-see approach before accepting this new technology. Ask yourself this question, how comfortable would I be driving in a vehicle without a steering wheel or pedals? Another good question if you’re a parent might be, would I put my children in this type of vehicle?
While Ford’s approach to autonomous technology includes consumer applications, it appears the bulk of their current effort is focused on commercial applications. There are currently two significant challenges in commercial transportation. The first and most commonly known is the shortage of drivers. The second is referred to as last mile delivery cost which accounts for as much as 53% of total shipping expenses. A solution to these two challenges would be very profitable, and I believe the vehicle below addresses both issues.
Can a vehicle like this be offered as a long-term lease (or subscription) including insurance and maintenance to businesses? Can it deliver packages for Amazon? Can it deliver packages for retailers to better compete with Amazon? Can it deliver groceries? As I stated earlier, I have concerns about how long it will take for autonomous driving technology to be adopted for consumer use. However, I believe that this technology will be very quickly adopted for commercial use and Ford appears to be in the lead.
As always, I hope you’ve found the information helpful and I thank you for reading.
These are my opinions and the content contained in or made available through this article is not intended to and does not constitute investment advice. Your use of the information or materials linked from this article is at your own risk.