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Ford (NYSE: F) Wall Street before this month with effects in the second quarter that were “well, much higher than expected.” Ford’s stock rose 4.3% with the news as investors rushed. According to Robintrack, Ford is now Robinhood’s top-owned company through investors.
But there’s a problem: Ford is profitable.
In the last quarter, the company lost $1.9 billion, bringing its 12-month return on capital to -2%. This deserves to inspire experienced investors to dry-prevent. The mountain of corporate debt is not just a problem. The story also shows that underperforming corporations also make bad long-term investments. So even though Ford’s inventory may accumulate from 20% to 30% in the short term, this is why investors deserve to sell for $7 while they can.
This is why. Companies live (and die) from a concept known as “return to invested capital” (ROIC). It is a deceptively undeniable formula, which measures the profitability of your debt plus your equity. And it’s extraordinarily accurate: corporations that make a low setback in investment tend to perform below the market.
Over the more than 10 years, the automotive industry has fallen in ROIC generation. In part, this is because automakers rate the massive expenses of their factories, creating a monetary gulf in their balance sheets. In part, it is also because market fragmentation makes the industry competitive. As a result, the returns of the top six car manufacturers across volume have lagged behind the market.
These effects matter. Over the past decade, NO major automaker has surpassed the inventory market. And as ford’s second quarter effects show, there is little hope that automakers will make a difference in the short term. Despite the top 3 product launches later this year, Ford Control has warned investors to prepare for a loss of EBIT.
In other words, automakers’ actions may seem cheap, but that doesn’t mean they never will be.
Now to ford cars.
The company continued to lose ground to foreign manufacturers. In 2018, Ford abandoned all two North American car models so far in trucks and SUVs. Its market share in the United States is now 14.1%, compared to 19% seven years earlier.
The Michigan-based automaker tried to retaliate. Ford plans to launch the all-new Bronco in 2021 to compete in the off-road segment and launch 40 electric vehicle models by 2022. On the production side, the company has plans for platforms of 16 to five in the future.
But do those adjustments mark a turning point in the company’s profitability? Unfortunately not.
Investors who take a closer look at Ford’s finances are prepared to receive even more bad news. That’s because the company has a lot of debt. In 2019, the company reported $14.6 billion in automotive debt. And, while it’s different, it should also be noted that Ford Credit, its money services arm, has a debt of $140 billion.
Between 2017 and 2019, Ford generated $3.3 billion in interest bills of $8.6 billion in operating revenue, a coverage rate of only 2.65 times. (General Motors (NYSE: GM), by comparison, had a policy index of 9.2x). And that before the coronavirus pandemic cut sales by 50% this quarter.
How did Ford end up with such high debt? Although the company escaped the bankruptcy of the 2008 currency crisis, the ordeal left the company overwhelmed at long-term fees that GM and Chrysler controlled to pay for in their Chapter 11 bankruptcy.
Ford’s nightmare isn’t over yet. Moody’s expects Ford to burn $8 billion by 2020 and another $3 billion in 2021. Its restructuring program will charge another $7 billion, leaving the company with a dubious monetary future.
What about your cars? “Customer acceptance and Ford’s ability to generate economic benefits are uncertain,” writes Bruce Clark of Moody’s. “Ford’s vehicle sales will be highly vulnerable to significant adjustments in market sentiment and customer demand under these unprecedented operating conditions.” In other words, Ford may fail simply because other people like other cars better. The growing festival of Indian and Chinese and upstart brands like Tesla and other electric vehicle (EV) brands won’t either.
The existing F percentage value of approximately $7 gives us 9.4 times the 2021 earnings (PE ratio), less than part of the S-P 500.
But make no mistake about it. Simple measures fail to capture the trade threat related to their debt. Its EV/EBITDA ratio of 20.8x, for example, is almost 50% higher than the market average (meaning investors are betting heavily on Ford’s debt). The average value target for 11 analysts is $7.56, with the most aggressive at a fair cost of $8.00.
Investors interested in investments from classic automakers deserve less indebted corporations, such as GM or Toyota (NYSE: TM). Both corporations are still low this year, but offer a much higher risk-reward profile than Ford.
Tom Yeung, CFA, is a registered investment advisor whose project is to bring simplicity to the investment world. At the time of writing, Thomas Yeung had a position in any of the above values.
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