Ford: High Pessimism Creates A Fantastic Buying Opportunity

In my previous update on Ford Motor Company (NYSE:F), I urged investors to try "avoiding catching the falling knives" in F stock. However, dip buyers refused to give up, likely seeing the potential in Ford's transformation plans.

Ford held its Capital Markets Day this week, as CEO Jim Farley & his team assured that the company is ahead of its electrification plans. In addition, the company provided helpful milestones for investors to assess, seeing a huge potential for earnings accretion through 2026.

Investors new to Ford should not rule out the criticality of its internal combustion engine or ICE segment (Ford Blue), which posted a segment-adjusted EBIT margin of 10.4% at its Q1 earnings release in early May.

It's essential to help fund the company's transition into EVs, as Ford focuses on higher-margin lineups while cutting down structural costs. However, Ford Blue's execution risks shouldn't be understated, as management reminded investors that "net pricing on ICE vehicles is expected to decrease." In addition, the company added cyclical headwinds normalizing average transaction prices, and the "growth of EV adoption" could add more pressure on Ford Blue.

As such, I believe management was astute in highlighting several efficiency gains as the company restructured its legacy segment. The company reminded investors that Ford Blue would focus on "what it does best: trucks, large SUVs, and commercial vans."

The company believes that such a focus will help it mitigate the highly competitive segments that could attract more intense price competition moving ahead. Farley highlighted that Ford sees "less price competition in these segments compared to the two-row crossover market." As such, it could avoid debilitating discounting that could complicate the economics of its transformation plans.

In addition, the company is also focused on reducing the structural costs in its legacy segment. Farley stressed that the company aims to "eliminate costs at the core of [Ford's] industrial system." With that in mind, Ford is confident it could lead to a low-double-digit adjusted EBIT margin for Ford Blue by 2026.

In addition, Ford expects its Ford Pro commercial business to provide critical support for its profitability through 2026. Ford Pro delivered an adjusted EBIT margin of 10.3% in Q1. Management expects Ford Pro to post an FY26 adjusted EBIT margin in the mid-teens.

Notably, Ford sees significant potential in Ford Pro as a "$50 billion revenue business." In addition, management regards the segment as a "secret weapon due to its intersection of hardware, software, and services."

As such, it's expected to provide additional support for the growth and success of Ford Model e (the company's EV segment). While it's expected to deliver an adjusted EBIT margin of 8% by 2026 (the lowest of all three segments), it's the company's future. Based on the company's expectations of a $3B segment loss for 2023, Ford sees significant potential for Model e in margins accretion, supporting the company's target of a total adjusted EBIT margin of 10% by 2026.

However, Model e is also the segment that could make or break the company's profitability, given the structural decline in ICE vehicles over time. As such, it also attracted interesting questions from analysts at the recent company event, as analysts assessed the viability of Ford's optimistic outlook.

It's important to note that Ford's FY26 outlook for its EV segment is driven by the volume modeling of achieving an annualized exit run rate of between 1.2B to 1.3B. It's a highly aggressive assumption over the next three years, which Farley is confident about its competitiveness by "offering differentiated features and software."

I think it's still too early to assess whether the transition to Model e will succeed as the auto industry dynamics continue to evolve. Hence, it's critical to reflect significant execution risks in Ford's transformation and consider buying aggressively only when F is assessed to be significantly undervalued.

Seeking Alpha Quant updated rating shows that F's valuation has improved to an "A-" grade. Therefore, I assessed that investors considering adding more at the current levels should have a reasonable margin of safety, as the market remains skeptical about Ford's transformation plans.

I cautioned investors in my previous update that F is mired in a medium-term downtrend that it needs to break away from to attract momentum investors back.

Despite that, dip-buying sentiments remained robust over the past few weeks, suggesting dip buyers are still confident about bolstering F's pullback at the $11 level.

Hence, the risk/reward profile remains constructive at the current levels for holders to add more positions. However, it's still crucial for F buyers to demonstrate stronger conviction to help it break out of its downtrend bias. High-conviction investors should view the current levels as attractive while the market remains pessimistic.

Rating: Buy (Revised from Hold).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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