Ford Stock: I Am Going Against The Grain, Again

Ford Motor Company () has been a part of my portfolio for well over two years now. Needless to say, I am not entirely happy with the performance of Ford stock over this period, but as a long-term-oriented investor, I am wired to focus on the long-term prospects for a company - not the short-run market performance. Earnings will eventually dictate terms over the long-term market performance of any company, which is why I believe investors should follow earnings - not the sentiment toward a certain stock at any given time.

Ford stock has had a forgettable year so far, with the stock up only 2% compared to the 8% gains registered by the S&P 500 index. When Ford stock hit a high of close to $15 last July, I thought it could mark the beginning of a new rally that would finally help bridge the gap between the valuation levels of Ford and Tesla, Inc. (TSLA) - at least some progress from this front - which was not to be. Just over a month ago, I published an article highlighting three risks every Ford bull needs to monitor, including the risk of an escalation of the problems with unions. With more clarity on this front and another 10% decline in Ford's market value, I am ready to add more Ford shares to my portfolio today.

The New Labor Deal

Labor strikes have sent shockwaves through various sectors, including the automotive industry. The pursuit of improved work-life balance and higher wages has placed a growing burden on even the most prominent market players. In particular, the recent labor negotiations between the United Auto Workers (UAW) and the Detroit Three automakers - General Motors Co (GM), Ford Motors, and Stellantis (STLA) - have been a source of concern for investors in the automotive sector. Despite a recent tentative agreement reached on Wednesday, analysts remain far from optimistic, and this has fueled the bearish sentiment toward Ford Motors.

Ford and the UAW have reached a significant labor agreement after a six-week strike, pending approval from union leadership. This marks the first resolution of strikes against the Detroit Three. The proposed four-and-a-half-year contract outlines a substantial pay increase, potentially setting a new benchmark. While it requires the approval of both union leaders and members, it would signify the end of a strike that involved 45,000 workers at the three automakers, which commenced on September 15. This strike against all three Detroit carmakers was a historic event in the UAW's 88-year history.

Under the agreement, workers can expect a 25% wage increase over the life of the contract, with an 11% increase at the start. When considering compounding and cost-of-living adjustments, the UAW has calculated the total pay hikes to exceed 33%, amounting to over $40 per hour over the contract's duration. Additionally, the agreement aims to reduce the time for new workers to reach the maximum wage from eight years to just three. Furthermore, the UAW has secured the right to strike over future plant closures, a significant achievement for the union. Additionally, lower-pay tiers for workers in specific parts operations at Ford will be eliminated.

This agreement holds historical significance and, if accepted, will represent a substantial victory for U.S. unions, aligning with the trend of double-digit pay increases for workers in several other sectors.

Ford has expressed satisfaction with reaching this deal and is eager to resume operations in its plants in Kentucky, Michigan, and Illinois, which had been idled during the strike. The UAW has called for Ford's 16,600 striking workers to return to work ahead of the membership vote. In contrast, approximately 29,000 workers at Stellantis and General Motors will remain on strike.

The economic impact of the UAW strike has been substantial, with total losses estimated at $9.3 billion, according to the Anderson Economic Group. If the contract is ratified by Ford-UAW workers, it could establish a precedent for negotiations at General Motors and Stellantis, with the contract expiring in 2028. This development has major implications for both the automotive industry and the labor movement in the United States.

Key Investor Concerns

Investors in the automotive sector are closely watching the recent labor deal between Ford and the UAW with a sense of apprehension. While this agreement has the potential to impact not only Ford but also its competitors, several key factors have raised concerns among investors.

Cost implications

One of the primary worries for investors is the potential cost implications of the labor deal. The demands made by the UAW, which have been accepted by Ford, could substantially raise labor costs for the company. This includes significant wage increases and other benefits. Such cost increases can directly affect Ford's profitability, and investors are concerned about how these additional expenses will impact the bottom line. Furthermore, these cost increases might have a cascading effect on the entire automotive industry. If GM and Stellantis are pressured into similar agreements by the UAW, it could lead to a domino effect of rising labor costs across the sector, which would be a point of concern for investors who were originally betting on improving profit margins in the next phase of the business cycle.

Electric vehicle ambitions

Another significant concern is the potential hindrance to the automakers' electric vehicle ambitions. Ford, GM, and Stellantis have been investing heavily in EV technology to compete with industry leaders like Tesla. However, the added labor costs from the UAW deal could undermine their ability to invest in and develop electric vehicles effectively. The fear is that this could put the Detroit Three at a competitive disadvantage compared to Tesla, which has been making rapid strides in the EV sector. There is a concern that the increased labor costs may restrict the capital available for research and development in the EV sector. As the global automotive landscape is increasingly shifting toward electric vehicles, it is reasonable to see this as a potential threat to the long-term competitiveness of these companies.

International competition

Foreign automakers, such as Toyota Motor Corporation (TM), have also caught the attention of investors. Unlike the Detroit Three, many foreign brands operating in the United States are non-unionized. This gives them an advantage in terms of labor costs, and there are concerns that the UAW's demands could exacerbate the cost gap between these foreign competitors and American automakers. The worry here is that, if American automakers are burdened with higher labor costs, they might struggle to compete with foreign brands, both in terms of pricing and innovation. This could lead to a potential loss of market share, and investors are cautious about the impact this could have on the Detroit automakers' stock prices. According to Cox Automotive, Ford's market share has declined to 12.8%, further fueling worries. The Ford brand's share accounted for most of this decline, slipping to 11.99% from 12.91% in the year-ago third quarter. In contrast, Lincoln's share remained relatively steady at around 0.51%.

Uncertainty and disruption

The fact that the agreement still needs to be ratified by union members is a source of uncertainty for investors. The ratification process, which could take weeks, leaves room for further negotiations and potential changes to the deal. This uncertainty creates a cloud of doubt over the future financial stability of these automakers. It's been estimated that Ford is currently losing approximately $44 million a day due to the strike. Although Ford has not officially confirmed this figure, the magnitude of the losses is a major point of concern for investors. This financial strain is a result of the strike's disruption to the company's operations, affecting production and sales. Additionally, a significant concern pertains to the future of battery plant employees, a matter left unaddressed when the UAW initially presented the deal on Wednesday. In the previous month, Ford's CEO, Jim Farley, accused the UAW of using the labor agreement as leverage, alleging that the union sought wage parity between workers at new battery facilities and those at assembly plants, effectively holding the deal hostage.

Underperformance in Q3

Going by the third-quarter earnings report, Ford's enhanced incentive spending did not yield the expected results, raising questions about its sales strategies. While some models, such as the F-Series and the small Maverick pickup, posted substantial sales gains, others like the Bronco and Ranger faced declines due in part to supply shortages stemming from the strike. Furthermore, the performance of Ford's luxury brand, Lincoln, was mixed, with the Aviator struggling due to product issues.

Incentive Spending Is Not As Bad As It Seems

Investors are turning bearish on Ford for obvious reasons, but it's essential to consider the bigger picture before forming conclusions. One important thing to understand is that Ford had a substantial increase in incentive spending in the third quarter, reaching an average of $2,731 per vehicle, marking a 194% rise from a year ago. However, the context here is unique. In 2022, incentives had been unusually low due to the global chip shortage, which significantly constrained supply. Consequently, this boost in incentives was partly a result of adjusting to a new norm after a period of exceptional circumstances. It's also noteworthy that despite the increase, Ford's incentives remain historically low, significantly below the levels seen in 2018 to 2020, where they exceeded $4,000 per vehicle, sometimes even nearing $5,000. This suggests that, while incentives have risen, they are far from reaching the peaks of recent years.

Exhibit 1: Ford's incentive spending in Q3

Moreover, the breakdown of incentives between the Ford brand and the Lincoln brand offers insights into this broader context. The Ford brand witnessed a 206% increase in incentives to an average of $2,641 per vehicle. While this is a substantial rise, it should be noted that before the pandemic, the Ford brand typically spent over $4,000 per vehicle on incentives. Lincoln's incentives, which rose by 101% to an average of $4,853 per vehicle, had historically ranged from $5,000 to more than $7,500 per vehicle between 2018 and 2021. These figures illustrate that the current incentive spending, although higher, doesn't reflect an unsustainable or unprecedented situation, and it's a reflection of Ford's strategy to remain competitive in a challenging market.

Examining average transaction prices (ATPs) provides further context. Ford's ATPs in the third quarter edged up by 4% from a year ago to $56,339, marking a new quarterly high. However, it's worth noting that the pace of price growth has slowed compared to previous years, and some models even experienced declines. The Bronco, for instance, saw its ATP soar by 14% from a year ago, reaching $60,733. The Transit van, driven by a robust commercial vehicle market and the addition of an electric version, had a 12% increase in ATP to $58,584. These increases are noteworthy as they indicate Ford's ability to command higher prices for specific models, particularly in the competitive SUV and electric vehicle segments.

Exhibit 2: Ford's ATPs for Q3

Within the Lincoln brand, ATPs edged 1% higher to $65,523, demonstrating its ability to maintain relatively high pricing. The Lincoln Navigator experienced the most significant rise at 4%, with the highest price tag at $105,065. While some other Lincolns remained flat or saw only modest gains of 1% to 2%, this indicates that Lincoln has maintained its premium positioning in the market.

Ford Remains Underappreciated

At a market capitalization of $46 billion, Ford is valued at around a quarter of expected revenue this year, with analysts projecting revenue of $167 billion in fiscal 2023. In contrast, EV leader Tesla is valued at a forward sales multiple of 7x. I am not even remotely suggesting Ford should be valued similarly to Tesla, but in the long term, I expect some convergence in the valuation levels of these two automakers with Ford continuing to make inroads into the EV sector. As the maker of some of the most popular trucks in the U.S., and trucks being the darlings among most American car buyers, Ford's electrification strategy should yield handsome results in the long term. The stellar debut of the F-150 Lightning, in my opinion, serves as an early indication of what Ford could achieve in the future.

The UAW deal will have a negative impact on earnings. Morningstar analyst David Whiston expects to slash his fair value estimate for Ford stock by $1-$3 once the deal is finalized, sending his fair value estimate to a midpoint of $18 from $20 today. The company management has made no changes to their guidance for EBIT of $11 billion to $12 billion this year, but for the coming fiscal years, management will be forced to factor in a meaningful hit resulting from the expected increase in operating costs. All that said, I believe finalizing a deal will be a win for Ford given that the company stands to lose more if production remains interrupted.

The growing EV losses are a concern, for now, but as a growth investor, I believe Ford has no option but to strategically invest in its EV business while doing its best to negate some of these losses with its other business units. The continued strength of Ford Blue and Ford Pro in the third quarter has convinced me of Ford's ability to do exactly this.

My investment thesis for Ford has always been a long-term-oriented one, and at the current valuation, Ford looks appealing. Investors, however, will have to go long and stay for the long haul as the prospects for Ford will not immediately improve.

Takeaway

Investors are understandably worried about the Ford-UAW labor deal and its potential ramifications for the American automotive industry. The combined impact of rising labor costs, potential setbacks in EV development, and increased competition from non-unionized foreign brands could have far-reaching implications for the Detroit automakers. This deal presents immediate challenges and expenses, particularly as the company strives to establish a stronger presence in the electric vehicle market. However, in the bigger scheme of things, this deal should be considered as a necessary step to secure the company's market share and sustainability of revenue growth. With Union concerns finally moving to the rearview mirror, I find Ford attractively valued today, and I am planning to add a few more shares to my portfolio in the coming days.

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