Low multiples make Ford Motor Company (NYSE:F) stock look tantalizingly cheap. You can buy Ford stock for 12 times earnings and only 7 times forward earnings. Ford stock also trades at 0.29 times sales, 1.45 times book value and 4.8 times free cash flow. Also, F stock yields 5.4%.
And this comes at a time when the market as a whole looks a bit frothy, with many observers raising concern over valuations.
Is Ford stock really so cheap? Or are there risks lurking in the background which could spell trouble for Ford and other automakers like General Motors Company (NYSE:GM)?
These possible catalysts make the sector appear interesting, especially when given the low valuations of automakers like Ford.
So why should investors hold back?
Right now, I can’t help but feel wary about this market. Valuations are stretched on multiple measures. And that’s without the Federal Reserve interest rate hike, which could impact Ford.
Rising Interest Rates Will Hit F Stock
Interest rates were unusually low in the past few years; maybe even the lowest in 5,000 years if Bank of America analysts are correct. During the 2008 recession, the Federal Reserve lowered interest rates close to zero in an effort to stimulate the economy.
The Federal Reserve also began quantitative easing, printing money to buy bonds and injecting liquidity into the weak economy. At one point, the Fed was buying $85 billion in bonds every month, and when it signaled that it couldn’t do this forever, yields jumped.
The Federal Reserve now holds $4.5 trillion in bonds, and wants to begin winding down its bond portfolio. This means less money floating around, and higher interest rates.
The Federal Reserve raised the benchmark rate from 1% to 1.25% on June 14.
Ford Stock’s Finances
Could Ford withstand higher interest rates?
Ford operates in a capital-intensive, cyclical business, and owes a great deal of debt.
For the year ending December 2016, Ford’s net debt to EBITDA ratio stood at 6.34. Ford’s operating cash flow to total debt ratio was 0.138.
For the most recent quarter, ending in March 2017, Ford’s debt-equity ratio was 4.76. Ford paid $279 million in interest expenses for that quarter, but earned an operating income of $1.442 billion, giving Ford an interest coverage ratio of 5.17.
Rising interest rates mean a higher cost of capital for Ford. And Ford already is having difficulty earning a return on invested capital that exceeds its cost of capital.
With higher interest rates, it might get difficult for Ford to service its debt.
And higher interest rates will also discourage new car sales in the years ahead.
Also, keep in mind that F stock is cyclical, and we are several years into a recovery. Eventually there will be a downturn, and automakers like Ford and GM will be affected more than defensive stocks. Remember what the last recession did to the auto industry.
Ford should underperform in two scenarios. If the economy does well, the Federal Reserve will raise interest rates, which will impact F stock. But if the economy does poorly, then Ford stock would also be hard hit.
When considering all this, the automaker doesn’t look that attractive. Ford stock might be cheap for a good reason.
Attractive Investment Opportunities for Ford Stock?
Like Ray Dalio said earlier this year, nothing looks really attractive and it may be getting hard to find great investment opportunities.
Pharma stocks like Pfizer Inc. (NYSE:PFE)? The political climate doesn’t look very favorable post-Valeant Pharmaceuticals Intl Inc (NYSE:VRX). And last year’s political realignment has left us with a Republican president who is no fan of Big Pharma and tweets about the high cost of medicines.
Retail? Traditional retailers are getting smashed by online retailers like Amazon.com, Inc. (NASDAQ:AMZN).
Telecom stocks, like AT&T Inc. (NYSE:T)? As I’ve written in the past, stocks in this industry face the threat of digital disruption as apps like Viber and WhatsApp deprive them of revenue. Competition between carriers is fierce, and average revenue per user has fallen since 2006.
Energy? Middle East geopolitics no longer seems able to move the needle here, with markets shrugging off the diplomatic crisis in Qatar.
There is one sector which seems to be largely free of these pressures: tech stocks. But even with the recent dip in the sector, how much more upside can there be when Facebook and Amazon stock are both up 30% and Alibaba Group Holding Ltd (NYSE:BABA) stock is up 55%?
But in the end, F stock itself doesn’t look any better right now.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.