Ford Motor Company (NYSE:F) is not having a great 2018 so far. And there’s little reason to expect that to change. F stock is down about 15% since its January peak and is back near its five-year low of $10 per share. You may be wondering, “Why is Ford stock so cheap?” Here’s the answer.
In fact, there is good reason for investors to be nervous. The company’s own CEO said that 2018 will be a “bad year.” Rising commodity prices and tariffs will take a toll on the company’s profit margins. Rising competition and a potential slump in American auto sales could also hurt. Regardless, the company still has a strong dividend, but can that justify holding F stock today?
Profit Margin Problems
Back in January, Ford CEO Jim Hackett said that 2018 would be a “bad year.” He blamed rising commodity prices with tariffs amounting to a double whammy on that front. InvestorPlace‘s Luke Lango explained last month that:
“In the medium-term, Ford is staring at significantly higher costs thank to hefty tariffs on steel and aluminum. UBS projects that Ford’s raw material costs could rise by another $300 million in 2018 thanks to tariffs. Meanwhile, Goldman Sachs estimates that tariffs could impact Ford’s operating profit line by as much as $1 billion, or roughly 7% of 2017 operating profit.”
Since then, we’ve seen fluctuating rhetoric out of the White House on tariffs against China, NAFTA negotiations and other sensitive subjects. Despite stated progress earlier this month, it remains murky what exactly will happen. Even if a more optimal outcome is reached, higher steel, aluminum and other metal prices will hit earnings for at least the first half of 2018.
Finally, it’s worth noting that General Motors Company (NYSE:GM) didn’t specifically blame commodity prices in its 2018 outlook. That suggests that Ford may be more vulnerable due to its reliance on trucks, and perhaps that management is looking to shift some blame from its own operational decisions.
Both the American economy and U.S. auto sales have been rising for years. It’s hard to forecast the next recession, but after nine years of growth, it’s not unreasonable to start suspecting the next economic dip will come fairly soon now.
The auto cycle also raises concerns. U.S. car sales have hit records the past few years. Ultimately though, consumers only need so many cars. When consumers buy more one year, it tends to lead to fewer sales in the future. After several years of record sales, a dip should be expected. Lower used-car prices and troubles with the auto credit space indicate this cycle may be coming.
On top of that, longer-term trends could hit Ford. The rise of services such as Uber and Lyft make car ownership less and less necessary. Many millenials no long feel the need to buy or lease a car well into their late 20s. This trend should accelerate in coming years.
In addition, ride-sharing services allow the average vehicle to be utilized more, thus reducing the number of total vehicles that get bought and end up sitting around unused most of the time.
F Stock: Not as Cheap as It Looks
A lot of investors rely heavily on the PE ratio to determine if a stock is cheap or not. It’s not a bad indicator to rely on, to be certain. But it’s not everything. In cases such as Ford, it can be outright deceptive.
Here, Ford is trading at a trailing 6.3x PE ratio and a forward PE ratio around 7x. That seems dirt-cheap compared to the S&P 500 in the 20s and other industrial companies such as Boeing Co (NYSE:BA) in the high 20s.
However, there are several factors at play. For one, union contracts remain problematic. When a company with unions appears excessively profitable, workers often demand higher wages. Many an airline has hit turbulence due to this problem.
Second, Ford, in a way, is a bank in disguise. A large portion of its profits come not from making cars but lending against them. Wall Street tends to set relatively low PE ratios for banks in general and subprime lenders in particular. And as we’ve been hearing, subprime auto loans are starting to go bad, so profitability here could drop in a hurry.
Finally, Ford still has legacy issues left with its pension obligations. They appear smaller now, but a bear market would probably cause the pension shortfall to widen significantly.
Ford Stock’s Best Feature: The Dividend
Is Ford stock a good buy if you care about yield? For patient investors, you can potentially overlook all the above reasons to avoid F stock. If you care about a dependable strong dividend, F stock certainly fits the bill.
The company’s 5.3% dividend is one of the largest you’ll find in the industrial space. Even assuming that Ford stock doesn’t go anywhere in 2018, the dividend still beats the return you’d get on most bonds, which also don’t generally offer meaningful capital gains potential, either.
That dividend certainly makes it a lot easier to stay with F stock through the rest of this year. Beyond then, the outlook could start to get brighter as the company’s leaner and more fit makeover starts paying off. On top of that, the spike in metals pricing should begin to revert, leading to a stronger outlook.
F Stock Verdict
So, should I buy Ford stock now? Ultimately, I’m not a huge fan at the moment, even with the selloff year-to-date. There are a lot of crosscurrents at play, making it hard to forecast where earnings are ultimately going. However, when the CEO says it is going to be a rough year, that’s often a good sign to take a pass on a stock for the time being.
While many of the company’s revitalization efforts should pay off, don’t forget that Ford is a cyclical company. And we’re near the end of a long economic growth cycle. Combine that with auto sales being unusually strong for several years now, and it’s hard to see where more demand growth will be coming from.
Even if we assume management does a great job, it’s running into some major headwinds over the next few quarters. As a result, I don’t expect F stock to deliver much more than its admittedly attractive dividend.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.