Shares of Ford Motor Company (NYSE:F) are fading again. The F stock price has dropped over 12% since the second-quarter earnings report three weeks ago. Ford stock now trades at its lowest level in almost four months.
Just around $9, Ford stock does look cheap at just 7x the midpoint of 2019 EPS guidance. A dividend yield of 6.6% adds to the case that the F stock price is simply too cheap. But there are risks here worth watching.
Earnings have been headed in the wrong direction. Investors clearly are worried about a U.S. recession, as stocks fell sharply in midday trading Wednesday. Few companies take a bigger hit in a macro downturn than carmakers. That was proven in the 2008-09 financial crisis, which Ford barely survived and which bankrupted rivals General Motors (NYSE:GM) and Chrysler (now part of Fiat Chrysler (NYSE:FCAU)).
This is not a safe play by any means, even if Ford stock looks cheap. Other iconic American companies like Kraft Heinz (NASDAQ:KHC) and General Electric (NYSE:GE) have offered the combination of low multiples and high dividend yields. Both stocks turned out to be painful value traps.
Even with those considerations, however, there’s an attractive case here. I argued at the beginning of the year that Ford stock was a buy, but one that would require some patience. Seven months later, that seems to be the case once again.
Why Did the F Stock Price Fall After Earnings?
On its face, Ford’s second quarter report looks disappointing. The company’s adjusted EPS of 28 cents rose only a penny year-over-year and came in three cents lower than Street consensus. Revenue was flat year-over-year, though in line with Street expectations.
Perhaps more notably, 2019 EPS guidance of $1.20-$1.35 looks somewhat disappointing. Ahead of the report, analysts on average had been projecting net profits of $1.40 per share.
But the quarter isn’t quite as grim as it looks. Ford, owing to new accounting rules, saw a three cent negative impact to EPS owing to its investment in Pivotal Software (NYSE:PVTL). That aside, Ford’s results almost exactly met Street expectations (or perhaps more accurately, analysts on average almost exactly modeled the company’s performance).
Even the almost flat revenue looks reasonably strong given that Ford is shrinking its lineup and seeing currency impacts overseas.
Full-year profit expectations are disappointing, to be sure. They suggest a potential year-over-year decline against 2018’s adjusted EPS of $1.30. Again, the big drop in the value of Pivotal shares is having an impact. More importantly, last year’s results benefited from an unusually low tax rate of just 10%. Ford estimates the headwind from the increased (and more normal) tax rate this year to be 12 cents to 16 cents per share.
This is not a quarter that suggests Ford earnings necessarily have peaked. Investors in the last three weeks, however, seem to be acting as such.
Risks to Ford Stock
That said, those investors might be right. Again, this is not a low-risk play, even with the low earnings multiple and the high yield. A recession would be painful for Ford, leading to both lower sales and potentially higher losses in Ford Credit. The company has some $90 billion in long-term debt attributable to that unit alone.
There’s still the long-running concern of “peak auto.” It’s possible that automotive unit sales — which are now falling on a global basis — have nowhere to go but down. Self-driving cars (at least in theory) would markedly lower demand, while Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT) see themselves as competitors to car ownership, not just each other.
And even with Ford expecting profit growth in 2019, earnings are declining on a multi-year basis. Adjusted EPS in 2015 was $1.93 (at a higher tax rate). The clear worry is that both auto sales and earnings for Ford have peaked. Combined with cyclical worries, that justifies the current price around $9.
The Case for F Stock
Ford stock, then, may not be quite as cheap as it looks. But that doesn’t mean it’s a sell. There’s still a broad argument that the F stock price should return to, and stay in, the double-digits.
Much of the earnings risk seems priced in at this point. Ford earnings have been declining in the second half of this decade, but there’s room for improvement going forward.
Cost-cutting will help. The smaller product footprint will lower capital spending, either creating more free cash flow for shareholder returns (or a recession buffer) or allowing Ford to invest in its own autonomous and electric vehicle efforts. Markets seem to be pricing in almost zero chance of success in those new markets.
Ford is still losing money overseas. At some point, that will change — or Ford will leave. Current earnings power from the U.S. business is likely in the range of $1.60 or higher, based on overseas losses and the consolidated tax rate. There’s still a path for Ford earnings to grow from here, if not consistently and not perfectly.
This is not a safe, “heads I win, tails I don’t lose much” scenario. Cyclical risks are real. Market concerns are an issue. But Ford still has levers to pull — and the F stock price still is cheap.
It may take some time, particularly in a suddenly nervous market. For patient investors, however, F stock looks attractive and should provide solid gains at some point.
As of this writing, Vince Martin has no positions in any securities mentioned.