The 2 Big Reasons Ford Stock Looks Good on This Dip

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Here’s a simple truth: Auto stocks don’t do well in recessions. Long story short, cars are big ticket purchases, and when the economy slows and things are tight, consumers don’t have the money or confidence to make big ticket purchases. As car demand plummets, auto company profits get wiped out, and auto stocks plunge.

The 2 Big Reasons Ford Stock Looks Good on This Dip
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Which explains why, as recession fears have ratcheted up in recent weeks, shares of U.S. auto giant Ford (NYSE:F) have taken a beating. From it’s mid-July highs, Ford stock has slipped more than 15%.

That’s peanuts compared to what could happen. In each of three last major market downturns (2007-2008, 2000-2002, and 1990-1991), Ford stock lost roughly 50% or more of its pre-downturn value, including roughly 80% drops in 2007-2008 and 2000-2002, when the broader market only dropped about 50% each time.

In other words, if a recession does materialize over the next 12 months, history says that Ford stock could get wiped out.

But, I don’t think that’s going to happen. Instead, I think Ford stock actually looks tasty on the dip for two big reasons. One, the most likely outcome here is that a recession does not materialize over the next 12 months. Two, the current fundamental trends underlying Ford stock are actually improving.

As such, I think overstated recession fears are creating a good buying opportunity in F stock.

A Recession (Most Likely) Isn’t Coming

When it comes to all the recession chatter, one opinion I’ve heard sounds much truer than all the rest, and that is the opinion of Honeywell (NYSE:HON) CEO Darius Adamczyk. In a CNBC interview, Adamczyk basically said that while the economy is slowing, it’s still doing pretty well, and that a recession will basically only happen if we talk ourselves into one.

Spot on. I couldn’t agree more.

The media is freaking everyone out because panic talk sells better than “everything is fine” talk. What about the inverted yield curve? It’s lost its predictive power because of distortion from QE which has produced negative government yields in many parts of the world. What about the trade war? It’s a footnote — total trade with China (exports plus imports) amounted to $650 billion last year, a measly 3% of the $20 trillion-plus U.S. economy. Slowing manufacturing activity? It happens, all the time, and most of the time, it reverses course and doesn’t lead into a recession – see 2011-2012 and 2015-2016.

In other words, all the “recession indicators” you’ve been reading about across the financial media landscape, are overstated headline risks which won’t derail the U.S. economy. They will only become a real problem if enough people believe they are a real problem, and businesses stop investing and consumers stop spending.

For the time being, that’s not happening. Businesses and consumers are still spending. So long as that remains true, the economy will keep expanding.

It’s also worth noting that the economy has strong safety levers here. The Fed has essentially said that they will do what it takes to prolong the current economic expansion. U.S. President Donald Trump — who has prided himself on having a strong economy — is heading into an election year. He will likely do anything (including resolving the trade war) to get the economy on solid footing ahead of that election to increase his chances of winning.

Net net, I don’t see a recession coming.

Ford’s Fundamental Trends are Improving

If a recession doesn’t materialize over the next 12 months, then buying Ford stock here seems like a smart move for four big reasons.

First, and foremost, the stock is priced for a recession. The forward earnings multiple (7x) equals the dividend yield (7%). That means this stock is ridiculously cheap. On any good news, Ford stock has big upside potential.

Second, Ford’s volume and market share trends are improving. Fiscal 2018 was a rough year for the automaker in terms of volume and market share. Across Ford’s entire automotive business, volumes dropped nearly 10% in fiscal 2018, while the company lost 0.7 percentage points of market share. In 2019, those trends have reversed course. Year-to-date, Ford’s market share in North America is roughly flat year-over-year, while Europe volumes rose 3% in Q2 and China market share dropped by its smallest amount in Q2 in recent memory.

Third, Ford’s domestic revenue trends appear to be on the cusp of a huge turnaround. Ford’s North America revenues are down year-to-date. Their market share is not. The implication is that although the North America market is weakening, Ford’s positioning in that market is actually starting to stabilize for the first time in a long time – mostly because Ford is electrifying is product portfolio and becoming more relevant to younger consumers. Consequently, if/when the North America auto market picks back up as recession fears back off, Ford’s North America sales trends should significantly improve.

Fourth, Ford’s margin profile is improving. Fiscal 2018 was a year of big investment for Ford, and the company’s margins took a hit as a result. In 2019, Ford has been able to reap the rewards of 2018’s restructuring efforts. North America EBIT margins are up year-over-year. Losses in Europe and China are narrowing. Global auto EBIT margins are up. Importantly, this uptrend in margins should continue over the next few quarters as recharged demand converges on cost-cutting measures.

Bottom Line on Ford Stock

If a recession materializes over the next 12 months, Ford stock is in for some serious pain.

I think the possibility of that happening is quite small. The far more likely outcome here is that the economy shakes off near term slowdown concerns, and returns to healthy growth in 2020. If so, F stock is due for a pretty big rally over the next 12 months as an economic resurgence converges on favorable underlying trends for the company.

As of this writing, Luke Lango was long F. 


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