In a world where Elon Musk is building electric cars and spaceships and launching his cars into space with his spaceships, Ford may seem like your father’s grand-fathers, and you can’t say this for many companies, but maybe even great-grandfather’s stock. We think this sentiment couldn’t be further from reality. Aside from ample idiosyncratic tailwinds, which we will discuss further below, we also believe that Ford is bringing to fruition the fate we have predicted for so many ‘Epicenter’ stocks; booming post-pandemic demand for their products, significantly better operating leverage, and thus earnings per share, and the type or do-or-die cuts and restructuring that only true crises can engender.

Ford has an exciting lineup of new models, credible plans to expand internationally, has made impressive and tangible strides in innovation, and its prodigious lending arm, Ford Credit, just had its best year in well over a decade. The last point: Ford’s massive financial services subsidiary has been the lynchpin in bearish arguments for why the company would falter. In what will likely be a very hot post-pandemic economy with a steepening yield curve, this supposed albatross will likely create significant upside that is not predicted by historically informed forecasts.

Everybody knows the dated narrative still pervasive among some investors; the Big Three of the American auto industry are uncompetitive, saddled with expensive legacy costs and dilapidated factories, and late to the party on electric vehicles. The narrative almost has a ‘Fall of Rome’ quality to it—Of course, once Rome stopped paying off the Visigoths (Or the UAW in Detroit’s case), it fell. Investors who lump Ford into this narrative would have been wrong for decades now.

If you examine Ford’s financial statements closely, you’ll see that their worst quarter of the pandemic was fortuitously hedged by a $3.5 billion gain from investments in AI and self-driving technology. Does that sound like a management team that has allocated capital poorly? Last quarter, the company reported that it had organic margin expansion via rising prices because of unexpectedly healthy demand. Its new products are in even higher demand than existing ones. Thus, this trend will likely only accelerate as the pandemic recedes, and Ford’s primary consumers have their balance sheets bolstered with robust stimulus. This suggests that historically informed forecasts for demand are likely too low.

Source: Trefis, Thinkorswim

As you can see, with slightly more optimistic assumptions than those which are informed by historical data, the implied valuation is significantly augmented.

New Product Lineup: BEVs (Battery Electric Vehicles) Are Great Alone, But Better with ICE (Internal Combustion Engines)

Our Head of Research, Tom Lee, got his start as a wireless analyst in the 1990s, and he has said that he sees multiple parallels between electric vehicles now and wireless in the nascency of his career. So, we undoubtedly have faith in electric vehicles’ eventual dominance. That doesn’t mean there isn’t exuberance in some names. With Ford, you get a two for one. Not only are you getting exposure to the multiple-expanding, very ‘growthy’ electric vehicle market; you are also getting a flagship ‘Epicenter’ stock that is poised to outperform the market because of a once in a lifetime cost reset. This, coupled with the impressive and trustworthy management, which the current products reflect, makes us think that Ford still has much upside even though it is near new highs for the year.

The pace of EV’s gains in market-share will eventually be heightened by multiple secular tailwinds. Right now, there are still many obstacles to achieving the type of full-scale ICE substitution that some valuations would suggest; one of them is the power grid’s inability to support such a reality currently.

The point is that particularly in the domestic American market, which is by far Ford’s largest, demand for old-fashioned gas burners will remain foreseeably intact. Even if you’re worried about that trend in the future, Ford seems to be on top of it. The all-electric Mustang Mach-E just won the award for Best SUV of 2021, and the F-150 simultaneously won for Best Truck, the first time two of the three awards have gone to the same brand since 2014.

The new lineup of Ford Broncos is already saturated with pre-orders, and post-COVID-19 consumer trends actually appear to work in Ford’s favor. It will be poised to grow its base business in ICE in size and profitability while also being a major player in the shift to all-electric (including the all-electric F-150). This goldilocks zone that Ford occupies means reaping great margins from very in-demand and high-margin ICE models while also being exposed to EV’s ascent. 

Ford can do better than many people think in the EV world for a few reasons. Firstly, Ford still qualifies for the $7,500 tax credit that TSLA has long-since outgrown. This will have a measurable effect on a product subject to very elastic demand, particularly when the quality is now confirmed to be about equivalent to chief competitors (and is already profitable for the company). The other thing is that many Americans still don’t want to buy an electric vehicle. We think Ford’s bet that they can entice consumers to give electric a chance using flagship brands and high-quality vehicles while also taking the company to have recurring revenue streams from software and AI is exactly what the company should be doing. This should positively affect Ford’s multiple over the coming years.

Source: Company reports.

Valuations for auto manufacturers are notoriously discounted due to the ever-present risk of fickle consumer attention to brands and products. Ford has suffered as much from this over the years as any automaker. Still, it’s the impeccable management team and steady, transparent strategy seems to show that leadership is ahead of the curve and has the re-invigoration of one of America’s most treasured brands well-in-hand.

Exciting Management at Ford

We are fans of the record and energy that Ford’s new CEO, Jim Farley, brings to the table. Farley, whose first cousin is the late, great Chris Farley from SNL, is an absolute car fanatic whose first conversation with Bill Ford upon exploring his potential ascent to the top job was telling the company’s patriarch that a condition of him accepting was that he is not prevented from his dangerous hobby of racing cars. He may understand the relationship between vehicle and consumers better than anyone in Detroit since Lee Iacocca.

Jim Farley may not build spaceships, but nobody in the world knows how to sell cars better. In fact, some of Toyota’s most impressive inroads against the American automakers were at his direction; he led the formation of Toyota’s luxury brand, Lexus, and led marketing efforts on some of their best-selling vehicles.  Betting against Jim Farley and Ford’s most exciting lineup in years seems unwise to us. Farley is the guy who can finally make Ford shine. A Toyota man running Ford, we like the sound of that.

The Bottom Line

Ford is one of our ‘Trifecta’ Epicenter stock picks, meaning that all three of our research departments recommend it. We see it benefitting from the same forces that attract us to ‘Epicenter’ and multiple idiosyncratic factors unique to Ford. The company’s valuation risk is significantly less than all-EV companies and we think its Price/Cashflow and Price/Book indicate that the stock is still a bargain even at new highs.

Source: Morningstar

Where We Could Be Wrong

Ford recently had to shut down production in some factories due to a shortage of microchips. Shortages in other components and rising commodity prices could hurt margins. However, our thesis’s largest risk is still the unpredictable path of COVID-19. Since production has already been shut down for significant periods this year, further delays in production or the failure of the demand to continue recovering because of adverse healthcare outcomes are primary risks.

Disclosures

This research is for the clients of FS Insight only. For additional information, please contact your sales representative or FS Insight at http://www.fsinsight.com/.

Conflicts of Interest

This research contains the views, opinions and recommendations of FS Insight. At the time of publication of this report, FS Insight does not know of, or have reason to know of any material conflicts of interest.

General Disclosures

FS Insight is an independent research company and is not a registered investment advisor and is not acting as a broker dealer under any federal or state securities laws.

FS Insight is a member of IRC Securities’ Research Prime Services Platform. IRC Securities is a FINRA registered broker-dealer that is focused on supporting the independent research industry. Certain personnel of FS Insight (i.e. Research Analysts) are registered representatives of IRC Securities, a FINRA member firm registered as a broker-dealer with the Securities and Exchange Commission and certain state securities regulators. As registered representatives and independent contractors of IRC Securities, such personnel may receive commissions paid to or shared with IRC Securities for transactions placed by FS Insight clients directly with IRC Securities or with securities firms that may share commissions with IRC Securities in accordance with applicable SEC and FINRA requirements. IRC Securities does not distribute the research of FS Insight, which is available to select institutional clients that have engaged FS Insight.

As registered representatives of IRC Securities our analysts must follow IRC Securities’ Written Supervisory Procedures. Notable compliance policies include (1) prohibition of insider trading or the facilitation thereof, (2) maintaining client confidentiality, (3) archival of electronic communications, and (4) appropriate use of electronic communications, amongst other compliance related policies.

FS Insight does not have the same conflicts that traditional sell-side research organizations have because FS Insight (1) does not conduct any investment banking activities, (2) does not manage any investment funds, and (3) our clients are only institutional investors.

This research is for the clients of FS Insight only. Additional information is available upon request. Information has been obtained from sources believed to be reliable, but FS Insight does not warrant its completeness or accuracy except with respect to any disclosures relative to FS Insight and the analyst’s involvement (if any) with any of the subject companies of the research. All pricing is as of the market close for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, risk tolerance, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies. The recipient of this report must make its own independent decision regarding any securities or financial instruments mentioned herein. Except in circumstances where FS Insight expressly agrees otherwise in writing, FS Insight is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice, including within the meaning of Section 15B of the Securities Exchange Act of 1934. All research reports are disseminated and available to all clients simultaneously through electronic publication to our internal client website, fsinsight.com. Not all research content is redistributed to our clients or made available to third-party aggregators or the media. Please contact your sales representative if you would like to receive any of our research publications.

Copyright 2020 FS Insight LLC. All rights reserved. No part of this material may be reprinted, sold or redistributed without the prior written consent of FS Insight LLC.