Ford Q3: I’ll Buy My Son $13 More (NYSE: F ) | Rare Techy
Q3 summary and thesis
Ford engine (NYSE:F) recently released its Q3 2022 earnings results. After reporting a different quarter in Q2 (more on that later), F reported quite strong results in Q3. Its non-GAAP EPS was in line with consensus of $0.30 assessments. And its automotive revenue was $37.2 billion, a strong 12.0% year-over-year increase and beating consensus estimates by $90 million.
Looking ahead, it also raised its 2022 full-year outlook. It raised its adjusted EBIT guidance to $11.5 billion, a ~15% year-over-year increase. For free cash flow (FCF), its new guidance is now between $9.5 billion and $10 billion, nearly doubling the previous $5.5 billion to $6.5 billion. The main drivers of his optimism are the strength of the automotive industry and restructured business models.
Of course, some headwinds are inevitable in the near term. And we’ll cover two of them in particular later: the recent 3k layoffs and also the Argo AI shutdown. However, I see a whole long-term growth curve ahead. And yet its current PE is in the single digits (only ~7x). For accounts that can ride out these short-term volatilities, the margin of safety for ignoring is wide.
And for the rest of this article, we’ll use our son’s UTMA account assets to further illustrate our point. You can see why I’m happy to add more shares to this account at prices near or below $13 (which means a FW PE of about 6.5x).
Readers familiar with our writings know that we have a young child. And we’ve funded a small Uniform Transfers for Minors (“UTMA”) account for him. UTMA account basics are detailed in our recent article. The account is at Fidelity (and its website offers a good 101 on UTMA accounts). Our main motivations were: giving our son seed funds and also the tax benefits these accounts offer. Our current holdings are listed below. A couple of notes:
- Due to our relatively small account size and long-term horizon, we are even more concentrated portfolio than our other accounts. You should adjust your diversification and exposure accordingly.
- For performance tracking purposes, I used prices on SA on July 11, 2022 (the date I first published this portfolio) as the entry price. So it is easier for readers to check and monitor its performance.
- Our actual portfolio size is significantly smaller. The starting size of $100,000 used here is just to simplify the math.
As you can see in the two charts below, F is the second largest holding in our UTMA portfolio, accounting for 18.3% of our total assets. It’s also the second-best performing holding since July 11, with a 25.1% gain.
Overall, the UTMA account has consistently outperformed the entire market (represented by SPY) since July amid extreme market turbulence, despite (probably because of) the fact that it only holds 6 stocks in total. As of November 15th, it currently outperforms SPY by 10.6% (we update the account monthly in the middle of each month). Note that the yield we selected is much higher (3.82%) than the SPY (about 1.51%) and the returns presented here were dividend yield adjusted.
Next, you can see why I’m happy to add even more F shares to this account at a price close to or below $13 based on Q3 results.
F: Expected revenue at $13 entry
The consensus estimate for its FW EPS is around $2. And an entry price of $13 or below implies a forward PE of 6.5x, recalling the earlier chart, its average PE has been around 7.6x. Therefore, the $13 entry price provides a wide ~15% margin of safety against short-term fluctuations. In the long run, as described in our previous article:
ROI (return on investment) in the long run is simply a function of two things: A) the price paid to buy the business and B) the long-term growth rate of the business. Specifically, Part A determines Owner’s Earnings (“OEY”). And part B, the long-term growth rate, is governed by ROCE (return on capital employed) and reinvestment rate.
And a PE of 6.5x already yields about 15.4% OEY (Part A) to begin with. For Part B, F ROCE has averaged 40.5% as seen in the chart below. Assuming a modest 5% reinvestment rate (“RR”), the real long-term growth rate would be about 2% (40.5% ROCE * 5% RR = 2% long-term growth rate). The nominal growth rate would be higher if the inflation adjustment is included. And the ROI at 6.5x PE would already be over 17% even without adjusting for inflation (as highlighted by the blue line and green diamond in the second chart).
As a thought experiment to illustrate how wide the margin of safety is, imagine that F loses half of his income (as shown by the red line in the second diagram). Now, entry PE doubles to 13x and OEY halves to 7.7%. Combining the growth rate contribution (2% real or 5% if you add a 3% inflation escalator), the investment would still provide a long-term return of between 9.7% and 12.7%.
Risks and final thoughts
F faces all the macroeconomic risks like the rest of the economy (inflation, labor costs, raw material prices, and the possibility of recession). Here, I’ll focus only on two risks more specific to F: the recent 3k layoffs and the Argo AI shutdown. In a recent announcement, F confirmed 3,000 job cuts as part of its plan to move from ICE (internal combustion engine) cars to EVs (electric vehicles) and AVs (autonomous vehicles). F indeed has the opportunity to be a leader in the EV and AV space, but the competition will be stiff and the road full of potholes. As a notable example, F had to record a $2.7 billion write-down on its investment in Argo AI in the second quarter (and recall that it recently recorded a $2.4 billion loss on its investment in Rivian). As of this writing, Argo AI is expected to be shut down, and it remains unclear how F and Volkswagen will pick up the pieces of its self-driving pilot program.
All in all, the gap between Fi’s upside potential and its current value is too large to ignore despite the uncertainty of the near future. But for accounts like our UTMA that can solve these short-term problems, it offers higher annual income potential in the upper teens. And note that my analyzes above assumed a 5% reinvestment rate, which is very conservative from my perspective. For example, I expect the US Inflation Reduction Act (IRA) to have a broad positive impact on the company starting in 2023. The loans and subsidies provided in this law would effectively increase its reinvestment rates and further increase its long-term growth. – short-term growth potential.