Ford UAW Update: We Don't Expect a Complete Offset of Higher Labor Costs
Ford UAW Update: We Don't Expect a Complete Offset of Higher Labor Costs
Ford CFO John Lawler spoke at a Nov. 30 conference and gave some detail on the company’s recently ratified UAW contract that expires in spring 2028. Further details are in our Oct. 26 note. Lawler said the strike cost Ford $1.7 billion in 2023 EBIT, with $1.6 billion of that in the fourth quarter. Wholesale volume will be about 100,000 units lower than planned. Ford announced it is resuming 2023 guidance with total company adjusted EBIT of $10 billion to $10.5 billion and automotive adjusted free cash flow of $5 billion to $5.5 billion—the latter is roughly half of what GM guided on Nov. 29. In July, Ford guided EBIT to be $11 billion to $12 billion and cash flow of $6.5 billion to $7 billion. Deducting $1.7 billion from the old guidance’s $11.5 billion midpoint is $9.8 billion but Ford’s new guidance midpoint is $10.25 billion, so its outlook excluding the strike has improved.
Lawler put the cost of the new UAW deal at about double what the firm initially expected, and the company said incremental costs will be $8.8 billion over the contract. Ford also said the incremental cost per vehicle by 2028 will be about $900 and cost about 60-70 basis points of adjusted EBIT margin. Lawler did not say exactly how much of the $8.8 billion Ford can offset but pointed to lean manufacturing initiatives and the new contract offering more flexibility on production lines as mitigating factors. Management expects a 2024 year-over-year pricing decline of $1,800 per vehicle, with $800 of that borne by the dealer, as the industry sees pricing fall from chip shortage-induced highs. In our view, Ford has been very conservative on pricing assumptions, which is fair given the temporary chip shortage impact, but 2024 could have some positive surprise in this metric. We are also more optimistic than Ford when Lawler said Ford believes pent-up combustion vehicle demand is finished. We are lowering our fair value estimate by $1 to $19 on a modest net cost increase from the new contract.
Published on Nov 30, 2023
Ford Has Plenty of Liquidity to Navigate 2024
Business Strategy and Outlook
Ford is turning itself around by focusing on light-truck models in the United States, which we think is the right move, since light trucks are nearly 80% of U.S. industry new light-vehicle sales. Ford's challenge is to increase share profitably while elevating Lincoln into a global luxury brand. The mostly no-moat nature of the auto industry makes these tasks difficult, and we see headwinds from areas such as restructuring, commodities, and exchange while investments in mobility and electrification take years to bear fruit. Ford targets 50% global all electric volume by 2030 and an annual production rate of over 2 million battery electric vehicles by 2026, though CEO Jim Farley in July 2023 indicated flexibility on the latter's timing.
Ford is also focused on spending on the most profitable vehicles. The March 2022 split of combustion and battery electric vehicles into their own segments (Ford Blue and Ford Model e) allows talent to focus on combustion hits like the Bronco and F-Series as well as build on the success of the F-150 Lightning BEV and Mustang Mach-E. Restructuring remains a constant with the global redesign program incurring $9.8 billion in charges and $3.9 billion of cash outflow from 2018-22. Ford Blue seeks about $3 billion in cost reductions and Farley in February 2023 lamented about the firm having too many engineers. Twelve days later, Ford announced a 3,800, mostly U.K. and German, headcount reduction by 2025 including 2,800 product development jobs. With more EVs, Ford does not seem to need the same people it's had.
Ford is building more models on common platforms, which should improve economies of scale. This move allows Ford to switch production faster to meet changing demand while cutting costs via better economies of scale. In the past, Ford had a different platform in each segment for each part of the world, which wasted billions. Lincoln entered China in fall 2014, and the Mustang Mach-E EV is bringing new customers in U.S. coastal markets, with 70% of its early buyers new to Ford. Many F-150 Lightning pickup customers are also new to Ford. In addition, the Transit BEV helps commercial customers save money.
Published on Nov 30, 2023
Ford does not have a moat, and we do not expect that to change.
Vehicle manufacturing is a very capital-intensive business, but barriers to entry are not as high as in the past. The industry is already full of strong competition, so it is nearly impossible for one firm to gain a durable advantage over another. Foreign automakers from China and India may soon enter developed markets such as the U.S., and South Korea's Hyundai and Kia as well as Tesla have become formidable competitors. Furthermore, the auto industry is so cyclical that in bad times even the best automakers can not avoid large declines in return on invested capital and profit. Cost-cutting helps ease the pain, but it does not restore all lost profit.
Rated on , Published on Nov 30, 2023
We are lowering our fair value estimate to$ 19 per share from$ 20.
Fair Value and Profit Drivers
The change is from modeling cost increases from the new UAW contract that expires in Spring 2028. At Ford's May 2023 analyst day, it announced a 2024 capital expenditure projection of$ 10 billion-$ 11 billion, up from as much as$ 9 billion in 2023. Before May, we were modeling$ 8 billion to$ 9 billion in capital expenditure annually for 2024-27, but since May we model$ 11 billion in 2024 and$ 10 billion in each of 2025-27. This 20.6% increase assumes capital expenditure after 2024 will remain close to 2024 levels to capture incremental spending needed in EVs and software as Ford transforms itself from a traditional automaker.
We think buying Ford's stock may require investor patience for management to restructure the Ford Blue segment while scaling up the Ford Model e business. Most Model e segment scale may not occur until after the BlueOval City BEV plant in Tennessee opens in 2025. Our midcycle total company EBIT margin number is about 6.5%, down from nearly 7%. Ford introduced a 2026 target of 10% for the metric as part of separating the BEV business from the Ford Blue combustion business but has said it's a target rate rather than an exit rate, so we keep our midcycle below 10%. Our midcycle EBIT margin excluding equity income and Ford Credit is about 5.1%. Automotive operating margin excluding equity income is modeled over 2023-27 to average about 4.1%, down from about 4.5%. We remain optimistic about CEO Farley longer term being able to execute on cutting warranty costs and reducing vehicle design complexity to bring more scale, but the transition will not be fast. Leadership has often said that the company needs to be more physically fit, so Ford is in the midst of a multi-billion-dollar restructuring program, mostly for Europe. We like that Ford has exited or is downsizing unprofitable businesses to focus on light trucks, off-road vehicles such as the Bronco, launching profitable variants of popular vehicles such as bringing the Raptor trim to Bronco and Ranger, and new segments like compact pickups in the U.S. with the Maverick, as well as investing $50 billion in all-electric vehicles for 2022-26.
Headwinds include rising competition in China, fluctuating commodity costs, foreign-exchange pressures around the world, rising interest rates, and pricing coming down after being inflated by the semiconductor shortage. Our midcycle total company operating margin including equity income and Ford Credit is around 6.5% in 2027. Ford targets 10% by 2026 but we model a more conservative number than 10% for the midcycle due to fierce, high-quality competition that has increased in size, threats of excess capacity, and the risk of macroeconomic downturns negatively affecting profits in a capital-intensive industry, creating an inherent risk of management not meeting its target.
Our compound annual automotive revenue growth rate is nearly 4%. We model capital expenditure at about 6% of automotive revenue on average, totaling $50 billion for 2023-27. We value Ford Credit at its 2022 year-end book value of $11.9 billion. Our fair value estimate could change dramatically, given the extreme sensitivity of our discounted cash flow model to inputs such as North American light-vehicle sales, midcycle margins, and a weighted average cost of capital of about 10%. We see uncertainty as to when improvement occurs, as some variables such as commodity and materials costs, interest rates, and the semiconductor shortage are mostly beyond management's control.
Published on Nov 30, 2023
Our Morningstar Uncertainty Rating for Ford is High.
Risk and Uncertainty
The semiconductor shortage brings more uncertainty as to recovery timing. Ford is spending$ 50 billion across 2022-26 betting consumers will switch to electric vehicles and so much capital will be wasted if that adoption is too slow or if regulations change due to not enough consumers switching to EVs. Barriers to entry are declining as a growing global market reduces fixed costs as a percentage of sales for new entrants. The company operates in a very cyclical industry and there is massive uncertainty as to the timing and magnitude of demand recovery following COVID-19. Macroeconomic conditions, rising interest rates, commodity prices, and trade agreement changes in key markets, such as the U.S., Europe, and China, can quickly derail management's own plans and guidance, while significant disruption is on the horizon as vehicles become more high-tech and autonomous.
Ford's union relationships historically have been better than GM's. However, UAW president Shawn Fain in 2023 said Ford and the UAW are no longer working together as a team. We are concerned about a very long strike in May 2028 because the UAW wants to resume pensions and retiree healthcare for all workers, something we don't see as affordable.
One of the largest environmental, social, and governance risks we see with Ford is increasing regulatory scrutiny on combustion vehicles, but we think management is planning for the change, and electric vehicles such as the Mach-E and F-150 Lightning show Ford is serious about switching away from combustion. Like many family companies that trade publicly, Ford has two share classes. Class A shares are available to any investor, and each share equals one vote. The Ford family always has 40% voting power through ownership of Class B shares. We prefer to see one share class, but the family's high ownership aligns its interests with those of outside shareholders.
Rated on , Published on Nov 30, 2023
We give Ford a Standard rating under our capital allocation methodology.
We like that management is willing to leverage up in times of crisis to avoid bankruptcy, as Ford has had to do in the late 2000s as well as in 2020 once the pandemic hit. These moves were drastic but necessary. In 2020, Ford was able to tap its credit lines and repay the entire borrowing before year-end, thanks to issuing bonds. The company's liquidity looks excellent to us as of the end of September at$ 50.6 billion and automotive net cash excluding retiree obligations at over$ 9 billion. Management’s moves to derisk the pension plan via duration matching to hedge interest-rate risk is also the right move, in our view. Pension contributions primarily fund annual service cost and pay-as-you-go plans. Total funding percentage for the combined U.S. and non-U.S. plans is 99.6% at year-end 2022 by our calculation, an excellent ratio to us. Notable automotive debt maturities at year-end 2022 is$ 996 million in 2025 and$ 4 billion in 2026, which we believe Ford can manage.
Automotive return on invested capital had easily exceeded cost of capital for several years but did not for 2017-21 in our model as profit fell. We don't see economic profit-worthy ROIC throughout most of our five-year explicit forecast period, and management's 10% 2026 total company adjusted EBIT margin objective, up from 7.3% in 2021 and 6.6% in 2022, could make our ROIC projection too conservative if the U.S. avoids a recession. In the first quarter of 2012, Ford resumed its dividend and raised it in early 2015 to $0.15 per quarter where it stayed until the coronavirus forced its suspension in March 2020. Management had long said the dividend was safe even if U.S. sales returned to 2009 levels, but the complete shutdown of plants in North America and Europe in March 2020, plus uncertainty on how long the virus disruption would last, proved too much to bear. We can't fault management for taking steps to ensure Ford made it through the pandemic. Ford resumed the quarterly dividend at $0.10 per share in December 2021. Given Ford's large cash holdings, we like that management increased the dividend for the third quarter of 2022 back to its prepandemic level of $0.15. Management seeks to return 40%-50% of free cash flow to shareholders via the dividend and also is open to paying supplemental dividend regularly. Years ago, Ford talked about an annual special dividend, but restructuring, EV investments, and the pandemic stopped that initiative. 2023 had a special dividend to return cash from selling Rivian stock.
We like Ford paying a premium in December 2021 to retire $7.6 billion of high-coupon bonds. We want to see it start a meaningful share-repurchase program but we don't expect that to happen. The shares have often traded below our fair value estimate, and a buyback would offset dilution from multiple share issuances in 2009. We suspect the Ford family prefers dividends to buybacks. We'd welcome buybacks when the stock is trading well below our fair value estimate, as well as more debt paydowns, provided Ford continues to first reinvest in the business, especially for electric vehicles.
Ford is investing for the future much more aggressively toward battery electric vehicles over hybrids than in the past, which we think is the right move to remain competitive with firms such as Tesla and General Motors. In March 2022, Ford announced its BEV investment for 2022-26 will be $50 billion. Ford’s first real attempt at a BEV is the Mustang Mach-E crossover. It was a bold choice to use the Mustang name, but we think is proving to be a smart move. Most of its buyers are new to Ford. We look forward to more competitive BEVs like the Mach-E. The F-150 Lightning BEV pickup, has done well and brought new customers to Ford, which is significant because F-Series trucks are the highest-selling vehicles in America. Management seems more willing to either form partnerships for BEV batteries or develop its own, which we like. We were disappointed in fall 2022 when Ford said it was shutting down its Argo autonomous vehicle partnership. It is spending over $10 billion for several U.S. battery plants and a BEV plant.
Jim Farley, 61, a longtime Toyota sales and marketing executive whom former Ford CEO Alan Mulally lured away in 2007, became president and CEO in October 2020 and joined the board at that time. Farley received a 21% salary increase at the time and a $4 million stock option grant, but we think he also has high intrinsic motivation to see Ford succeed because of the well-documented bond with his grandfather, an early Ford employee. Like many family companies that trade publicly, Ford has two share classes. Class A shares are available to any investor, and each share equals one vote. The Ford family always has 40% voting power through ownership of Class B shares. We prefer to see one share class, but the family's high ownership aligns its interests with those of outside shareholders.