Potential Trade: Buy Ford (NYSE:F) Around $15.70 | Stop-loss: $14 | Target: $18
Outline of Investment Thesis:
Lately there have been articles floating around that outline the negative implications of a depreciating Japanese Yen for companies such as Ford and General Motors (NYSE: GM). The authors claim that American car companies will face a competitive disadvantage to Japanese companies such as Honda (NYSE:HMC) and Nissan. One thing these articles fail to mention is something far more impactful than a short-term depreciation of a currency: consumer preferences. I have been hesitant to purchase shares of Ford because I believed in the supposed competitive advantage Japanese automakers are forecasted to experience in 2014. Once I realized the implications of a territorial dispute between Japan and China, I became bullish on Ford. In this article, I will conduct a risk-reward analysis of buying shares of Ford and describe how Chinese consumer preferences will completely change the market's valuation of Ford as well as the competitive positioning of certain companies within the auto industry.
3 Huge reasons to buy Ford and dump Honda:
1. The risk-reward is outstanding
Primarily due to comments made by Ford on December 18, 2013 about the competitive disadvantage the company faces due to a depreciating Yen, analysts lowered their earnings expectations by 20%. Although this earnings projection cut may have been warranted, the share price depreciation of 7% was not. The supposed competitive disadvantage that caused the share depreciation is not significant enough to lower the present value of Ford's future stream of income by 7%. The advantage Honda Motor Co. gained was roughly one billion dollars of income from favorable currency translation during 2013. That is something far less significant than a negative shift in consumer preferences caused by geopolitical tensions. If the market had been paying more attention to the long-run implications of Chinese consumers boycotting Japanese goods rather than a one-time boost of income, it is likely the shares of Ford would have dropped by a lot less than 7% if at all after the company's year-end update. I predict that as tensions rise, more and more investors will begin to identify the negative implications of a consumer preference shift on companies such as Honda.
[The share price movements outlined below are my estimates and are expected to take place between 01/28/2014 and 02/28/2014]
The current price in the after-hours market for Ford stock is 15.74.
Once the market factors in the long-term implications of the current shift in Chinese consumer preferences, the shares of Ford will recover 3.5%.
Scenario 1: If actual earnings lag estimates, shares could drop 5% to $14.95/share, but will recover to $15.47 (3.5%) within a month due to the market realization outlined above.
If earnings beat estimates, shares could rise to 17.31/share (10%) within the week and to $17.91/share (13.79%) before the end of February 2014.
Risk-Reward Ratio: 8.02:1
2. Japanese companies may lose competitive advantage gained by currency translation (Reason to dump Honda)
a. Many Japanese auto manufacturers, such as Honda, generate a significant amount of their revenue from selling vehicles in Chinese markets. If the trend of Chinese consumers boycotting Japanese goods continues, we could see a large decrease in Japanese auto sales in China.
The information below depicts the extreme nature of current Chinese consumer preferences:
- According to a Voice of the economy "Financial World" article from January 5, 2014, Japan's Kyodo News survey of 1,000 showed that 66% of Chinese people said because of the Diaoyu Islands dispute they will not buy Japanese products.
- January 24, 2014: Over 30 Chinese associations jointly initiated action Jumairhuo which will be held on March 1, 2014 at the Illinois Institute of Technology to launch the "Fight Japanese militarism, do not buy Japanese goods" forum.
- The China Daily called for Shinzo Abe to be barred from China because of his recent visit to a World War 2 shrine in Tokyo.
Not only will sales in China be negatively affected if this trend continues/intensifies, sales of Japanese automakers all over the world could be affected. The second bullet point above describes a forum being held within the United States and depicts how the distaste for Japanese goods is not concentrated within the borders of China. Chinese Americans all over the world may be following this revolution. Below I attempt to quantify the effects of 66% of Chinese Americans boycotting Honda automobiles:
(Some figures are based on rough estimations)
Total Chinese Americans in 2014: 4,000,000
Total Chinese Americans in car-buying age: 2,000,000
Percent of Chinese Americans of car-buying age who are due for a new car in 2014: 400,000
Honda market share 2013: 10%
Total projected Honda automobiles that would be purchased by Chinese Americans in 2014, assuming Honda market share and demand are the same as in 2013: 40,000
Total projected Honda automobiles that would be purchased by Chinese Americans in 2014 if distaste for Japanese products becomes as significant in Chinese Americans as it is for citizens of China (66% say they will not buy Japanese Products) and market share and demand are the same as in 2013: 40,000-26,400= 13,600
This is a loss of 26,400 car sales, which would equate to $578,246,369.73 decrease in revenue in North America alone.
Clearly, a change of this magnitude in consumer preferences has a much larger effect on a company's competitive positioning than a somewhat short-term change in currency prices.
3. Ford is an outstanding company with large upside
In 2013, the company experienced one of its best years in history and is positioned to continue its forward momentum by continuing to target healthy sales channels. 43% of the cars Ford sold in 2013 were all-new or significantly improved models. This trend of healthy sales should continue in 2014, as the company will be rolling out at least 7 new models. Ford is a car company that knows how and when to invest. During the financial crisis, Ford made strategic investments while other companies were filing for bankruptcy. It is a strong company with great fundamentals and a profitable future.
This trade has a terrific risk-reward ratio due to a current misnomer in the market's valuation of Ford Motor Company. I predict that if you take advantage of this opportunity by purchasing shares of Ford Motor Company at their current discount, this trade will yield substantial short-term capital gains and a solid long-term investment.