The 'Top-down DCF Approach'
The discounted cash flows model is the most prevalent and widely-accepted tool for fundamentally valuing companies. It is widely accepted because of the accuracy of its theoretical predictions for companies that are in the "mature" life cycle of the business. This approach can be applied to companies in all stages of the business cycle, but because it relies heavily on future predictions, it is easy to incorrectly value companies that are experiencing high growth rates. For this reason, I believe that Ford (NYSE:F) is the perfect company to value using this approach.
The top-down DCF approach begins with researching and understanding macroeconomic trends throughout the world and directly applying them to the sector/industry that your corporation belongs to. This is what this first article will be about. In later articles I will analyze industry trends within the automotive manufacturers industry, directly applying these to Ford. Lastly, I will present an article or two on analysis of Ford and what I believe Ford should be worth using the discounted cash flow method of valuations. Let's begin with the macroeconomic trends throughout the world.
Global Real GDP Growth
Real Gross Domestic Product growth is the market value of all goods and services produced in a nation during a specified time period, adjusted for inflation. This metric is the most common metric used to determine a nation's growth and ability to sustain growth within the capital markets. Since a healthy, growing economy is vital to the automotive industry, seeing growth around the world in Real GDP would be a great sign for Ford and other automotive manufacturers.
The last few years have seen dismal Real GDP growth around the globe. In the United States, Real GDP has bounced between 2-3% growth since the Financial Crisis, most recently being closer to the 2% figure. In fact, in 4Q 2015, Real GDP only grew at 0.7%(and yes, that is an already annualized figure). It is said that in the long run a corporation's revenues can only increase as fast as Real GDP, this does not bode well for Ford.
For the last thirty years, China's Real GDP has been growing at an average rate greater than 10% per year. However, China reported 2015 Real GDP growth at 6.9% which is why the world's commodities markets are all near historic lows. China was importing tons of commodities when it was growing greater than 10%, but with the slow in growth there is no longer a need for all of these commodities and there is a large over-supply in the market. What is worse, many economists believe that the 6.9% growth figure for China is actually overstated and could be closer to 5.5%. Although China is the fastest-growing, large country in the world, its growth is slowing. This is not as bad for Ford as it is for the rest of the capital markets. While Real GDP is slowing the citizens of China are as wealthy as they have ever been and tens of millions of citizens are now able to afford vehicles. China's slowing growth should not be Ford's concern. Rather, Ford needs to capture a much larger market share in the growing country.
Even though short-term Real GDP growth does not look good, I believe that the world will exit the current slowing in growth by 2018. This will occur because emerging markets, such as India, parts of Africa, Brazil, and Russia will see growth at levels we have seen in China for the past 20 years. This will create a great macroeconomic demand for Ford vehicles as people in these countries will become wealthier and travel greater distances because of infrastructure development that the period of growth has caused.
The other large market that Ford is active in is the European Union, which has struggled to recover from the European Banking Crisis. With Real GDP growth struggling in almost every country in Europe, European Central Banks have resorted to "negative interest rates" in an attempt to stimulate spending. Implementing lower, or even negative, interest rates theoretically will stimulate spending by encouraging banks to make more loans instead of keeping the money deposited in the European Central Bank. While this approach has not worked so far, many economists believe that it will eventually stimulate spending and allow Real GDP growth to begin. When looking at Ford, we should be considering the effects that interest rates have on the ways that consumers spend their money. With interest rates at historically low levels, it has never been cheaper to finance large purchases, such as cars, houses, and other luxury items. This is great news for Ford because there is no sign of increasing rates in the European Union and Australia's Central Bank has said that it will cut interest rates if it needs to. This will be a boon to the automotive industry as people can afford more car, with less money.
The United States just saw its first interest rate hike in December 2015 and the market has been in turmoil since. It is likely that the Fed will avoid raising interest rates at the March meeting. Fed Chairwoman, Janet Yellen, has even said that the Fed is willing to cut to negative interest rates if a situation occurs that requires it. But, I believe that people will be more likely to buy cars over the next year because of the future expectations of higher interest rates. Think about it, if you knew that interest rates were going to be higher one or two years from now, wouldn't that cause you to consider making that car purchase now? Effectively, I think that the expectation for future rate hikes in the United States will bring future automobile purchases to the present time period. While there should be a net zero effect in the long-run, over the next two to three years Ford and the automotive industry will benefit.
Real GDP & Interest Rate's Effect on Ford's Value
While global Real GDP growth points to a tough period for Ford, it is not as dismal as the slowing in world GDP growth may show. In the short-run, Real GDP is not a great indicator for automobile sales. Look at the United States, the US grew at 1.8% in 2015, yet automobile manufacturers sold the most cars ever. So, while an uptick in growth could definitely help Ford, long-term Real GDP growth is a more important factor to consider when valuing Ford. We will talk more specifically how I will use Real GDP growth forecasts to help forecast the growth of Ford in multiple regions of the world in a later article.
I think that the current state of interest rates have the largest effect on the short-term (2-4 years) growth prospects for Ford Motor Company. With interest rates at the lowest in history, and not much of an expectation for rates to continue their decline, consumers will expect higher rates in the future. This will cause some consumers to move their future auto purchase to the present. This results in more car sales in the short-term period. I think that we will see this expectation effect most in the United States because of the recent rate-hike and expectations of higher rates sooner in the future. In Europe, I think that interest rates will continue to stay low until 2018, where the world's growth will be healthy enough to normalize rates around the world. At this point, the expectations of higher future interest rates will cause a similar shift in purchases from the future to the present, as it has over the last year and will continue to do so over the next year.
My next article will be about industry-specific items and forecasts. Please leave in the comments if there are any macroeconomic or industry trends you would like me to discuss in Valuing Ford: A Top-down DCF Approach, pt. 2.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.