Regarding Ford's Brexit Rumor

| About: Ford Motor (F)


In times of certainty, investors tend to think the worst.

UK sales accounted for 7.7% of total revenue, but EPS impact will be less than 1%.

A depreciating pound can actually spur demand, possibly offsetting the translation loss.

If UK exports decrease, German operation can prosper.

Unfavorable trade deals are far from a certainty.

A rumor has been circling around saying that Ford is planning to cut jobs as the result of the EU referendum, implying a Brexit disaster for Ford (NYSE:F). While I did state that Brexit will be beneficial to the UK overall (read Don't Fear The Brexit), I admit that there is still a tremendous amount of uncertainty. Because the UK exports 40% of its auto production to the EU, unfavorable trade deals (e.g. high tariffs) could reduce demand for UK exports. As the company is already suffering from a lower pound (translation loss), reduced demand would be pouring salt on the wound. Given the above, it's easy to see how a bear argument can gain traction.

You may know that I am not a Ford bull, but it's important to be realistic. I believe that Brexit will have minimal effect on Ford's short-term performance and negligible effect over the long-term, even if we assume negative outcomes (i.e. no free trade, depreciating pound).

Over the short-term, quarterly earnings will no doubt take a hit. Because Ford reports in US dollars, the recent drop in the pound will negatively impact earnings (read why I disagree). This will be the most immediate impact, but it is one that you need not fear. In 2015, the UK only generated 7.7% of Ford's total revenue. It seems significant, but if we apply the currency impact of -12% (spot GBPUSD against 2015 average of 1.53), the actual EPS impact will likely be -0.9%. So even if the pound's depreciation persists, earnings will unlikely suffer significant deterioration.

Over the long-run, there are two factors that can offset Brexit's short-term impact. We just discussed how a depreciating pound can hurt Ford's earnings, but at the same time, a weaker pound can also spur demand. This is the same reason why many believe that China competes unfairly by artificially devaluing the yuan. Would this be enough to offset potential tariffs? I don't know, there are simply too many moving parts to make an accurate projection (the actual tariff, future FX movements, etc.); but then again, neither does anyone else (i.e. doesn't have to be doom and gloom).

Secondly, I believe that Ford will be able to offset any UK woes with its German operation. Even if UK exports decrease, the rest of the EU would have to make up the volume from somewhere else, demand doesn't just simply evaporate. If prices don't go up as UK exports shrink, then supply must increase, which will result in more business for German factories. As the region stabilizes, I believe that any decline in UK exports will be coupled with an increase in German exports. The net effect will be close to zero .

Why None Of This May Matter

I believe that the world is being overly pessimistic about Brexit. Thus far, most economic research found a net negative benefit associated with Brexit because tariffs and various friction costs are automatically assumed. While anything is possible in the political space, I think it's worthwhile to mention that the UK is a net importer with EU. Trade in goods deficit was a whopping $24 billion from February to April. Protectionist policies will likely negatively impact the EU much more than the UK itself.

Where does this leave Ford? The market may continue to be volatile, but Ford will still sell cars, people will go to work, and the cash will roll into shareholder's pockets. I believe that no major actions will be taken until significant trade deals are signed. This is the sentiment of many other car manufacturers as well.

To end, I leave you with this quote from Jaguar Land Rover:

For Jaguar Land Rover, today is just business as usual. We are a British business with a strong manufacturing base in this country, we call Britain home and we remain committed to all our manufacturing sites and investment decisions.

We respect the views of the British people and in line with all other businesses, Jaguar Land Rover will manage the long-term impact and implications of this decision: nothing will change for us, or the automotive industry, overnight.

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