Comparing Ford's Operational Efficiency To Tesla And Others
Summary
- A look at Ford's ROE decomposition shows that it isn't heading in the right direction.
- Ford continues to decrease its efficiency.
- Ford is a classic value play.
Tesla Inc (TSLA) is an industry disruptor that has been responsible for the shift towards electric vehicles from other carmakers. As a result, competition has been heating up for Tesla with Ford Motor Company (NYSE:F), along with others, trying to make a splash in the EV market. In this article, we will be quantitatively comparing Ford to its main competitors: Tesla, General Motors Company (GM), Toyota Motor Corporation (TM), Honda Motor Co Ltd (HMC), and Volkswagen AG (OTCPK:VWAGY).
DuPont Analysis
Stocks that have a high ROE tend to have a higher chance of delivering outsized returns. As a result, it's a very important metric to look at.
Source: Finbox
When looking at the return on equity of each company over the past 5 years, we notice a few things. First off, both Tesla and Volkswagen have seen the metric steadily improve over the past 5 years. Tesla started off at -89% and clawed its way up to 13%. Volkswagen started off at -2% and more gradually increased to 14%.
In contrast, Ford's ROE has been steadily declining. Five years ago, it had an ROE of 28% and has since seen the metric drop to 10%. In addition, Toyota has had a relatively steady ROE in the range of 10-15% whereas General Motors and Honda have seen much more volatility.
On the surface, it would appear that General Motors is the winner of this comparison, however, ROE on its own doesn't tell the whole story. Let's break it down.
Using the DuPont analysis, we can separate return on equity into 3 different parts:
- Net profit margin
- Asset turnover
- Equity multiplier
Net profit margin measures the ability to make money, asset turnover measures the efficiency of operations, and equity multiplier measures leverage. In essence, an increase in ROE is favorable when driven by increases in net profit margin and asset turnover. It's much less desirable when primarily driven by leverage.
Source: Finbox
Net Profit Margin
Tesla and Volkswagen have increased their profit margins consistently almost every year whereas the other automakers have seen choppier results. Currently, Toyota has the highest profit margin at 10% followed closely by General Motors at 9%. However, the companies aren't separated by much and tend to have single-digit profit margins. Ford currently has the lowest margins.
Asset Turnover
Tesla's investments in its manufacturing capabilities appear to be paying off when comparing the asset turnover ratio. All the legacy automakers have seen a very slight decline in the efficiency of their operations. Alternatively, Tesla has seen its efficiency increase by 50% over the lookback period. In addition, Tesla is 28.6% more efficient than Honda, 50% more efficient than General Motors, and 80% more efficient than the rest. Once again, Ford scores the lowest in this metric although it is tied with Toyota and Volkswagen.
Equity Multiplier
The equity multiplier is what determines the true quality of the ROE metric. The higher the multiplier, the higher the ROE because the higher leverage lowers the book value. Tesla has seen its ROE increase over the lookback period despite reducing its leverage. The other companies have also reduced their leverage over the lookback period with the exception of General Motors, although, GM has been reducing over the past couple of years.
However, the main takeaway is that Ford and General Motors are significantly more leveraged than the other 4 automakers with ratios of 7.9x and 5.3x, respectively. Comparing the market cap values to the enterprise values highlights just how highly leveraged some of these companies are.
Source: Finbox
Tesla is the only company that has an enterprise value similar to its market cap.
Overall, when we put all 3 metrics together, Tesla has a higher quality ROE because everything is heading the right direction. Net income is increasing, leverage is decreasing, and most importantly, it's the only one with an increasing asset turnover ratio. Ford, on the other hand, can't say the same thing. Net margin has decreased along with asset turnover.
Additional Comparisons
Although we love the DuPont analysis, it's not the end-all-be-all. For example, when it comes to efficiency, the cash conversion cycle paints a slightly different picture.
Source: Finbox
The cash conversion cycle is a metric that measures the number of days it takes for a company to convert its investments in inventory and other resources into cash flows from sales. The shorter the time, the better because it means the company has more liquidity. It is calculated as:
DIO + DSO - DPO = CCC
As you can see, Ford and GM have negative cash conversion cycles which means they receive cash before having to pay their suppliers. However, we believe the most important variable of the cash conversion cycle is the days inventory outstanding. As the name implies, it measures how many days it takes to move inventory. Once again, Ford and GM have the shortest time. Therefore, by these measures, Ford and GM are more efficient.
However, Tesla is not far behind and a closer look at the trends paints a worrisome picture for the 2 legacy automakers:
Source: Finbox (Ford's DIO)
Source: Finbox (GM's DIO)
Source: Finbox (Tesla's DIO)
We can see that Ford's DIO has been consistently increasing over the past decade. In addition, GM has seen its DIO trend mostly sideways. On the other hand, Tesla has seen its DIO trend downwards over the past decade. Thus, it will be interesting to see if the legacy automakers will be able to maintain their current efficiency advantage over Tesla.
Valuation
Ford is a classic value play trading at a low book value. Therefore, to value the company, we will use the justified price to book method.
The formula is as follows:
Justified P/B = (ROE - Growth) / (Discount Rate - Growth)
Since Ford is a mature cyclical company that sees low single digit growth, we will use a growth rate of 2%. In addition, the current discount rate for Ford is 6.62% when using the current risk-free rate. We will round up to 7% to account for potential fluctuations to the upside in risk free rates. Plugging the numbers into the formula, we get the following:
1.6 = (10% - 2%) / (7% - 2%)
Therefore, Ford's current fair value is 1.6x book value. With Ford currently trading at 1.4x book value, the company is undervalued. Feel free to modify the inputs in the formula above to see how the valuation changes under different circumstances.
Risks
Ford faces an uphill battle for the EV market as it plays catch up to Tesla. To make matters worse, every other automaker is also joining the EV race. Therefore, competition is fierce and Ford hasn't exactly had a stellar operational performance in the past decade. Therefore, although the company is making interesting moves with the launch of its electric pickup, it remains to be seen whether or not the company will be able to create any substantial shareholder value.
Final Thoughts
Ford is an iconic company that has been around for a very long time. The push towards EVs is definitely interesting especially from a consumer's perspective. However, the industry as a whole is unattractive as it is cyclical with low margins and very high capital expenditures.
Until Ford and other legacy automakers begin generating substantial software revenues and reduce their sensitivity to business cycles, it's unlikely that the share prices will experience sustained long-term outperformance relative to index funds.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of TSLA either through stock ownership, options, or other derivatives. 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.