Ford: Spin-Off Of EV Division Could Create Value
Summary
- Ford is going to distinguish between its EV segment and its combustion engine segment going forward.
- The business separation must be seen in the context of accelerating adoption of electric vehicles around the world and Ford's EV rivals getting much higher valuation factors.
- The move is intended to show how Ford is growing margins while offering investors an opportunity to get a better understanding of its EV business.
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Ford (NYSE:F) said that this week that it will create separate electric vehicle and internal combustion engine segments to better manage the EV transformation. The new business structure could unlock value for Ford and investors as the company targets a material margin improvement over the next five years and could be the first step towards a spin-off of the electric vehicle division.
Ford's electrification plan (Ford+) gets a boost
Ford's recent announcement regarding the separation of business units must be seen in the context of the car brand's accelerating investments into its electric vehicle transformation. Ford has said that it plans to achieve a 50% electric vehicle share globally by 2030 (up from 40% previously), indicating that the car brand is making a bold bet on electric vehicles becoming the dominant form of transport in the future. Ford is also going to increase its investments in electric vehicles from $30B to $50B in a bid to grow as fast as possible. Adoption trends and projections in the EV industry back Ford up. Schroders estimates that the majority of new global car sales will be fully electric by 2040. As part of its push into the EV segment, Ford is also going to ramp up global production capacity for its electric vehicles to 600 thousand units by year-end 2023. By 2026, Ford wants to produce 2M electric vehicles annually.
Schroders
Ford's announcement this week indicates that the company is looking to unlock value in its high electric vehicle business.
The EV business, from a reporting point of view, represents a problem for Ford. The production of electric vehicles, due to heavy investments in the ramp of production, has been weighing on Ford's financial results and a separation of business units will allow investors to better understand how margins are evolving, especially in the EV business. The result could be that investors value Ford's rapidly growing electric vehicle business at a higher valuation factor.
Ford has detailed its ambition to grow its EBIT margin from 7.3% in FY 2021 to 10% by FY 2026 and electric vehicles are going to play an important part in achieving this business goal.
Ford
The key to achieving this goal is for Ford to improve profitability in the EV business, especially regarding battery packs, and showcase this profitability in a more transparent way. Battery prices for passenger electric vehicles are still expensive, putting EVs at a relative disadvantage to traditional combustion engine models. But this is changing, chiefly because of rapid progress in the development of more efficient battery packs. Ford committed in 2021 to material investments into battery technology with its development partner SK Innovation. Together, both companies are going to invest $11.4B into battery production capacity in Tennessee and Kentucky.
The degree to which Ford's electric-vehicle transformation will be successful depends chiefly on advancements in battery technology. Prices for battery packs have plummeted significantly in the last decade and will continue to decrease as investments in battery technology pay off and result in cheaper battery packs with higher performance.
Schroders
EV division spin-off might increase Ford's valuation factor
Ford's valuation factor is diluted because of the combination of a traditional combustion engine business with a rapidly growing EV business. Ford, with sales of gas-powered passenger vehicles still dominating the sales mix, cannot achieve the valuation factor of a pure-play EV company like Tesla (TSLA). But a spin-off of Ford's electric vehicle business potentially could.
Tesla's and Ford's valuations are seemingly from different worlds, with Tesla achieving a materially higher valuation based on its sales potential than Ford. However, if Ford at some point were to completely spin off its EV division, then Ford's electric vehicle business could attract a much higher valuation factor than the current business which includes Ford's legacy gas-powered segment. Ford has materially higher sales than Tesla, but also a depressingly low valuation factor based off of those sales. Tesla's sales-based valuation factor is higher than Ford's by a factor of 19 X. If Ford were to eventually spin off its EV division, then Ford would have a real chance at growing the valuation of its electric vehicle business.
Other electric vehicle companies also get significantly higher market-capitalization-to-sales ratios than Ford.
If Ford did a spin-off of its EV business, the car brand would have a good chance of achieving a materially higher valuation. Based off of Ford's EV-driven free cash flow growth, a spin-off could even be a catalyst to drive Ford up to its free cash flow-based fair value of $40.
While it is only speculation that Ford will spin off its electric vehicle business, the unit separation is the first step in this direction. If Ford separates its business units, investors will get a much clearer understanding about how to value both businesses. Ford might not get the kind of sales multiplier factor Tesla has, but the stock would likely respond positively to such an announcement and revalue higher.
Risks with Ford
Ford must currently deal with supply chain disruptions and soaring inflation that poses a short-term margin risk for the car brand. There is also a risk that the production ramp for various new electric vehicle models will be delayed due to part shortages and longer production times. Limited computer chip supply poses the biggest risk right now to Ford's free cash flow guidance for FY 2022.
Final thoughts
The business separation is unequivocally good news for Ford and it could lead to a much higher valuation in the future simply because investors can better understand how the electric vehicle business operates. A business separation is also the first step towards a spin-off which could reward Ford's EV unit with a much higher valuation factor compared to the one that is currently applied to shares of Ford!
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