The downturn could be a great entry point for investors – but it may still be a risk
Ford (NYSE:F) stock has slumped 20% to $11 in the days following the automaker’s second-quarter 2024 financial results. Ford admitted to having quality-related issues with vehicles from 2021 and earlier, so investors should wait for further action from the company before considering buying the dip in Ford stock.
The temptation for value investors to grab some shares will be strong. Ford’s trailing 12-month price-to-earnings (P/E) ratio is around 11.5, so it’s easy to conclude that Ford shares are cheap right now.
However, it’s hasty to buy seemingly cheap Ford stock when there’s a crucial, unanswered question: can Ford regain its reputation for producing reliable cars and trucks that don’t incur high warranty costs?
Ford’s surprisingly rough quarter
The 20% slump in Ford stock may seem extreme, but it’s not entirely unjustified. After all, Ford’s second quarter results in 2024 were worse than anticipated.
Admittedly, not all of the data points were bad. In particular, Ford’s revenue grew 6.2% year over year to $47.8 billion.
However, the automaker’s bottom-line results were definitely subpar. The company’s operating profit fell 26% year over year to $2.8 billion. The lowest operating-profit estimate, per FactSet data, was $2.9 billion, so Ford’s $2.8 billion was a major shock.
Furthermore, Ford’s adjusted earnings of $0.47 per share came in far short of Wall Street’s call for $0.67 per share. Therefore, even if Ford stock at $11 may be tempting, it could take the market a while to digest the negative bottom-line quarter data and forgive Ford for falling so far short of Wall Street’s expectations.
Vehicle quality issues lead to high warranty costs
Vehicle quality is a costly issue for Ford. The automaker’s second-quarter warranty-related expenses increased $800 million over the first quarter to around $2 billion, translating to 4% of Ford’s sales.
Furthermore, Ford spent a whopping $4.8 billion fixing its customers’ vehicles in 2023, according to Warranty Week magazine (via Bloomberg). For context, that rate is about three times greater than the industry average vehicle-repair cost.
CEO Jim Farley tried to reassure investors about vehicle quality. He assured that Ford is currently “testing vehicles to failure” and running them “at extremely high mileage” to detect quality-related issues.
That’s not much reassurance for the short term, though. Per Bloomberg, it will “take as long as 18 months to see the benefits of that new process show up in lower warranty costs” for Ford.
Farley added that these measures make the firm’s quarters “lumpy”, but that it will reduce warranty over time. However, judging by the 20% drop in stock price, the market hasn’t put much faith in the assumption that things will only get better for Ford.
In fact, it looks like Wall Street experts aren’t pinning their hopes on Farley’s assumption of a better future. For instance, Barclays analyst Dan Levy complained that “the warranty challenges are frustrating for investors, as they follow many other warranty issues in past years and at times drag results without warning”.
Similarly, Freedom Capital Markets analyst Mike Ward observed that “warranty has been a growing issue at Ford over the last five years and has escalated over the past year”.
Thus, it appears that Wall Street wants more evidence of Ford’s vehicle-quality improvement.
Ford’s reputation at stake
A giant automaker like Ford has dealt with many problems over the years, including last year’s autoworkers’ strike. However, persistently substandard automobile quality is unacceptable, as it will ruin the firm’s reputation if it continues.
Therefore, investors shouldn’t just take Farley’s word for it when he implies that the warranty-cost situation will improve. Until this improvement shows up in the data, which will require at least another quarter or two, it’s wise to treat Ford as a “show-me story” and Ford stock as a dip that shouldn’t be bought yet.
