Ford’s Rivian Earnings: Tangible Value Effect Analysis (NYSE:F)
Ford (NYSE:F) had a lineup of benefactors in 2021 that ultimately caused the stock price to double. First, the game of the cyclical dynamics of consumption by investors, which has made Ford one of the most bought stocks by investors. After the mentioned systemic support, Ford gained momentum by recording better-than-expected e-vehicle sales after its F-150 sold like hot cakes.
This article is looking at something in particular, however. This is not a buy, sell or hold recommendation, but rather an analysis of the company’s $8.2 billion return on investment in Rivian (NASDAQ:RIVN).
Aspects of Financial Reporting
So many may think that the gain on the Rivian investment represents an additional $8.2 billion in revenue for Ford, and here we go. No, it’s not as simple as that. Ford holds an aggregate of approximately 12% in Rivian, which classifies this as an investment in a financial asset, meaning Ford will report its recent unrealized gains as profit in the income statement, but any dividends or profits will not be reflected accordingly.
It is possible that Ford will increase its stake in Rivian in the future due to the expected success of its subsidiary. If Ford ownership begins to exceed 20% (up to 50%) of the asset’s free float, it will be classified as an investment in associates, in which case Ford will reap the benefits of any goodwill on Rivian’s balance sheet but will be liable for any dividends that are due to be distributed to Rivian shareholders .
That being said, the fundamental conclusion is that Ford’s investment in Rivian will impact its bottom line more than anything else.
The valuation effect
Considering the mentioned fact that Rivian’s gains will be reported in the income statement, we are likely to see a sharp increase in net income relative to balance sheet equity value.
Looking at the graph above, it is evident that Ford correlates with its return on equity in an almost fortuitous way. Given the additional $8.2 billion in its income statement, we’ll likely see the company’s return on equity increase and most likely the stock price as well.
To provide some insight into the timing of the reported gain, Ford mentioned it would likely report the $8.2 billion gain in its fourth-quarter earnings report to be released Feb. 3. He also mentioned that he would carry over $900 million of gains from the same investment from Q-1. I don’t know if this has been taken into account by the market or not, but again, that is not the purpose of this article.
Here is the downside
Many may think the gains on Rivian are a good reason to buy Ford stock, and rightly so, but that can’t be seen in isolation. Although Rivian is now making revenue, the company has barely delivered double-digits in vehicles, and its future is very uncertain amid growing competition. The stock is trading at a price that cannot be inherently guaranteed and therefore contains a lot of volatility, as evidenced by its drop in value of more than 30% so far this year.
Many of you may be wondering why this is so important to Ford’s stock price. Well the answer is simple, and I’ll go back to what I said in the reporting section, Rivian’s unrealized and realized gains are/will be reported in Ford’s income statement, which means even if Ford is still maintaining its exposure to the stock and not getting rid of its exposure, yearly gains/losses will be reported in accordance with Rivian’s price movement.
Given the market’s apparent move toward value at a time when growth stocks are set to be battered by rising interest rates, it’s highly unlikely that we’ll be sitting here next year talking about a cumulative gain of $8.2 billion for Ford.
Additionally, you can add risk-return utility to the argument, more commonly referred to as risk versus benefit. If Ford has a stock in its portfolio that could potentially change billions of dollars on the company’s reported income statement, that could change things slightly from a risk perspective, especially since the company recently took a bet with its pivot towards electronic vehicles.
To end this section, I would like to illustrate Ford’s negative relationship with its beta. A stock’s beta is a statistical explanation of its asset-specific risk where the stock’s covariance with the market is measured relative to the market variance.
Historically speaking, Ford has performed best when its beta has tended to drop. I highly doubt that having billions of dollars of wild swings (Rivian’s gains/losses) while expanding to a new consumer base with EV will reduce the stock’s beta in any way. In fact, I think we’re about to see a high beta for Ford at a time when the market really doesn’t want it.
This is not a holistic analysis of Ford stock, but rather a description of the tangible effects of Ford’s earnings on its Rivian investment. I also gave some details on the risk-return effects and the correlation of the stock with its return on equity. This should in no way be taken as a recommendation to buy, hold or sell, but rather as a piece of the puzzle in your analysis of Ford shares heading into 2022.