Auto Industry Update
Featuring Daniel Ruiz
Published on: March 28th, 2019 • Duration: 18 minutes • Topic: Valuation, Trading, US EconomyDaniel Ruiz of Blinders Off Research returns to update us on five of his stock picks from January. In this interview with Justine Underhill, Ruiz dives into what he saw a few months ago, and the new data he received in the last few weeks that has him spooked. Filmed on March 27, 2019.
Welcome to Real Vision's "Trade Ideas." Today we're sitting down with Daniel Ruiz of Blinders Off Research. Great to have you here.
DANIEL RUIZ: A pleasure to be here as well.
JUSTINE UNDERHILL: So this is your first time on "Trade Ideas," but you've been on for "Expert View" before. And actually, the last time you were on in January of this year, you were looking at the automotive sector. Could you give us a little bit of a quick summary as to what you were talking about and also some of the stock picks that you had?
DANIEL RUIZ: Sure. So I came here and did an interview. The show aired on January 23. During the interview, I talked mostly about indicators that are very commonly used by economists and also folks in the automotive industry, which in my opinion, are not very good at forecasting results.
So I went through an explanation of the ones that don't work, in my opinion. I discussed the ones that do work in my opinion, which were flashing some warning signals at the time. FCAU, Fiat Chrysler, is down 8% since the call, primarily because, when they reported earnings, they announced weaker guidance than anticipated by analysts' consensus estimates.
JUSTINE UNDERHILL: And you were bearish on them?
DANIEL RUIZ: And I was bearish on FCAU. Another short pick was General Motors. That stock is down around 8% as we speak. They're at a little bit of a different time horizon than FCA in terms of severity of their situation and the things that I'm tracking. But nonetheless, that's going well. And things are progressing in the right direction.
The other short idea was Hertz, which is up right about 1%. So that one's going a little bit against me, but I would say relatively flat. I think it's a stock that's going to go to zero in the next recession. There's no nice way to put it. They have not generated enough operating income in the last three years to cover their interest expenses. And their debt's skyrocketing.
And I would say that in terms of last year, it was literally as good as it can get from a used car value standpoint. And that's one of their biggest expense components is their vehicle expense. So the better used vehicle values perform, the less vehicle expense they have, because it's a depreciation number. I don't expect the same this year.
And two long picks, so not all bad news. The one was Carvana, very controversial. I've gotten some heat from that call from friends and colleagues. But the stock's up 61% since then. The other long was Ford. The long pick was based on wholesale estimates, which came in right in line when they announced earnings. Their North American business, the US was performing very, very well on the strength of trucks. Their wholesales were down just slightly. But the mix of trucks more than offset that. And really, it was the cornerstone of the earnings call, despite a lot of weakness in other markets. It's also the reason why I'm here today.
JUSTINE UNDERHILL: What would you say is the most exciting thing right now that's going on in the auto sector?
DANIEL RUIZ: So a lot has happened since January 23. I was very concerned about inventories. I started writing about it in September of 2018, because the rate of change of inventory, it was very alarming. The main thing that's happened since then is the indicators that I follow have deteriorated. Time to equity, I would recommend for further explanation that they watch the prior video for that indicator. It's the one that, throughout all my research, is the most accurate at predicting new vehicle sales velocity.
That one had peaked in the beginning of 2017, right when auto sales were being pressured, when mid-year production cuts were announced. And three weeks later, because this is a lagging report, they report that new vehicle manufacturing had dropped by 4.3%.
So if inventories have reached an all-time high for the month, and we know now that production fell by 4.3%, if I'm not mistaken-- forgive me if I'm off by a tenth or so-- that just means that production has to be decreased even more. There have to be greater production cuts to match demand, which is-- it's a big deal.
I'm a big fan of Twitter. I do quite a bit of work on there, as I said. And there has been some amazing people that I've met there that I communicate with. One of my favorite by far is Danielle DiMartino. And when layoffs start being announced, well, guess what, that's in her wheelhouse.
So I sent her a couple of updates on the layoff situation. And out of the blue, one day, she sends me a link that is a report that I've never heard of. It's called the Challenger, Gray, and Christmas Job Cut Announcements. And automotive job cut announcements had soared in the month of February. They were up significantly year over year.
So I'm a bit picky about what indicators I hold in high esteem and what I expect or add to my process. But it really intrigued me. So I asked her, if there's historical data, to please send it to me, because I want to dig into this a little bit more. And what I decided to do was graph everything, use a 12-month rolling average so I can smooth out the volatility from month to month.
And the whole time in the back of my head, I have Grant Williams whispering in my ear, not literally but figuratively, because he's written about the importance of automotive jobs in the community several times. And the one thing that really stuck out to me was he said that each direct automotive job supports five indirect jobs in the community. So it's a big deal when you start laying off auto workers. It has a very, very big impact on their community.
I said, OK. I love theory. But I like to test it. I went immediately to the US unemployment rate. And again, I took the monthly unemployment rate figures. I used a 12-month rolling average to get rid of the volatility. And I just put those two things on one chart. Well, sure enough, auto job cut announcements lead the unemployment rate quite a bit. So Mr. Grant Williams is likely very correct.
And the thought behind that is just simple. Autoworkers hold very, very good jobs. They earn good income. And it's not a hard set of dots to connect to say that, hey, if one of those folks loses their job, it's going to have an impact on the local restaurant business, the local dry cleaner, a local pizza place, whatever the case might be in the community that they support through their spending habits, which, again, are supported by their job.
So I said, OK. In typical fashion, I'm not stopping here. If this is an onion, I need to start peeling back the layers. And I knew in order to do that, I was going to have to go really, really far back as far as automotive data is concerned. It literally turned into a fill out one cell at a time for 20 years worth of data. And I've been at it for 10 hours a day for the past-- I want to say-- seven or eight days.
As I started compiling the data and I started looking at these numbers, I would say I have an extreme sensitivity to inventory and that type of data. And stuff started really jumping off the page. So now, the 10 hours turned into 13 hours. And I just kept going. I finished yesterday.
And I'm going through this stuff. And when I got when I got done, I just shut my computer down. And I'm not trying to be funny or cute. I thought I saw a ghost. Literally, the data was that bad. And it was now by comparison purposes.
The first thing I did, which is 100% true, is I got up off my desk. I walked around the room two or three times. I immediately logged into my trading account. And I sold every one of my Ford shares.
JUSTINE UNDERHILL: Wow. So you completely reversed course there?
DANIEL RUIZ: Correct, which was one of my long picks. The things that would job cuts, the obvious one would be automotive production, right? So that's easy enough. Chart automotive production, see if it leads to automotive layoffs. It does.
So now that I know the two are linked, I can say, OK, is there anything going forward that would put pressure on automotive production, which would lead to a continuation of these job cut announcements? And sure enough, I look at days supply.
So days supply is very simple measure. It's a very simple calculation. It is literally a period of sales divided by the selling days. That gives you a daily sales rate. You take that number, you divide it by the total amount of inventory. And it lets you know how many days it would take for you to run out of inventory.
I used a 12-month sales total, rolling, to calculate the daily sales rate. So you have each month to represent the year. So in essence, you're reducing or eliminating seasonality. I then took the amount of selling days. And that's how I arrived at my daily sales rate. Find each level of inventory, and then you get a more stable days supply figure.
So this chart I wasn't able to provide. But once I went through that entire process and I smoothed out the volatility in the days supply figures, I started looking at historical numbers. And sure enough, before the recession and before auto manufacturing fell off a cliff, before the prior recession, the days supply numbers spiked. Probably the number that stood out the most, more important than the overall days supply number, was the day supply number of trucks, which in February was the highest since July of 2008. So now we're talking in the heart of the recession. And Ford jumped right off the page.
So currently, their truck day supply as of February is the highest since 2005. You can see on the chart why that really, really matters. That's the point where I walked up and I and I sold all my shares. The reason why I did that is just, I'm going through the thought process. And they backed away from producing cars. They've shifted to the more profitable trucks. I get it. But I think they're going to cut production and soon.
That days supply number is alarming. I don't see inventory levels based on my indicators getting any better in March. And their sales are forecasted to be down anywhere from 5% to 7%. When your inventory levels are that high, there's no margin for error. We can't miss by 1%, 2%, 3%. There's no margin for error. They're going to have to cut production.
JUSTINE UNDERHILL: So then what levels, in terms of stock price, are you looking at for Ford right now?
DANIEL RUIZ: So a good stop for safety would be, I think, $10 per share, right around that area. There was a lot of long-term support in that area, which I think has now turned into significant resistance. As far as downside targets, I don't think that the $7.84 low is going to hold. I think the stock could trade as low as $6 or even $5 from here.
A catalyst for a move like that, though it seems extreme, would be, number one, cutting production in their most profitable segment, trucks, at a time when worldwide sales are down significantly. And that's literally the only pillar that's holding up the business.
Probably the biggest headwind, though, is that last year, their credit rating was cut to one level above junk. That's not the news, though. That's not the important part. When that announcement was made, they said it would be unlikely to be reversed in 2019 or 2020. But they said their credit rating would be likely to be downgraded further, meaning into junk status, if they didn't show clear evidence that their restructuring plan was going according to plan.
Well, if sales are falling worldwide, right? And yes, they have made adjustments. They have cut jobs. They have lowered costs in other markets. Again, the last pillar is the truck market. And with that much days supply, if production falls, I think it could trigger the downgrade.
JUSTINE UNDERHILL: What would you see as the potential time horizon on this?
DANIEL RUIZ: Well, Moody's provided a frame for their next decision, and they said early 2019 to mid-2019.
JUSTINE UNDERHILL: So do you see Ford potentially hitting $5 to $6 a share sometime in 2019, or is that a longer-term target?
DANIEL RUIZ: So here's the thing. In terms of time horizons, I'm looking at this less like a trade and more like this is an ongoing issue that's going to pressure the stock. It could be for years.
JUSTINE UNDERHILL: All right, as best you can, can you break down your thesis in 30 seconds?
DANIEL RUIZ: To summarize everything, there's absolutely nothing in my view right now that needs to be done with the prior picks other than Ford. I think that North American auto production is going to be impacted materially this year beyond what some folks are expecting. And that's going to affect Ford as well as Fiat Chrysler and General Motors.
I don't have a time horizon at this moment, because I think this is something that needs to be monitored. And I think we need to be prepared for this to last a while.
JUSTINE UNDERHILL: A lot of things to watch. Daniel, thank you so much for breaking this all down for us.
DANIEL RUIZ: It's my pleasure. Thank you for having me again.
JUSTINE UNDERHILL: So Daniel's bearish on the automakers. Specifically, he's adjusting his Ford call from January. He likes shorting Ford at current levels with a target between $5 to $6. And he has a stop at $10. Just remember that this is a trade idea and not investment advice. You should do your own research. Consider your risk tolerance and invest accordingly. For Real Vision, I'm Justine Underhill.