Ideally, an investment portfolio should pivot during changing monetary circumstances and underweight cyclical exposure when restrictive monetary policies are deployed. The reason for this has to do with declining purchasing power and the fundamental theory of “need versus want”. Therefore, I have identified the following three cyclical stocks on which I am bearish in the 2022 rising interest rate environment: Ford (NYSE:F), You’re here (NASDAQ: TSLA), and Embraer (NYSE:ERJ)
The US Federal Reserve raised interest rates an additional 75 basis points earlier this week in a bid to rein in resilient inflation rates. The Federal Reserve’s decision-making process is beyond the control of financial market participants; all investors can do is adjust accordingly.
Ford shocked the market with a bombshell earlier this week. The company’s shares fell more than 10% after it revealed it lacked sufficient inventory to fill operating capacity. According to the release, Ford is set to deliver between 40,000 and 50,000 vehicles in its third quarter, well below estimates.
In addition to its supply issues, Ford faces a series of macroeconomic headwinds. For example, global GDP growth is slowing, inflation rates remain high, and Europe is on the verge of an energy crisis. Cumulatively, these factors could stun demand for Ford’s vehicles, subsequently sweetening its earnings.
Plus, Ford’s key metrics spell trouble. The company’s return on invested capital (6.50%) is low, suggesting that it is unable to effectively monetize its working capital. Moreover, Ford’s gross profit margin is only 12.19%, implying that its pricing power is on the edge, and any downward price elasticity could add severe pressure to the company’s income statement.
Finally, Ford is likely overvalued on a forward-looking basis. The stock’s forward price-to-earnings ratio of 19.4x exceeds its price-to-earnings ratio of 2.78x, reflecting declining earnings per share.
Is Ford stock a buy, hold or sell?
On Wall Street, Ford gets a Consensus Hold rating based on four buys, nine holds and one sell given over the past three months. Ford’s average stock price target of $15.96 implies upside potential of 31.8%.
Legendary “Big Short” investor Michael Burry recently tweeted, “If I tweet this you can bet I’m not. But I should be.” Based on Burry’s tweet, he’s probably expecting Tesla shorts for wallet reasons. However, it’s safe to say that his sentiment towards the stock is as bearish as it gets.
Tesla’s sublime run since its 2010 IPO was due to an array of company-specific and idiosyncratic reasons. However, times are changing and the previously mentioned macroeconomic headwinds will likely affect Tesla in the same vein as Ford.
Even though Tesla is exposed to a hyper-growth industry in electric vehicles, its current stock price resembles previously expected growth; therefore, its price is probably embedded. Additionally, few consumers were expecting the magnitude of the current economic downturn, meaning the EV industry’s hypergrowth status could be stunned in the coming quarters.
Tesla’s gross profit margin has deteriorated recently, implying that its pricing power has a ceiling. In fact, Tesla’s gross margin of 27.1% is 25.52% below the industry median, raising a big red flag. Additionally, a price-to-sales ratio of 13.16x and a price-to-earnings ratio of 104.09x imply that Tesla is firmly overvalued, offering investors little to no value for money.
Is Tesla a good stock to buy?
On Wall Street, Tesla has a Moderate Buy consensus rating based on 18 buys, six holds and five sells assigned over the past three months. The average TSLA stock price target of $311.97 implies 13.2% upside potential.
Embraer is a Brazil-based jet manufacturer. The company caters to commercial aviation, defense and business jets. Business jets make up about 23.5% of Embraer’s revenue mix, which is concerning. Luxury aircraft sales are highly cyclical, and the highs seen in 2021 will likely fade as rising interest rates dilute consumer asset financing capabilities.
Cumulatively, the company’s growth is slowing down. Embraer missed its second-quarter revenue target by 9% after seeing its revenue and net profit margin decline 10% year-over-year.
Going forward, things could get worse for Embraer as it is clearly a cyclical business. The company’s 5-year CAGR (compound annual growth rate) of -0.20% reflects volatility in its sales, suggesting its mean reversion could be severe.
Finally, Embraer’s return on common equity of -0.10% means that the company has a poor residual, which translates into below average economic returns for shareholders. As such, macroeconomic headwinds and fragile key metrics could coalesce to form a further decline for Embraer shares.
What is the target price for the ERJ stock?
As far as Wall Street is concerned, Embraer gets a consensus Hold rating based on two Holds. The average ERJ stock price target of $11.50 implies 19.3% upside potential.
Final Thoughts – F, TSLA, and ERJ Stocks Are Excessively Risky
Cyclical equities are expected to decline amid rising interest rates. Ford, Tesla and Embraer are in the crosshairs amid concerns over key metrics, valuation and overall sensitivity to the economic cycle. Reducing or avoiding exposure to these stocks would improve the risk outlook relative to returns for most portfolios.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.