Ideally, an investment portfolio should pivot during changing monetary circumstances and underweight cyclical exposure as contractionary monetary policies are deployed. The reason for this is bound to receding spending power and the basic “need versus want” theory. Therefore, I identified the following three cyclical stocks that I’m bearish on during 2022’s rising interest rate environment: Ford (NYSE:F), Tesla (NASDAQ:TSLA), and Embraer (NYSE:ERJ)
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The U.S. Federal Reserve raised interest rates by another 75 basis points earlier this week in an attempt to curb resilient inflation rates. The Federal Reserve’s decision-making process is beyond the control of financial market participants; all that investors can do is adapt accordingly.
Ford
Ford shocked the market with a bombshell earlier this week. The company’s stock dipped by more than 10% after it revealed that it lacks adequate inventory to fulfill its operational capacity. According to the statement, Ford’s set to deliver 40,000 to 50,000 vehicles in its third quarter, well short of estimates.
Adding to its supply-side woes, Ford is faced with an array of macroeconomic headwinds. For example, global GDP growth is softening, inflation rates remain elevated, and Europe’s on the brink of an energy crisis. Cumulatively these factors could stun demand for Ford’s vehicles, subsequently softening its top-line earnings.
Furthermore, Ford’s key metrics spell trouble. The company’s return on invested capital (6.50%) is weak, suggesting it’s unable to monetize its working capital effectively. Moreover, Ford’s gross profit margin is running at a mere 12.19%, implying its pricing power is on a knife’s edge, and any downside price elasticity could add severe pressure to the company’s income statement.
Lastly, Ford’s likely overvalued on a forward-looking basis. The stock’s forward price-to-earnings ratio of 19.4x exceeds its trailing price-earnings ratio by 2.78x, conveying softening earnings-per-share.
Is Ford Stock a Buy, Hold, or Sell?
Turning to Wall Street, Ford earns a Hold consensus rating based on four Buys, nine Holds, and one Sell assigned in the past three months. The average Ford Stock price target of $15.96 implies 31.8% upside potential.
Tesla
Legendary “Big Short” investor, Michael Burry, recently tweeted: “If I am tweeting this, you can bet I am not short it. But I should be.” Based on Burry’s tweet, he’s likely holding off on a Tesla short for portfolio reasons. However, it’s safe to say his sentiment towards the stock is as bearish as can be.
Tesla’s sublime run since its IPO in 2010 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 hypergrowth industry in electric vehicles, its current stock price resembles previously expected growth; therefore, it’s likely priced in. Moreover, few consumers expected the magnitude of today’s economic downturn, which means the hypergrowth status of the EV industry 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% settles 25.52% lower than the sector median, raising a big red flag. In addition, a price-sales ratio of 13.16x and a price-earnings ratio of 104.09x implies that Tesla is firmly overvalued, providing investors with little to no value for money.
Is Tesla a Good Stock to Buy?
Turning to Wall Street, Tesla earns a Moderate Buy consensus rating based on 18 Buys, six Holds, and five Sells assigned in the past three months. The average TSLA stock price target of $311.97 implies 13.2% upside potential.
Embraer
Embraer is a Brazilian-based jet manufacturer. The company caters to commercial aviation, defense, and executive jets. Executive jets make up approximately 23.5% of Embraer’s revenue mix, providing cause for concern. Luxury aircraft sales are highly cyclical, and the highs experienced in 2021 will likely fade as rising interest rates dilute consumers’ asset financing abilities.
Cumulatively the company’s growth is slowing. Embraer missed its second-quarter revenue target by 9% after seeing both its top-line and net profit margin recede by 10% year-over-year.
Looking ahead, matters might get worse for Embraer as this is clearly a cyclical business. The company’s 5-year CAGR (compound annual growth rate) of -0.20% conveys its sales volatility, suggesting that its mean reversion could be severe.
Lastly, Embraer’s return on common equity of -0.10% means the company posts poor residual, resulting in sub-par economic returns to shareholders. As such, macroeconomic headwinds and fragile key metrics could coalesce to form further downside for Embraer stock.
What is the Price Target for ERJ Stock?
Turning to Wall Street, Embraer earns a Hold consensus rating based on two Holds. ERJ stock’s average price target of $11.50 implies 19.3% upside potential.
Concluding Thoughts – F, TSLA, and ERJ Stocks Exhibit Excess Risk
Cyclical stocks are set for a decline amid rising interest rates. Ford, Tesla, and Embraer are in the firing line amid concerns regarding key metrics, valuation, and overall sensitivity to the business cycle. Reducing or avoiding exposure to these stocks would improve most portfolios’ risk versus return prospects.
