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Was it good news or bad news? Maybe a bit of both: Ford (NYSE: F ) announced today that the company earned $2.4 billion in the second quarter. That was down from $2.6 billion a year ago and $2.55 billion last quarter, but it was solidly ahead of analyst estimates.
Wall Street had expected the Blue Oval's profits to fall on rising structural and commodity costs, and indeed they did -- but the strength of Ford's products in the marketplace helped make up some of the difference.
As I said, good news and bad news -- but not too bad.
Solid sales in a tough environment
The nutshell story of Ford's quarter is this: Sales and margins remain strong despite rising costs and an economic environment that continues to be a tough slog around the world:
- North America saw a slight improvement in operating profits, which Ford attributed to a "significant increase in net pricing" (the amount of money Ford is able to get per vehicle) as well as "favorable volume and mix." The cars they sold were the more profitable ones, in other words, many carrying the wildly popular SYNC infotainment system that Ford developed jointly with Microsoft (Nasdaq: MSFT ) and Sony (NYSE: SNE ) . The apparent growing popularity of this service certainly bodes well for all three parties. However, the price increases were offset by rising costs (more on those below), but sales and revenues were up.
- Europe is a major problem area for rival General Motors (NYSE: GM ) , but Ford hasn't been able to take advantage. While Ford is still making money in the region, profits were down significantly from year-ago numbers. That's partly because of costs and partly because of sales challenges, which is to some extent attributable to the end of European cash-for-clunker-type programs that were still in effect during the second quarter of 2010. Still, Ford managed to keep sales roughly flat and increase revenue by $1.5 billion, a decent result in a difficult economic environment.
- South America was down a bit on rising costs, but it remains a profitable success story for Ford, with sales and revenue up over last year's strong numbers.
- Asia/Pacific/Africa isn't as important to Ford (yet) as it is to rivals like GM, Honda (NYSE: HMC ) , and Toyota (NYSE: TM ) . Profits fell sharply to a mere $1 million in the quarter, despite increases in revenue and vehicle sales, thanks to rising costs -- partly due to Ford's ongoing investments in product development and manufacturing capacity within the region -- and what Ford managers called "unfavorable product-line and market mix."
- Ford Credit, the company's lending arm, earned $383 million during the quarter, down $173 million from year-ago numbers. The decrease is no surprise and is largely attributable to some unique lease depreciation issues that drove up last year's profits. Credit losses remain low, and other indicators remain healthy.
You'll note that "rising costs" were a theme here, and that deserves some explanation.
Cost challenges, carefully managed
Ford raised vehicle prices several times during the first half of 2011, explaining that rising costs were to blame -- but the competitive strength of popular vehicles like the Fiesta and Explorer were what made those increases possible. Those increases helped push Ford's overall operating margin during the first half to 7.3%, down half a point from a year ago but stronger than it could have been -- and management said today that they expect the company's full-year margin to beat last year's mark of 6.1%.
So what are those rising costs, and should shareholders be worried? There are a couple of forces at play here. First, as global economies continue to rebound and industrial demand rises, prices of commodities like steel and rubber are being pushed up. Although some automakers may manage those cost increases better than others in the near term, over time everyone will be affected more or less equally. While rising prices may depress sales somewhat across the board, Ford isn't at a competitive advantage here.
The second situation is Ford-specific, although it's another one of those bad-but-good things: Ford's structural costs have risen somewhat as the company has moved to increase production. These costs come from things like adding additional work shifts and production lines, as well as product development, and they're intended to address both short-term issues (meeting demand for hot-selling vehicles) and longer-term issues (improving products and growing demand over time).
These are investments that need to be made, in other words, and they should more than pay for themselves in coming quarters. Ford management said today that, for the full year, they expect structural costs as a percent of net revenue to improve over last year's (pretty good) numbers, a good sign.
Last but not least, some unambiguously good news: Ford again took a big chunk out of its remaining debt load during the quarter. The company reduced the balance of its term loans by $2.3 billion and paid off the remaining $800 million on its revolving credit line. As of June 30, Ford had $22 billion in "automotive gross cash" (its term for cash on hand outside of Ford Credit), a comfortable $8 billion more than its remaining debt, and its "automotive liquidity" (cash plus available credit) totaled $32.2 billion.
That's an increase of $4.3 billion since the end of 2010. It's also another sign that the company continues to remain focused and on track, despite rising commodity costs and economic conditions that continue to keep industrywide sales levels well below pre-2008 norms in important markets like the U.S. and Europe.
Long story short, as the company moves to begin contract negotiations with the United Auto Workers, I think Ford shareholders should be heartened by the success of the company's products and the discipline of its management -- but a little concerned about macro conditions that could continue to squeeze profits in coming quarters.
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