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Few investors were surprised when Ford (NYSE: F ) announced on Wednesday that second-quarter profits had dropped more than 50% from year-ago levels. Ford CFO Bob Shanks had warned in June that losses overseas, especially in Europe, would take a big bite out of the Blue Oval's profits, and that's pretty much how the story played out: Europe lost $404 million during the period.
The big question for Ford right now, of course, is what will they do about it? While Shanks and CEO Alan Mulally weren't willing to give details on their plans to restore Europe to profitability, they did drop a few clues to reporters on Wednesday -- and it's not too hard to guess where they're going.
Look to the (not-so-distant) past to predict the future
"This is going to be a holistic response, and if I were you guys I'd go back and look at what we did in North America with our One Ford plan." -- Shanks, speaking to reporters on Wednesday
The "One Ford" plan, put in place by Mulally shortly after his arrival at Ford in 2006, is essentially the set of guiding principles that have formed the foundation of Ford's historic turnaround. The plan's points include a unified global product lineup and strict financial discipline, but as Mulally emphasized on Wednesday, "The most important thing about our One Ford plan is that we match production to real demand."
There was more. Shanks said that Ford views the problems in Europe as "more structural than cyclical in nature", acknowledging -- as rival General Motors (NYSE: GM ) has in its own European struggles -- that riding out the downturn isn't an option. Instead, major, permanent changes will have to be made in order to restore operations in the region to sustainable profitability.
Those major changes aren't exactly secret. "Matching production to real demand" means having just enough factories making just enough cars and trucks to satisfy the market. Europe's auto industry as a whole has more car factories than its sales can justify. That's a problem for the whole region: As a general rule, auto factories running at less than 80% capacity are probably losing money -- and that describes most of the factories in the region. Morgan Stanley recently estimated that Ford's are running at just 63% -- a number that leads to an obvious conclusion: Ford's going to have to shut down some factories.
Unfortunately, that may not be as easy as it sounds.
Why closing a European factory isn't so simple
Ford's factory in Genk, Belgium, which makes the outgoing Mondeo sedan, and its plant in Southampton, England, which makes the Ford Transit van, are both thought to be likely targets for shutdowns. Products made at both are also made elsewhere in Europe, making their closure a relatively simple matter from a logistical perspective.
But from a political perspective, things may not be so simple. Strong labor-friendly laws and public (read: political) resistance to job losses in Western Europe make closing a factory a complicated, time-consuming affair. Just ask GM, which has hinted that it plans to close one of its plants in Germany -- but may have to wait until 2017 before that can happen. Or beleaguered French automaker PSA Peugeot Citroen (NASDAQOTH: PEUGY.PK), whose plans to close a Paris factory were characterized by union leaders as an act of "war" -- and that factory won't close until at least 2014.
Ford is likely to face similar hurdles. The Blue Oval signed a four-year contract with the unions at the Genk plant in 2010, in which it promised job security through the length of the agreement. It's possible that Ford may not be able to close the plant until the end of 2014 -- a problem it may face at its other plants as well.
Without other changes, big quarterly losses at Ford Europe could continue for some time.
What a "holistic response" might mean
As Shanks made clear on Wednesday, Ford is likely to look far beyond factory closings in its efforts to restore its European operation to success. The product line is already in the process of being streamlined and globalized -- the new Escape and upcoming Fusion each replace two different vehicles, their North American namesakes and the Kuga and Mondeo sold in Europe.
The nameplates will be different, but they'll be the same vehicles. Likewise, other European favorites like the Fiesta, the Focus, and the C-MAX are already part of Ford's "global" fleet, meaning that they take advantage of larger development budgets (which lead to better quality) and larger economies of scale, meaning that they can be produced at lower cost.
Expect Ford to streamline its European product line further, and to bring it more in line with its offerings in the U.S. and Asia. Likewise, as more of Ford's top-tier global vehicles hit the European market, expect marketing that emphasizes Ford's high quality, deep features, and global footprint.
It's hard to say when Ford will roll out its plan for remaking Europe -- if I had to guess, I'd say it would be rolled out in little steps over the next several months. But if we can extrapolate from Mulally's approach elsewhere, and from the success of "One Ford" here in the U.S., we can safely say this: Ford is likely to take decisive action sooner rather than later, and that action will be well thought out and carefully executed.
Beyond that, we'll have to wait and see.
Thanks in part to concerns about Europe, Ford's stock has been under pressure lately, with its stock dropping to levels not seen in years. But the company is still performing very well at home and is investing heavily for growth abroad. Have these short-term pressures created an incredible buying opportunity, or are there hidden risks with the stock that investors need to know about? To answer that, one of our top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Get instant access to this premium report.