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Here's Why Ford Is Making Big Money

Big troubles in Europe? Big investments weighing on profits in Asia?

It's no problem for Ford (NYSE: F  ) . Despite overseas challenges, the Blue Oval's profits continued to impress in the third quarter thanks to big earnings at home.

Ford's pre-tax profits in North America were $2.3 billion, up 48% in the third quarter over year-ago totals. That's despite U.S. sales that are up just 4.9% so far this year through October.

How did Ford manage to pull that off? By making the most of what it has.

How Ford built big margins at home
Ford's operating margin in North America in the third quarter was 12%, far ahead of General Motors (NYSE: GM  ) and most other rivals. Some of that margin comes from Ford's product and pricing strategies: By offering well-executed vehicles loaded with features that compare well with competitors, Ford creates strong demand – and takes advantage of it by holding down discounts.

That's a big part of the "One Ford" blueprint that remade the Blue Oval's business. But another big part of One Ford is summed up in a phrase I hear from CEO Alan Mulally every time I talk to him: matching capacity to real demand.

What Mulally and other Ford executives are talking about when they use that phrase is keeping Ford's fixed costs as low as possible. The costs involved in making cars on an industrial scale are massive: factories, complex specialized tooling, and labor contracts all add up to very big numbers.

The ability to get the most out of Ford's tooling, assembly lines, and workers is another big part of those fat margins. And according to a recent report, Ford is doing just that.

Squeezing more cars out of existing factories
A Reuters report last week quoted Ford's North American manufacturing chief, Jim Tetreault, as saying that two factors have driven Ford's manufacturing costs down this year: new "entry-level" workers, and effective use of Ford's factories.

Production constraints have already led to shortages of some hot Ford products. Back in May, Mulally said that Ford was selling all that it could make of some models. He said that Ford would address that to some extent by ramping up production, adding third shifts in several plants. That has already started to happen, and more may be done before the end of the year.

Ford already has five North American factories operating on three shifts – working around the clock, in other words. Its other factories are working two eight-hour shifts, with many adding additional overtime.

Ford considers a factory working two shifts to be at 100% capacity. Under that standard, Tetreault said that Ford's North American factories are currently running at 114% of capacity, the company's highest level in over 30 years.

Ford is also taking advantage of a provision first established in its 2007 contract with the United Auto Workers that allows the company to hire "entry-level" workers. Those workers are paid an hourly rate that is about $12 less than the UAW veterans who make up the bulk of Ford's factory workforce in the U.S.

Over time, workers making the lower rate will come to represent the majority of Ford's hourly workers, lowering Ford's costs even further.

The upshot: A great situation – but it might not last
Ford's margins in North America are terrific right now – but they're unlikely to last. At some point, as U.S. auto sales continue to recover, the Blue Oval really will max out its existing production capacity here, and some hard (and expensive) decisions about adding production capacity will have to be made.

Will Ford make the big investments needed to add new production lines when the time comes, or will it be content to lose more market share while collecting fat profits? We'll find out.

Ford has been performing incredibly well as a company over the past few years -- it's making good vehicles, is consistently profitable, recently reinstated its dividend, and has done a remarkable job paying down its debt. But Ford's stock seems stuck in neutral. Does this create 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. Simply click here to get instant access to this premium report.

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  • Report this Comment On November 13, 2012, at 5:03 PM, spawn44 wrote:

    Matching capacity to demand also creates the ideal inventory level to maximize profits. In the past the auto companies overproduced then had to bite the bullet by discounting to move the excess inventory out.

  • Report this Comment On November 13, 2012, at 5:43 PM, TMFMarlowe wrote:

    @spawn44: Very true.

    Thanks for reading.

    John Rosevear

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