Top American automakers General Motors (NYSE:GM) and Ford Motor (NYSE:F) have come roaring back in the U.S. since the Great Recession. Last year, Ford earned pre-tax income of $8.8 billion in North America, while GM was not far behind at $7.5 billion.
However, both automakers have been bleeding cash in Europe, creating a drag on each company's global profitability. At Ford, the problems crept up fairly recently, in conjunction with the sovereign debt crisis. On the other hand, GM has been struggling in Europe for more than a decade.
Fortunately, conditions are finally improving in Europe. Today, both Ford and GM are returning to sales growth in Europe, helped along by popular new models. Meanwhile, each company is planning to close a manufacturing plant by the end of the year. This will address some of the lingering overcapacity issues and help both companies return to profitability in Europe within a year or two.
Two growth plans
Both Ford and GM vowed to cut costs in Europe by closing underutilized factories. This part of their turnaround plans has been widely publicized. However, both companies also understand that building cars people want to buy is the key to long-term success -- you can't just cut your way to profitability with a bad product portfolio.
As a result, both Ford and GM's Opel unit are putting a lot of effort into refreshing their product portfolios with more desirable vehicles. Ford is introducing seven new models in Europe this year, part of a five-year plan to introduce 25 new or refreshed models in Europe. Opel's plan is similar. A couple of years ago, it announced plans to introduce 23 new models by 2016.
The sales turnaround
Both plans seem to be gaining traction now. Last month, Ford posted its 10th consecutive monthly sales gain in Europe. For the full first quarter, Ford's vehicle sales in the 20 European markets it tracks rose 11% year over year. Ford achieved particularly strong sales growth in the U.K., its largest European market, as auto demand is rapidly rebounding there.
Ford's sales volume in Europe is still dominated by the Fiesta and Focus small cars. However, the Kuga compact SUV (which is marketed as the Ford Escape in the U.S.) is starting to gain popularity, with sales up by one-third year over year. This bodes well for the introduction of the EcoSport subcompact SUV this year, as it will target budget-conscious buyers who want an SUV.
Meanwhile, GM's Opel division reported this week that it achieved its highest market share since 2011 last month. Opel is also crediting its sales revival to new models, particularly the Mokka subcompact SUV and the ADAM mini-car. Like Ford, Opel's sister-brand Vauxhall benefited from strong auto demand in the U.K.: sales jumped 17% last month.
Factory closures will accelerate earnings
With auto sales in Europe returning to growth, Ford and GM should be able to shrink their losses in Europe this year. Strong product launch cadences at both Ford and Opel/Vauxhall should help both automakers regain some market share in Europe -- without resorting to margin-killing discounts.
This provides a good setup for both automakers to return to profitability in Europe as soon as next year. Recently, Ford has been reporting bigger losses in Europe than GM. Ford is booking accelerated depreciation for the factory in Genk that it's closing at the end of 2014, creating an artificial drag on earnings.
By contrast, GM took a one-time asset impairment, and so its reported losses are smaller than Ford's now, totaling less than $1 billion last year. Next year, Ford's accelerated depreciation will go away, which will put it back on an even footing with GM. This means both will be in striking distance of the breakeven mark.
The closing of Ford's Genk plant and GM's Bochum plant later this year will lead to hundreds of millions of dollars in annual cost savings for each automaker, bridging much of the gap to profitability. Higher sales volumes will also help. Most importantly, with European production capacity coming more in-line with demand next year, the brutal pricing environment should ease, allowing some margin recovery.
Foolish final thoughts
Less than two years ago, there was no end in sight for the red ink at Ford and GM's European operations. Today, the outlook is much brighter. Auto demand is finally starting to recover in Europe, and a slew of new models are helping Ford and GM to regain market share while boosting their profit margins.
Ford and GM are each planning to close a major plant by the end of this year. This may be the final piece of the puzzle in the road map to profitability in Europe. It will still be many years before Europe is a major profit driver for Ford or GM, but as soon as next year, Europe could start contributing to global profitability for both companies, rather than holding it back.
Adam Levine-Weinberg is short December 2014 $15 puts on Ford. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.