Why Did Ford Motor Company's Profits Get Clobbered?

January's unveiling of the all-new 2015 F-150 was a high point for Ford in the first quarter. But several big expenses hit Ford's bottom line as the quarter went on and profits were down sharply. Source: Ford Motor Company.

Ford (NYSE: F  ) on Friday reported a first-quarter profit of $989 million. That was down significantly from the $1.6 billion it made a year ago, and well short of estimates from Wall Street analysts.

Wall Street hates an earnings miss, and Ford's shares were down more than 3% shortly after opening on Friday. 

So here's the question: Is Ford in trouble, or is this one of those "buying opportunities" we hear about? I say it's the latter. Ford's profits weren't down because of some new chronic problems. They were down (mostly) because of a bunch of one-time costs that hit Ford during the quarter.

But Ford missed estimates. Isn't that bad?
Not really -- at least, not in the sense of Ford's long-term prospects. There's nothing new that has gone wrong with Ford. The company's businesses and plans are on track. 

But Ford was hit by several different one-time issues all at once during the quarter. It's unusual for that many one-time situations to happen all in a single quarter, and Wall Street didn't take them all into account when analysts made their estimates.

In order to help us understand exactly what went on, I spent some time talking to Ford's chief financial officer, Bob Shanks, on Friday. In turn, Shanks explained all of these expenses to me.

So what were all those charges?
For starters, Ford incurred a charge of about $400 million for what it called "warranty reserve increases for fields service actions for prior models." 

That's not related to the recalls Ford announced earlier in April, it turns out. It's an accounting change. Shanks told me on Friday that every time Ford sells a vehicle, it creates a reserve on its balance sheet to cover potential future costs related to that vehicle. Those costs could include service and repairs that the vehicle gets under its factory warranty or they could include the expenses of future recalls affecting that vehicle. Those reserves are held for six or seven years, Shanks said, after which they're "released" -- if there's money left over, that's a gain for Ford.

Shanks explained that Ford regularly monitors the costs its past vehicles are incurring over time and makes adjustments to the reserves it holds as needed. In this case, Shanks said, Ford has determined that it should hold a larger reserve for the vehicles it sold between 2009 and 2013. 

(Shanks didn't say so, but this might be related to concerns raised in the wake of rival General Motors' (NYSE: GM  ) recall scandal. Sometimes, there's a genuine question over whether a potential problem is big enough to justify a full-blown recall. Given GM's experience, I think Ford -- and other automakers -- will err on the side of conducting recalls even for issues that seem relatively minor for a while. Ford's move to increase its reserves might have been made with that likelihood in mind.) 

A costly winter in more ways than one
Rough winter weather in many parts of the U.S. hurt Ford's sales during the quarter (and those of many of its competitors, too). Sales started to pick up as the weather improved, but it was too late to help Ford's first-quarter totals. Those sluggish (or maybe we should say "slushy") sales hurt Ford's revenue and profits in North America, its most profitable region, and that hurt Ford's earnings. 

But that weather also increased Ford's costs during the quarter to the tune of about $100 million. Weather-related shipping delays meant that some parts were late to arrive at Ford's factories. That interrupted Ford's production schedules at some factories, and some factories had to work overtime (and pay overtime rates to their workers) to make up the volume.

Ford also had to pay premiums to shipping companies to get its delayed products to dealers as quickly as possible. And, Shanks noted, things like increased heating expenses at Ford's factories added to its costs as well. 

Together with the changes to the warranty reserve, that took a big bite out of Ford's first-quarter profits in North America.

Big hits in South America
Ford took a charge of $310 million (which was less than expected) to account for a major devaluation in Venezuela's currency. That wasn't a surprise, but Shanks said that Ford ended up taking a second charge of $70 million to account for a similar currency devaluation in Argentina. 

Why do currency devaluations lead to charges for Ford? Here's why: As part of doing business in a place like Venezuela, Ford holds Venezuelan currency -- called the bolivar -- in its accounts. When it does its accounting for the quarter, to report to shareholders it has to give the value of those bolivars in U.S. dollars.

Ford had been valuing its bolivars at 6.3 bolivars to one U.S. dollar. But the bolivar has lost value in recent months because of government actions in Venezuela. To account for that change in value, Ford made a change: It now values its bolivars at 10.8 to the dollar. 

It's just an accounting change, but it wipes away $310 million of value, and it has to be accounted for at earnings time.

More costs to come as the year unfolds
There was also a one-time special charge of $122 million for costs related to Ford's ongoing restructuring in Europe -- mostly severance payments for laid-off workers. 

As part of its European overhaul plan, Ford closed two factories in the U.K. last year, and is closing another one in Belgium this year. Severance payments for unionized workers in Western European countries can be a significant expense

Ford's factory in Genk, Belgium, will close at the end of this year. Source: Ford Motor Co.

Shanks told me on Friday that there would be further charges for layoffs over the next few quarters as the factory in Genk, Belgium, winds down. Those charges will total somewhere between $400 million and $500 million by year-end, but then they'll be done, Shanks said.

Ford is on track, but 2014's profits will lag 2013's
All of that is expensive, but nothing there is a sign of larger problems. Ford reiterated its previous guidance for the full year on Friday. Overall profits should be on track once the year has unfolded.  

But as we've known for a while, those overall 2014 profits are likely to be lower than last year's. Back in December, Shanks warned Ford investors that the company's profits in 2014 would likely come in a bit lower than the $8.6 billion it made in 2013, and its margins in North America would be lower as well. 

Ford noted on Friday that it has 23 new-product launches planned for 2014 around the world. That's the most that Ford has ever done in a single year. Shanks warned last December that costs related to those launches, which include everything from expensive new factory tooling to logistics charges to TV ad campaigns, would weigh on Ford's profits in 2014.

The upshot for shareholders: Sit tight
As a Ford shareholder, there's nothing in today's report that makes me think I should sell my stock. Ford's European turnaround remains on track, its Asian growth story is unfolding even better than expected, and new products should help bolster its sales and profits in North America and elsewhere after this year.

But there are some things to keep an eye on: Ford's U.S. sales need to recover from the rough winter, as the U.S. remains Ford's most important and profitable single market. And all of those new-product rollouts around the world need to go smoothly, especially the all-important launch of Ford's new pickups later this year.

In fact, the U.S. is one that gives me pause right now. Ford should get through 2014 just fine, but if it starts to lose ground to rivals, if new products (like those trucks) don't do as well as we expect, or if it has to increase its spending on incentives to keep pace with competitors, that will be cause for concern.

But we'll be watching it very closely. Stay tuned.

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  • Report this Comment On April 26, 2014, at 9:58 AM, jesslo65 wrote:

    Wow do you think it is because they started building junk. The triton engines are a complete fail. And they refuse to do anything about it. Why is it so hard for people to admit it when they are wrong. But we consumers are held accountable for or deeds. Ford needs to man up if they want man to back them up.

  • Report this Comment On April 26, 2014, at 10:10 AM, gskinner75006 wrote:

    Maybe because their products still have quality problems?

  • Report this Comment On April 26, 2014, at 1:11 PM, LouisTewl wrote:

    Another of JR's Ford Propatorials - Spin, Spin, Spin!

    Funny those "weather conditions" didn't hurt FCA's sales OR revenues during the same period (in case he's going to trot out that same old tired "FCA has higher incentives") canard.

    If I were a Ford shareholder, instead of a FCA shareholder, which, (THANKFULLY), I'm not, I would take a deeper look at why Ford is closing (3) European factories while FCA (Fiat-Chrysler) is ramping its factories in Italy back up for full production of the new global Jeep crossover and the Alfa-Romeo, which will be returning to America next year.

    JR says he sees no reason to sell his Ford stock, but by the same token, he doesn't present a case for buying Ford shares either, so I have to give him credit there.

    I guess it's as good a place to park money as anywhere, but Ford fumbles, then it stumbles, then it fumbles as it stumbles - it just can't seem to get out of its own way.

    Just look at what TTM (Tata Motors) did with the Jaguar/Land Rover Brand after Ford sold it to them-which has been a great thing, both for TTM and the world, because, do you really want to own a Jaguar designed and built by Ford? They had same stultifying effect on Volvo when they owned them.

    But this also illustrates the current point - Ford is retrenching while it's introducing "23 new products" around the world?

    I, for one, would like to see a breakdown by country and product for that statistic.

    I would also be mildly interested in analysts' consensus on stock price performance going forward.

    My point? Ford is still too big - it's not a growth story, it's a turnaround story - maybe. It's like trying to turn a huge oil tanker that's sitting too deep in the water - it's going to take time - a long time.

    FCA, on the other hand, has doubled its share price over the past year and continues to post new highs on consistent volume in advance of it's full NYSE listing later this year. The stock price, by the way, is reflective of FCA's increasing sales and revenues, both in the U.S. and internationally.

    In my opinion, JR and TMF are riding the wrong horse, and, what's even worse, they're trying to get other people to bet on it too.

  • Report this Comment On April 26, 2014, at 6:47 PM, SkepikI wrote:

    ^ Hmmm in F at 9-10, with 3% div and P/E of 9 at current prices.....I reckon I HAVE a long time..... my objective will be to buy on weakness as F solves its long term problems one by one. Something neither GM nor Chrysler are doing at the moment. Long F the taxpayer's friend.

    NEVER going to buy product or stock from two time loser Chrysler or its Italian "savior"?

  • Report this Comment On April 28, 2014, at 8:59 AM, XXF wrote:

    I'm personally long on Ford, but why do you keep saying things like "it's an accounting change"? When Ford increases warranty reserves by $400MM that means they expect to have $400MM less to return to shareholders somewhere down the road. Same with currency conversions, the devaluation now means Ford has $310MM less in value to return to shareholders. Is your suggestion that somehow Ford should not be evaluated as an investment based on it's expected return to shareholders? That's a pretty confusing piece of advice to share in a financial advice article...

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