Ford Motor Company Earnings: Pickup Profits Remain Strong

An all-new F-150 pickup is due soon. But despite a slip in market share, profits on the current model continued to be strong during the second quarter. Source: Ford Motor Co.

Ford (NYSE: F  ) reported on July 24 that it had earned $1.3 billion in the second quarter, on strong profits in its home market of North America.

Ford's result of $0.32 a share fell slightly short of the Wall Street consensus estimate of $0.37 as reported by Bloomberg, as restructuring charges and higher taxes weighed somewhat on a strong operating result in North America and a surprise profit in Europe.

Ford's result was a positive contrast to the paltry $278 million earned by old rival General Motors (NYSE: GM  ) over the same period. But GM's result was clobbered by the huge costs of its ongoing recall scandal; excluding those costs and other special items, GM earned a solid $0.58 a share.

Ford shares rose modestly on the news.

An update on Ford's global business, region by region
The best way to understand Ford's quarterly earnings is to look at the results from each of its business units in turn. 

Ford's automotive business is organized into five regional units; results for each of those, plus Ford's in-house financing arm, are reviewed below. Note that these are operating results; they don't include the effects of taxes and interest charges.

North America
North America is best thought of as the "engine" of Ford's business. In recent years, consistently strong results from North America have helped carry the company while it completes expansion and restructuring efforts in its overseas units.

That was true again in the second quarter:

Data source: Ford Motor Co.

Ford earned $2.4 billion in North America in the quarter, up $119 million from last year. That improvement came largely from lower costs: Ford's wholesale volume and revenue were down 5% and 3%, respectively, from year-ago totals. 

On a year-over-year basis, Ford's North American market share fell 1.2 percentage points to 15.3%. There are two reasons for that drop, neither of which was unexpected.

First, Ford is deliberately reducing its sales to rental-car fleets. Those sales tend to have very thin profit margins, and while some level of rental-fleet sales is good for marketing purposes, Ford has made a strategic decision to allocate more of that production to higher-profit retail sales. 

Second, Ford's F-Series pickup-truck line lost market share during the quarter. Again, that's the result of a strategic decision by Ford. The company is in the midst of switching over its two pickup-truck factories to production of the all-new 2015 F-150. Those changeovers require substantial factory downtime, and as a result, supplies of the current trucks are expected to be tight for several months. 

The all-new 2015 F-150 features aluminum body panels, a radical change that requires different manufacturing techniques. Ford's two pickup factories will each require 12 weeks of downtime to get set up to make the new truck. Source: Ford Motor Co.

To ensure that supplies of the current trucks remain sufficient to meet demand, Ford has reduced its incentives on the current model. That has reduced sales somewhat, but it has increased Ford's profit per sale, helping to preserve a very strong operating margin of 11.6% for North America for the quarter. (For comparison, GM's operating margin in North America was 9.2% excluding its recall costs, while Fiat Chrysler's (NASDAQOTH: FIATY  ) NAFTA unit and Honda (NYSE: HMC  ) North America both posted operating margins of 4.8%.)

Ford's North America margin is likely to slip somewhat as the year goes on, however. Ford said it continues to expect its full-year pre-tax profit in North America to be somewhat lower than its 2013 total, and its full-year operating margin to be in the 8%-9% range. That's because Ford expects higher costs because of the high number of new-product launches in 2014, including its biggest seller in the region, the all-new F-150 pickup.

South America
Ford has done business in South America for many decades. But in recent times, a weakening economy in the region's largest market, Brazil, and difficult political situations in Argentina and Venezuela have challenged all of the automakers doing business in the region.

Ford is no exception. Its South America unit lost $295 million in the quarter, a $446 million drop from a profitable year-ago result -- but an improvement of $215 million from its substantial first-quarter loss. Wholesale volumes were down 22% on a year-over-year basis, and Ford South America's revenue declined 30% over the second quarter of 2013.

An all-new version of Ford's tiny Ka began rolling out in South America during the quarter. The new Ka, developed in Brazil, is expected to be sold in Europe and South Asia as well. It's a size smaller than the subcompact Fiesta. Source: Ford Motor Co.

Ford expects improvement as the year goes on. It's bringing several new models to the region, including a much-needed all-new version of its Ka minicar. For the full year, Ford now expects to break even or post a small loss in South America.

Europe
Like rival General Motors -- and nearly all of the other automakers doing business in the region -- Ford has lost a lot of money in Europe over the past few years. Austerity programs in key European countries have prolonged deep recessions and clobbered new-vehicle sales; at one point in 2013, new-car sales hit lows not seen in two decades. 

European new-vehicle sales are still far from pre-recession highs, but they've recovered somewhat over the past year. Meanwhile, Ford has been working on an extensive restructuring plan, aimed at making its European operation sustainably profitable even through recessionary times.

It's working: Ford Europe reported a surprise profit of $14 million during the second quarter. That may sound tiny, but it's a $320 million improvement over results from the second quarter of 2013.

Ford's Europe turnaround includes a slew of new models for the region. Those new models will include the Mustang, which Ford has never officially offered in Europe. Source: Ford Motor Co.

That profit was the result of a few factors, including a 10% increase in revenue as Ford's turnaround plan -- which emphasizes profitable retail sales over fleet sales, and a more profitable mix of models -- began to show benefits. Ford's costs were also down, again as a result of the ongoing turnaround efforts, and a favorable exchange-rate shift also helped.

But Ford Europe isn't out of the woods yet, and more losses are likely in the coming quarters. A big slowdown in new-vehicle sales in Russia is likely to stay, and there are more restructuring charges to come as Ford completes the shutdown of a major factory in Belgium. 

Ford's total loss in Europe in the first half of 2014 was $180 million. It expects a somewhat higher loss in the second half of 2014 -- but total losses for the year should be well below the $1.7 billion it lost in 2013, and the company continues to expect Europe to be profitable in 2015.

Middle East and Africa
This is a new business unit for Ford. The company is planning a substantial expansion in Africa over the next decade, and it broke this unit out from its former catch-all "Asia Pacific Africa" region to reflect that increased focus.

Big SUVs sell well in the Middle East. Ford's all-new 2015 Expedition should bolster sales and profits in the region. Source: Ford Motor Co.

Results in the region are modest right now, but that will change in time. For the second quarter, the unit reported a $23 million profit, an increase of $10 million from the year-ago result. Wholesale volumes and revenues were down, a drop that Ford attributed to increased competition for its Expedition SUV in the Middle East as well as some unfavorable exchange-rate moves. 

For the full year, Ford expects the region to roughly break even.

Asia Pacific
This region includes Ford's fast-growing operation in China, which is now the world's largest new-vehicle market. Ford earned $159 million in the region during the quarter, an increase of $29 million from a year ago -- despite heavy ongoing investments in new factories in the region.

Ford sales have been absolutely booming in China: Wholesale volumes were up 26% over the year-ago quarter. Revenues were up 9%; that number excludes most of Ford's China income, which is booked separately. Like most automakers, Ford's efforts in China are conducted via joint ventures with Chinese automakers. Ford's accountants track the income from those joint ventures as equity income from investments, not as profits from operations.

An all-new version of the Ford Mondeo sedan, a near-twin of the U.S.-market Fusion, has helped boost Ford's sales in China in recent months. Source: Ford Motor Company.

The total income is substantial, but the overall profit number remains fairly modest as a lot of that income is being reinvested. Ford has five factories under construction in China and India, part of a major investment in future growth -- Ford's biggest investment in factories since the 1950s. Ford is also gearing up for a nationwide launch of the Lincoln luxury brand in China this fall, a massive effort that could pay substantial dividends in the coming years.

Ford's Asia Pacific guidance remained unchanged at the end of the second quarter, with the company still expecting full-year profits to come in somewhat ahead of 2013 results.

Ford Motor Credit
Ford Credit is the company's in-house financing arm, a wholly owned bank. It makes loans to customers, administers Ford's leasing programs, and provides financing of various kinds to Ford's dealers.

Ford Credit earned $434 million in the second quarter, a drop of $20 million from a year ago. Ford attributed the drop to "insurance losses from storm damage to dealer inventory in the quarter." 

Generally speaking, Ford Credit's profits tend to be fairly steady from quarter to quarter, with minor variations caused by the ebbs and flows of things like Ford's leasing efforts. It is a conservatively run operation, with subprime exposure that's modest by industry standards. 

Ford boosted its guidance for the unit slightly in its second-quarter report. Ford Credit is now expected to report a full-year profit slightly greater than its solid 2013 result.

Special items, debt, and cash
Ford took a series of one-time charges totaling $481 million during the second quarter. The key items were expenses related to Ford's planned shutdown of a Belgian factory; further charges for severance payments to laid-off workers are likely between now and the end of 2014. 

Ford also took a charge to reflect impairment of its equity stake in a joint venture with Russian automaker Sollers. That charge reflects Ford's lowered outlook for sales and production in Russia, a result of deteriorating economic conditions in the country.

Ford had $25.8 billion of what it calls "automotive gross cash" at the end of the second quarter. Ford, like GM, uses the term "automotive cash" to distinguish cash holdings that are related to its core automaking business from cash that may be held by Ford Credit as part of its banking operations. 

The company also has an additional $12.2 billion in revolving credit lines available, of which $2 billion has been allocated to Ford Credit. The cash and credit lines include a critical reserve for Ford intended to ensure that the company can continue to invest in new-product development during a severe economic downturn, when profits may be very thin. 

Ford's ability to invest in new products during the last economic downturn -- a result of the move by then-CEO Alan Mulally to raise over $20 billion in cash in 2006 -- left it in a very strong competitive position when the economy started to improve in 2011 and 2012, and it's a big reason its profit margins in North America have been so strong in recent quarters.

The upshot: A solid result with no big surprises
Ford shareholders had one big question ahead of the release of these results: Would Ford's loss of full-size pickup market share affect profits in North America? The F-Series pickup line is widely known to be Ford's most profitable product anywhere in the world; in a sense, the whole company's ongoing efforts depend very heavily on the success of those pickup trucks.

But the good news was that there was no surprise: Ford had made it clear that it was reducing pickup incentives to try to preserve profits, and that plan appeared to work well during the quarter. 

The small profit in Europe was a pleasant surprise, but Ford CFO Bob Shanks made it clear that it was a blip, not the beginning of a sustainable trend. That was no surprise, as Ford has said that it doesn't expect sustainable profits in Europe until 2015. It was, however, solid confirmation that the company's efforts in Europe remain solidly on track.

Tough conditions in South America continue to be a concern, but Ford appears to be making reasonable moves to limit the damage. On the other hand, the strong sales gains in China are a very nice story, and they bode well for solid, steady profits in the region once Ford's aggressive investment cycle is completed.

Long story short: It was a good, if unsurprising, quarter for the Blue Oval, as the next phases of its growth story -- Europe and China -- remain well on track.

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