Ford Motor Company (NYSE:F) said this past week that it earned $2.2 billion in pre-tax profit in its North America region in the second quarter. That's a solid result, but it's down from a year ago, when Ford earned $2.7 billion.
The story of the drop isn't as simple as you'd think. It's true that Ford's U.S. sales, which drive most of its results in North America, were down 3.3% in the second quarter from the same period last year. It would be easy to conclude that that's the story.
But here's the thing: That sales drop is more than explained by a year-over-year decline in sales of Ford's lower-profit car models. U.S. sales of Ford's higher-profit SUVs and F-Series pickups were both up (3.3% and 7.4%, respectively) in the quarter.
At first glance, it appears that the overall effect should have given Ford a profit boost -- or at the very least, the more favorable mix of products and better pricing should have offset the effects of the overall sales decline. So what happened?
The story: Ford's costs jumped
Here's the slide from Ford's second-quarter earnings presentation that summarizes what changed year-over-year.
As you can see in the callout box above the first green bar, "mix" -- the mix of products that Ford sold in the region during the quarter -- drove a $217 million improvement in pre-tax profit year-over-year. Stronger pricing, particularly on new models like Ford's Super Duty pickups, also helped, though that pricing was offset somewhat by higher incentives.
The chart shows us that the real year-over-year impact came from higher costs, and from $150 million of "Other." That latter has a simple explanation: In the second quarter of last year, Ford sold its equity stake in a company called OEConnection LLC, and obviously that wasn't repeated this time around.
But I thought the higher costs were worth some investigation, so I investigated -- by asking Ford's chief financial officer to explain them.
What was behind Ford's year-over-year cost increase
Ford CFO Bob Shanks said that the story here is one that he had warned about in his first-quarter presentation: The prices of key commodities, particularly steel, are up year-over-year. That had an impact on Ford's results in other parts of the world as well:
For the company itself, [commodity costs are] up about nearly $400 million. I talked about this in the first quarter, when I said it's going to be over $1 billion for the full year. it's probably going to be about $1.2 billion [for the full year] based on what we know today.
When you look at the first half, we've seen about half of that, nearly $560 [million], and the biggest portion of that in terms of where it occurs is in North America. And the biggest portion within the commodities is steel. Everything is up, but the biggest piece of that is steel. So here, you're just simply seeing happen in the quarter what we talked about in the first quarter.
Shanks noted that increased commodity costs had a $69 million impact on Ford's results in Europe in the second quarter, and smaller effects elsewhere in the world.
The profit decline was a fluke, but it's also a trend
While the explanation for Ford's second-quarter profit decline in North America is something of a fluke, in the sense that it's not related to Ford's business execution, it's hard to deny that the trend for profits and margins in Ford's most important region haven't been good over the last year and a half.
That trend is, of course, what we would expect to see as the market for new vehicles passes the peak of its cycle. Sales are still strong, but incentives are rising as automakers try to generate year-over-sales growth in a market that's more or less flat, and that in turn squeezes profit margins. Ford wasn't alone: General Motors' (NYSE: GM) profit in North America fell 7% in the second quarter, while Fiat Chrysler Automobiles' (NYSE: FCAU) profit in the region fell 2% year-over-year.
Ford is still faring well, though it has clearly been hit harder than some rivals by rising steel prices. But history, and the trends we're seeing now, both suggest that things might get worse before they get a whole lot better.