Investors were in full panic mode before Ford Motor's (NYSE:F) third-quarter earnings report. As of last Wednesday's close, just before the earnings release, the stock was down more than 30% year to date and more than 50% for the past five years.
Sure enough, competitive issues in multiple regions around the globe weighed on Ford's sales last quarter. Meanwhile, profit plummeted. But while Ford has issues to fix across the world, the sudden deterioration of its business in China drove the vast majority of its profit decline.
Ford's two key profit pillars grow their earnings
It's no secret that Ford relies heavily on its North American business and its Ford Credit subsidiary for its earnings. Over the past decade or so, these have been the only consistently profitable parts of its business.
Last quarter, both of these long-term profit pillars posted strong results. In North America, Ford achieved an adjusted operating profit just shy of $2 billion, up $136 million year over year. While wholesale volume slipped 1%, segment revenue jumped 7%, as Ford's product mix shifted dramatically away from passenger cars and toward pricier crossovers, SUVs, and trucks.
The mix shift also allowed Ford to hold its segment margin flat at 8.8% in the face of severe commodity price headwinds and rising warranty costs. The strong results in North America were particularly remarkable in light of the Blue Oval's dated crossover portfolio. Ford will update each of its three high-volume crossover models by the end of 2019, which should lead to substantial pricing improvements on those vehicles thereafter.
Meanwhile, Ford's finance subsidiary capitalized on improving consumer credit and a jump in used vehicle resale values last quarter. As a result, Ford Credit booked a $678 million pre-tax profit, up from $600 million a year earlier. This was its best quarterly result in more than seven years, according to Ford CFO Bob Shanks.
China is a disaster
Improving results in the North America and finance segments, however, couldn't offset a sharp decline in Ford's profitability in China.
Ford is facing several challenges in China right now. The Chinese auto market contracted significantly last quarter, because of slowing economic growth and fewer government incentives for car purchases. Making matters worse, Ford faced a big increase in import tariffs on vehicles that it ships to China from the United States. Lastly, the automaker has an outdated product portfolio in China that doesn't really match customers' desires.
As a result, Ford deliveries in China plunged 32% in July, 36% in August, and 43% in September. These results brought the company's year-to-date sales decline in China to a dreadful 30%.
Not surprisingly, the steep sales declines have eviscerated Ford's profitability in the Middle Kingdom. Operating income in China -- including both local joint ventures and Ford's wholly owned operations -- plunged $480 million year over year to a loss of $378 million. This performance drove the entirety of the Ford automotive segment's $477 million operating income decline last quarter.
Can Ford turn things around?
While Ford's profit decline last quarter can be explained by its troubles in China, the company remains deeply unprofitable in South America, and its European operations took a turn for the worse earlier this year. In other words, the company is struggling in multiple major regions.
Thus far, investors have been disappointed with the speed of Ford's turnaround initiatives. Yet many countries require Ford to consult with labor unions before making decisions that could have a big impact on employment, so it will take time to fix some of the underlying problems. Ford has hinted that it may eventually move to a joint-venture model in South America, or even sell that business entirely. In Europe, management thinks it can turn things around through a combination of cost cuts and a mix shift from cars to more profitable crossovers and SUVs.
Most importantly, Ford is about to launch a huge product offensive in China. The first new offering is the Ford Territory, a low-cost, midsize SUV targeting consumers in China's second- and third-tier cities. Ford plans to introduce a total of 50 new vehicles in China by 2025. This ambitious target will help it better match customers' tastes.
Finally, there is room for Ford's successful North America business to be even more profitable. As in Europe, the key will be a dramatic shift in the production mix from cars to crossovers, SUVs, and trucks. With several important new products coming in the next year, investors won't have to wait too much longer to start seeing real signs of improvement at Ford.