On Wednesday afternoon, Ford Motor (NYSE:F) reported excellent third-quarter results, blowing past the downbeat forecast it issued three months ago as well as analysts' expectations.
This earnings beat doesn't mean Ford has solved all of its long-running challenges. Nevertheless, it should give investors more confidence in the company's turnaround prospects. It's also great news for General Motors (NYSE:GM), which is likely benefiting from similar tailwinds, but has fewer near-term problems to work through.
A huge recovery
In the second quarter, Ford recorded a $1.9 billion adjusted operating loss, as revenue plunged 50% year over year primarily due to coronavirus-related production interruptions. This result was much better than the $5 billion-plus operating loss that management had braced for in the spring, but that hardly made it a successful quarter.
Furthermore, as of late July, management projected that Ford would earn a modest adjusted operating profit between $500 million and $1.5 billion in the third quarter, followed by a loss in the fourth quarter. That guidance implied a significant operating loss for the full year.
Instead, Ford was able to deliver a monster adjusted operating profit of $3.6 billion last quarter. That put its adjusted operating margin at 9.7%, well above the company's long-term target of 8%. Adjusted earnings per share nearly doubled year over year to $0.65, far ahead of the analyst consensus of $0.19.
Ford achieved these strong results by capitalizing on a favorable supply-demand balance to push pricing higher, particularly in North America. Vehicle wholesales declined 5% year over year, but automotive revenue still grew by a little more than 2%. Ford reported a $1.5 billion tailwind from net pricing, with about 60% of that coming in the North America region. As a result, adjusted operating profit reached $3.2 billion in North America, up from $2 billion a year earlier, with a stellar segment margin of 12.5%.
A second contributor to Ford's profit growth was a big jump in used vehicle auction values. This allowed the company's Ford Credit subsidiary to post a $1.1 billion pre-tax profit, up more than 50% year over year.
Progress won't be linear
Notwithstanding the big earnings beat, Ford's management cautioned that there are still a lot of problems to fix. The company is early in the process of restructuring its business outside of North America. Furthermore, it needs to cut material costs and improve vehicle quality to reduce warranty expense.
In the near term, Ford also faces significant headwinds from its efforts to upgrade its vehicle portfolio. In the fourth quarter, lucrative F-Series wholesales will fall by about 100,000 units as Ford slowly ramps up production of an all-new version of the F-150 for 2021. Management is also bracing for elevated manufacturing costs and advertising costs for the new Mustang Mach-E and Bronco Sport SUVs, both of which went into production last week. As a result, the company still expects to report a Q4 operating loss of up to $500 million.
These particular headwinds will start to dissipate in 2021. However, Ford will have to absorb launch costs associated with the highly anticipated full-size Bronco next year. The company will also likely continue to experience elevated restructuring costs and weak results in many of its international markets in the near term. Realistically, investors will have to wait until 2022 to see consistently strong results from Ford -- and of course, that assumes the success of its turnaround initiatives.
GM has the upside without the near-term headwinds
Like its crosstown rival, General Motors probably took advantage of strong truck demand and severe supply constraints to lift pricing. Additionally, the General has been booking very conservative profits at its GM Financial subsidiary, assuming that used vehicle pricing would weaken significantly in the second half of 2020. With used vehicle prices rising last quarter, GM Financial is primed for bumper profits, just like Ford Credit.
Furthermore, GM is much better off than Ford outside North America. While Ford's results in China improved last quarter, the company still lost money there. By contrast, GM earned a profit in China in the second quarter and posted a 12% year-over-year increase in deliveries during the third quarter. General Motors has exited Europe and numerous smaller underperforming markets around the world, so it isn't ringing up huge losses abroad.
Ford's stellar Q3 results give investors reason to hope for better times ahead. But GM is likely to post equally strong results -- and unlike Ford, its momentum will probably continue into the fourth quarter and 2021. So while both stocks look undervalued, GM stock appears to offer a better balance of risk and potential reward right now.