What Does Ford's New Labor Contract Mean for Investors?

And so it ends.

On Oct. 30, the United Auto Workers (UAW) labor union representing workers at Ford Motor Company (F -1.92%), General Motors Company (GM 0.48%), and Stellantis (STLA 0.57%) called a halt to its six-week-long strike across multiple factories owned by the Big Three automakers. The return to work followed GM's agreement, following similar decisions by Ford and Stellantis, to offer UAW workers a historic deal that will give carmaker employees more pay raises over the next four years than they've received in the past two decades combined.

What did the workers get?

UAW workers still need to ratify the contracts being offered by their employers, but assuming that happens, they can expect to receive a total increase of 25% to their maximum hourly wage over the next four years. Additionally, the time to rise from entry-level wages to the top will shrink to just three years.

Improved retirement benefits (including an extra $2,500 in payments to current retirees and their spouses) and the UAW's right to call a strike in the event any employer attempts to close down a plant are also included in the agreement.

What does it mean for Ford investors?

Ford employees can now expect to earn as much as $42 an hour at the top of the pay scale -- but that's only the start. Factor in fringe benefits on top of simple wages, and analysts suspect the total cost to Ford could rise to as much as $90 an hour. So what does this mean for investors in Ford stock?

Well, the strike itself has already cost Ford $100 million in lost profit (from vehicles not produced, and therefore not sold) in Q3 alone. Over the ensuing weeks, the company ended up not producing 80,000 vehicles that it otherwise would have -- at a pre-tax cost of $1.3 billion in lost profits, according to a transcript from Ford's Q3 earnings call prepared by S&P Global Market Intelligence.

But that's just the start of the bad news.

According to Ford CFO John Lawler, the new UAW contract will add $850 to $900 in labor costs for each vehicle Ford builds. Presumably, this is the cost after wages have risen their full 25%, and thus won't come fully into effect for another four years. But even so, it's worth considering today how much of a bite this might take out of Ford's profits.

Consider: Through the end of Q3, Ford has reported 1.51 million U.S. car and truck sales, putting the company on track for just over 2 million sales through the end of this year. Times $900 in additional labor costs per vehicle, this implies that going forward, Ford's annual labor costs could rise by $1.81 billion.

(This assumes constant sales. Should Ford's sales grow -- they were up 10% through the end of Q3, for example -- the added costs of sales would grow in tandem. It also assumes for simplicity's sake that Ford vehicles sold in the U.S. are largely built by U.S. workers. Ford itself says that about 80% of its vehicles sold in the U.S. are also assembled here).

What will that mean for Ford profit margins?

With these caveats in mind, $1.81 billion in extra spending on UAW workers would be almost precisely 1% of the $174.2 billion in revenue Ford recorded over the last 12 months. So it's possible that going forward, investors can assume Ford will see about a 1% impact on its long-term net profit margin.

Now, over the last 12 months, this profit margin was a modest, if unimpressive 3.5% -- comprising stronger internal combustion engine profits offset by losses on electric vehicles sales. Absent an improvement in the latter, this implies that profit margins in the new wage environment might be perhaps 2.5% at Ford, resulting in a nearly 30% reduction in per share profits.

And that's the good news.

Looked at another way, Ford's profit margins have been rather hit or miss in the years surrounding (and during) the pandemic, ranging from about negative 1% in 2020 and 2022 to roughly 0% in 2019 to positive 13% in 2021. Still, averaged out across the four years preceding this one, Ford earned an average 2.5% net profit margin -- implying that a 1 percentage point reduction in margin might even drop Ford's long-term net profit margin from 2.5% to 1.5% -- a 40% reduction in per-share profits.

Ultimately, two things seem certain:

First, unless Ford raises prices on its products to absorb the higher labor cost, the new UAW contract is going to result in a significant decrease in Ford's profits going forward.

Second, the smaller Ford's profit margins are, the worse a 1% reduction in those margins is going to hurt.

Crazy as it sounds to say this about a company with a P/E of only 6, and a 6.1% dividend yield, now actually might be a good time to think about selling Ford stock.