On Tuesday morning, Ford (F -0.45%) reported fourth-quarter results that easily beat Wall Street's expectations on revenue and EPS. Nevertheless, the stock dropped more than 5%, due to the company's relatively bleak guidance for 2013. North America remains a strong, profitable market for Ford, but Ford's international markets are expected to post another combined loss in 2013.
Recently, Ford has produced very strong sales growth in Asia, and particularly in China. However, the company is investing heavily to support further growth in Asia, and this has hurt profitability. Ford posted a small loss in its Asia-Pacific-Africa segment for 2012, and expects breakeven results in 2013. Meanwhile, the company continues to post big losses in Europe. These are expected to worsen from a $1.75 billion loss this year to a $2 billion loss next year.
Unfortunately, shareholders should not expect Asian profits to outweigh European losses anytime soon. The China market is very big, but at present it is not very profitable, even for market leader General Motors (GM 0.33%).
Changing of the guard
Ford's future is a tale of two continents. The company needs to grow its presence in Asia, in order to reduce its reliance on Europe. Ford's management has presented a credible plan to turn the European business around by mid-decade, but the worsening industry outlook may delay the return to profitability past 2015. While Ford is cutting capacity, it still needs to increase its European sales just to reach breakeven. In a tough competitive environment, this could be difficult to achieve.
If Europe continues to struggle, demonstrating success in Asia will be even more important for Ford. In China, Ford has recently benefited from nationalist backlash against Japanese automakers such as Honda (HMC -1.80%), Nissan, and Toyota (TM -1.92%). Japanese automakers held over 20% of the Chinese market prior to this recent disturbance, but their sales have slid since August. Ford took advantage of this opportunity to rapidly gain market share.
Ford's growth in China was the primary catalyst for a 41% increase in wholesale unit volumes during Q4 in the Asia-Pacific-Africa region. Additionally, Ford is in the midst of a project to double capacity in China to approximately 1.2 million vehicles by 2015.
A key concern
Ford's growth strategy in China is undoubtedly the right move for the company. It will allow Ford to tap into the world's largest auto market. However, investors should keep their expectations in check. Heavy investments will continue to limit profitability in Asia for the next two years. Moreover, profits will be quite modest when they do arrive.
Market leader GM sold more than 2.8 million vehicles in China during 2012. Despite these massive unit volumes, GM is on pace to produce equity income of just $1.5 billion for the full year from its Chinese joint ventures. Ford's 2015 target production is less than half of GM's current Chinese production, and its profits will be correspondingly smaller.
Conclusion
Ford's plans to expand in China are necessary because it is a large and growing market. However, it is not a very profitable market right now, except for luxury automakers. Recent improvements in China (and Asia as a whole) cannot fully offset the worsening outlook in Europe. Investors should understand that Ford will need to fix its European business to produce significant profit growth in the future. The company's opportunity in China is a longer-term, developing story.
