Are Ford's (NYSE:F) profits in North America -- its most important market -- set to shrink?
Ford says they'll dip a bit in 2014, in large part because of the costs of launching the all-new F-150 and other key models. That's not a surprise, and it's not anything for longer-term Ford investors to worry about.
But Ford has also said that its profit margins in North America will likely shrink in coming quarters -- and not because of some onetime costs. In fact, they've already started shrinking.
What's that about? Let's take a closer look.
Why Ford's profits have been huge recently...
First, some background. Over the last couple of years, Ford's profit margins in North America have been absolutely huge by auto industry standards, rising as high as 12% at times. (Something like 7% is more typical for a mass-market automaker.)
Ford's North American profits have been carrying the company while it works to turn around Europe and expand in Asia. Last year, the company reported $8.78 billion in pre-tax profits in North America -- and $8.6 billion in overall pre-tax profits.
In other words, taken together, Ford's operations outside of North America actually lost money. (In truth, the story is more complicated than that. But the importance of North America to Ford is obviously huge.)
Why is Ford making such big profits here? There are several factors at work, but two big ones come to mind. First, Ford's factories have been very busy. The company was able to close its underutilized facilities during its restructuring last decade. Ford's remaining plants have been hopping ever since the economy started to recover.
That's important. Auto factories, with their elaborate tooling and well-paid union workforces, represent high fixed costs -- costs that Ford has to pay whether it builds one car a day or 10,000. Clearly, the more vehicles that Ford builds in any given factory over any given time period, the more money it will make. Lately, most of its factories have been very busy, working two or even three shifts.
Here's the second factor: Ford has been following a strategy of offering well-designed premium options packages on all of its vehicles. You can get a high-tech infotainment system in a Fiesta, leather seats in a Focus, and an F-150 pickup with many of the comforts of a high-end luxury car -- for a price.
Those options packages are very profitable, and they've proven to be very popular with buyers. That has increased Ford's profits per vehicle sold, especially on its best-sellers, the pickups.
That has led to fat profit margins. But recently, those margins have started to come under pressure.
...and why they'll be a bit less huge going forward
COO Mark Fields made headlines -- and shook Ford's stock price a bit -- when he said late in 2012 that Ford's profit margins in North America were likely to fall in coming quarters.
Sure enough, he was right: Ford's profit margin in North America in 2013 was 9.9%, compared with 10.4% in 2012. And CFO Bob Shanks said on Tuesday that even that was at the high end of what was reasonable to expect going forward. Shanks said that Ford's margins in North America would likely stay in the 8%-10% range in coming quarters -- still very strong but not as impressive.
Why? In the near term, Ford's profits will be affected by the costs of its new-product launches. It has an all-new pickup to roll out, along with a new Mustang and some other key models, and those launches will be expensive for a number of reasons.
But there are some external forces at work as well. Top of the list: competitive pressures. Toyota (NYSE:TM) and Honda (NYSE:HMC) have currency exchange rates working in their favor right now. The value of the yen versus the dollar has shifted in such a way as to make dollars worth more in yen terms. That means that the Japanese automakers can afford to earn fewer dollars per sale and still report a strong profit when those dollars are turned into yen at home.
That in turn means that Ford has been coming under pressure to cut prices or raise incentives on its small- and mid-sized cars and SUVs, market segments where the Japanese brands are especially strong.
There's also some simple reversion to the mean going on as well. Ford got out in front of key rivals -- not just the Japanese brands but also General Motors (NYSE:GM) -- with its strong, overhauled product lineup and reduced manufacturing footprint. Those gave it big advantages. But now, the competition is catching up. Ford is still in a strong position, but it's not quite as strong as it was.
That doesn't mean that it's time to sell Ford stock. On the contrary: Ford's overseas operations are improving quickly, and should drive plenty of profit growth over the next few years. But it does explain why Ford's extremely impressive profits at home are likely to be a bit less impressive over the next couple of years.
Fool contributor John Rosevear owns shares of Ford and General Motors. You can connect with him on Twitter at @jrosevear. The Motley Fool recommends and owns shares of Ford. It also recommends General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.