On Tuesday, Ford Motor Company (NYSE:F) reported strong full-year results for 2013. The automaker earned pre-tax profit of $8.6 billion last year, up by more than $600 million from 2012. That was just below the record $8.8 billion pre-tax profit it posted in 2011 (excluding special items).
Despite this momentum, Ford's management has projected that the company will take a step back earnings-wise in 2014, with pre-tax profit (excluding special items) of $7 billion-$8 billion. At first, this might seem like bad news for investors. Indeed, the Associated Press reported ominously, "Ford Motor Co. enjoyed one of the best years in its history in 2013, but the celebration won't last long."
However, most of the expected decline is being driven by investments that will pay off in 2015 and beyond. Most notably, Ford is launching its next-generation F-Series trucks this year, and the associated plant downtime will limit supply of Ford's top cash cow. In fact, Ford's slight step back in 2014 is creating a path to record earnings in 2015.
Headwinds creep in
Ford's expected decline in profitability in 2014 will be driven by lower earnings in North America. The company has forecast that its loss in Europe will narrow and all other regions of the world will post similar earnings compared to 2013. (The Ford Credit lending subsidiary is also expected to deliver roughly flat earnings.) Thus, the expected drop in North American profitability must be sizable enough to more than offset improvements in Europe.
On Ford's recent earnings call, CFO Bob Shanks admitted that the introduction of the new F-Series trucks is the main culprit behind the expected decline in North American earnings. Ford produces the F-Series trucks at its Dearborn and Kansas City plants, and the Dearborn plant in particular will have 11 weeks of downtime this year due to the changeover.
With less production scheduled, F-Series sales are likely to dip in 2014. Furthermore, when the highly anticipated 2015 models hit dealer lots, Ford will have to offer discounts on 2014 models in order to help dealers clear their remaining inventory.
Ford executives have also pointed to pricing pressure as an additional headwind. The weak yen has allowed Japanese automakers like Honda Motor to become more aggressive on pricing in the U.S. However, the effect of this will be smaller than that of the F-Series launch, and will also be offset to some extent by the benefit of having a fresher product portfolio in 2014.
Looking for a rebound
Barring a global economic downturn, Ford is likely to see a surge in profitability in 2015, driven by solid improvements in its North America, Europe, and Asia-Pacific regions. In North America, the dislocation caused by the F-Series launch will be more or less over by 2015. In its place, Ford will have the newest full-size pickup lineup in the industry, one which is expected to deliver best-in-class fuel economy.
In total, Ford is launching 16 new or significantly refreshed products in North America during 2014. This will entail some initial launch costs in 2014 and have its biggest benefit in 2015.
Ford should also see a return to earnings growth in the Asia-Pacific region in 2015. Ford's profit in that area improved by nearly $500 million last year due to surging sales, particularly in China. Sales growth will be slower in 2014 due to capacity constraints, while investments in new factories and new models will hold earnings around 2013 levels. However, Ford should be able to leverage those investments in 2015, leading to higher earnings.
The biggest earnings tailwind of all for 2015 could be the return of Ford's European operations to profitability. Ford posted a pre-tax loss of $1.61 billion in Europe last year, following a $1.75 billion pre-tax loss in 2012. The loss is expected to shrink again in 2014. However, it will probably remain around $1 billion or more due to restructuring costs, such as accelerated depreciation on Ford's plant in Genk, Belgium, which will close at the end of this year.
In 2015, that accelerated depreciation cost will go away, and Ford will also save hundreds of millions of dollars in labor costs. Combined with Ford's plan to significantly update its product offerings in Europe, this could drive a more than $1 billion improvement in Ford Europe's pre-tax earnings in 2015.
As an investor, it's easy to be sucked into focusing on monthly sales and quarterly earnings results at the expense of longer-term trends. In Ford's case, the company's guidance for a lower pre-tax profit in 2014 may be causing some investors to miss the longer-term picture. However, many of the headwinds that Ford is currently facing are specific to 2014, and by 2015 the company could be posting record adjusted earnings.
Looking even further ahead, Ford has a very strong brand in the U.S., and the new F-Series trucks should ultimately solidify its lead in the pickup market. Meanwhile, Ford's European operations are improving and Asia remains a massive long-term-growth driver. Considering all of these factors, Ford stock seems very reasonably priced at less than 10 times trailing earnings.