Fiat Chrysler's (NYSE:FCAU) profits jumped 69% in the second quarter, largely on the strength of big truck and SUV sales in the U.S. Now, with one month of the third quarter now in the books, that trend looks set to continue: FCA's U.S. sales rose another 6% in July, thanks to, yes, another big leap in Jeep sales.
Jeep's U.S. sales rose 23% last month, the brand's 22nd consecutive month of year-over-year sales increases. Given the fat profit margins that most automakers get on their SUVs, the boom in Jeep sales should be a great sign for FCA's profits.
But in the past, FCA's sales gains haven't always translated into profit gains because of the automaker's heavy use of incentives. Has that changed?
Incentives are part of the business -- but they can be dangerous
"Incentives" are those cash-back or cheap-financing deals that automakers often advertise on TV. They're funded by the automakers. Some level of incentives are normal and healthy. And some market segments -- full-size pickups, for example -- require more incentives than others.
Incentives are just part of the business of selling cars, and automakers build some allowance for incentives into their pricing. But sometimes, some automakers spend aggressively on incentives in an effort to boost sales. But those sales boosts come at the expense of per-sale profits.
All three of the traditional Detroit automakers have been guilty of that in the past. That's one of the reasons they all ended up in dire financial straits last decade. But during the last few years, General Motors (NYSE:GM) and Ford (NYSE:F) have made efforts to reduce their reliance on incentives. The result: Much stronger profit margins.
General Motors managed a pre-tax profit margin of 10.5% in North America in the second quarter, while Ford posted a margin of 11.1%. For both, profits in North America have been paying the bills while they undertake much-needed restructuring and expansion efforts overseas.
FCA is scrambling to pull off a global restructuring of its own; it needs a dose of the same medicine. Its sales of pickups and SUVs have been strong for months. Those products should have been generating fat profits. But FCA was making heavy use of incentives, apparently to meet aggressive internal sales goals.
After a dismal first-quarter result during which FCA's operating profit margin in North America was just 3.7%, CEO Sergio Marchionne said that the company would take immediate steps to improve profitability in North America. He didn't quite come out and say it, but the strong hint was that the days of fat incentives would be coming to an end.
Those efforts started to pay off in the second quarter. FCA's operating profit margin in its North America business unit, which it refers to as "NAFTA," was 7.7% in the second quarter. Pretax earnings in the region rose by 732 million euros ($798 million), of which Improvements in "net pricing" -- which includes incentives -- contributed 351 million euros ($382.7 million), FCA said.
But how are FCA's incentives looking now?
Incentives are an expensive way to boost sales
According to estimates from TrueCar, FCA's incentives were at 11.4% of its average transaction prices back in March, as the first quarter ended. That's high: GM's were at 9.3%, Ford's were just 8.7%, and the industry average was 8.4%.
Last month, FCA's incentives were at 10.5% of its average transaction prices, TrueCar estimates. That's still on the high side, but it's much closer to the industry average, which rose to 9% in July. FCA and industry levels were similar at the end of the second quarter, in June.
A drop from 11.4% to 10.5% sounds like a small move, but a closer look at the numbers shows that it was a big deal. FCA sold 178,027 vehicles in the U.S. in July. TrueCar estimates that the average transaction price of those vehicles was $32,369. The difference between 10.5% of average transaction prices and the 11.4% that FCA was paying in March adds up to about $57 million worth of incentive payments.
That's roughly $171 million per quarter. And that doesn't include additional discounts that FCA may have been giving its dealers behind the scenes.
The upshot: More changes are needed, but FCA has already made progress
Here's the takeaway: FCA still has a lot more work to do to boost profitability in North America (and around the world). Its incentives are still high, and that's a big factor in profitability. But they're already lower than they were just a few months ago, and that seemingly small change is already making a big difference.
John Rosevear owns shares of Ford and General Motors. The Motley Fool recommends Ford, General Motors, and TrueCar. 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.