Ford reported third quarter 2018 adjusted earnings of $1.17 billion, or $0.29/share, down 34% from the year-ago earnings of $1.74 billion, or $0.44/share. Adjustments included $183 million, or $0.04/share, of pre-tax and tax-related items.
Ford’s overall revenues grew 3%, as did Automotive revenues which exclude Ford Credit and the new Mobility division which generated a tiny $8 million in revenues.
Compared to consensus estimates, automotive revenues were about 5% better, and per share earnings were 4% better.
Overall operating margins of 4.4% were significantly lower than the 6.3% margin a year ago.
North America Automotive doing fine but International Automotive is struggling
North America revenues were $22.3 billion, up about 6% from a year ago. Operating profits were $2.0 billion, up about $100 million from a year ago. The operating margin of 8.8% was unchanged. We believe that the underlying margins are actually stronger, but are being diluted by Ford’s aggressive and necessary spending to catch up to competitors in electric/hybrid vehicles.
Helping Ford is the increasing preference of consumers for trucks and utility vehicles over passenger cars – Ford has a strong position in these higher-margin products. Also, many of new CEO Jim Hackett’s productivity initiatives are being implemented first in North America. While difficult to isolate each of their effects, we believe that much of the quarter’s strength is from market positioning, buying time for more significant productivity improvements later. Ford’s North America business is the heart of the company – this segment needs to remain healthy and continue to improve to allow the remaining geographies to undergo the transformation that Hackett is implementing.
International operations are struggling. While revenues of $12.4 billion fell about 2%, profits fell to a $558 million loss, a reversal from the year-ago profit of $55 million. Only the Middle East & Africa segment generated a profit (modest, at $47 million). Asia Pacific lost $208 million compared to a profit of $314 million a year ago, driven by sharp declines in China as industry-wide car volumes fell 10%.
Ford Europe sales grew modestly, but losses grew to $245 million, compared to a $53 million loss a year ago, as difficult conditions in Russia and Turkey, along with costs related to the launch of the new Ford Focus, weighed on profits. Passenger cars dominate the European vehicle market, making this an important launch for Ford.
South America results were largely unchanged from a year ago and remain unprofitable (producing a $152 million loss in the quarter). Middle East & Africa sales of $600 million were down about 7% but profits surged to $47 million from a loss of $56 million a year ago. Ford sees tremendous opportunity in these markets, particularly Africa, and is likely to push more aggressively there.
Ford China – potentially big changes underway?
Asia Pacific operations outside of China produced a healthy 9% profit margin. Overall results were dragged down by China, in both the company-owned and joint venture operations. The Chinese car market is ailing from the re-instatement of the purchase tax. Consumers had purchased cars ahead of the new tax, so the subsequent slowdown is producing a surplus of vehicles. We’re a bit surprised that Ford didn’t adjust better to this readily-foreseeable change. Ford believes its inventories are now in better shape and is introducing a number of new and fresh models to re-invigorate sales.
Ford received some promising news on October 29th that China is proposing to cut its automobile tax by 50%, which could boost demand there meaningfully.
More significantly, Ford is separating its China business into a stand-alone segment. This makes strategic sense as China is large enough and unique enough to merit its own entity. It also gives Ford the ability to isolate and aggressively manage China, particularly with its complex legal and operating challenges. Longer term, Ford could theoretically manage China completely separately from the rest of its global operations, spin off its China operations or prepare for a situation in which the Chinese government demands unusual concessions.
We note the recent hiring of Anning Chen in the newly created position of CEO Ford China. Chen is deeply established in the Chinese auto industry, with tremendous operating and strategic expertise. Previously, he was CEO of Chery Automobile, the major Chinese car company that also owns Jaguar and Land Rover. This looks like a good move on Ford’s part.
The Mobility segment, which focuses Fords efforts in autonomous vehicles and other communications and tech services, produced a $196 million loss, weaker than the year-ago $72 million loss as investments ramp up.
Ford Credit continues to show impressive results, earning $678 million in pre-tax profits, its strongest quarter in seven years. Credit metrics look solid. Much of Ford Credit’s lending is for leased cars. Encouragingly, the company is receiving healthy prices when it auctions off its cars that come off-lease.
The company maintained its earnings guidance for the full year 2018. However, it said it will no longer reach its goal of 8% operating margins or high teens ROIC by 2020. For reference, the third quarter operating margin was 4.0% and the Return on Invested Capital (ROIC) for the trailing four quarters was 8.2%.
Ford’s cash flows improved from a year ago, largely due to timing differences and working capital reductions. For the year, Ford will not likely be able to cover its $2.9 billion in dividend payments with operating cash flow from its automobile operations alone. The company’s balance sheet, excluding Ford Credit, is sturdy, holding $23.6 billion in cash, partly offset by $14.7 billion in debt.
Transformation – Faith needed as visibility is murky at best
CEO Jim Hackett’s mandate and mission makes sense: to fundamentally redesign Ford’s business to make it inherently more profitable, faster-moving and require less capital to operate. Ford fell noticeably and broadly behind its competitors in new technologies. We agree that nothing short of a fundamental redesign will suffice, particularly in a global car industry struggling with chronic over-capacity.
We think Hackett has the capability to successfully lead the redesign. His involvement is at the strategic level, reflected in his deferring questions about details to CFO Robert Shanks. Our preference is to have the CEO be more involved in the operational details. We recognize that the task at hand involves a very complex manufacturing and marketing business with 175,000 global employees, 65 production facilities and over $150 billion in revenues generated from selling over 6 million vehicles a year. We also appreciate this complexity in light of Tesla’s difficulties with even the most basic elements of producing cars. So, we are accepting that Hackett’s approach almost requires him to delegate most of the detail-work to trusted lieutenants.
Jim Hackett has been CEO for about 17 months, not nearly long enough to complete the redesign nor to fully grasp all the scope and depth involved. We are patient with the pace of his progress, recognizing that it might take a few years to fully implement.
However, considerable faith is necessary to stay with the story – but which the market is understandably lacking. Progress with its redesign is murky. North America is farthest along with its changes but we would like to see it produce more profits and cash flow to provide some tangible evidence and to provide the financial cushion to absorb the ongoing losses from the international operations.
Ford’s investments in electric cars and new mobility technologies hopefully is not detracting from car-building basics. Many of the anecdotes that Hackett provided on the conference call were encouraging, but at some point the market will want to see tangible evidence of improvements. Ford lost market share in all of its markets around the world – it has new models ready for launch, but this also requires some patience by investors. Similarly, Ford’s proactive plan to essentially phase out passenger cars in North America makes sense now, but if gasoline prices return to $4/gallon, or if a recession crimps consumer demand for expensive trucks, the merits of this plan could unravel.
The company is noticeably avoiding providing much detail on its restructuring. This is frustrating, especially in light of its admission that not only will it fail to reach its 8% operating margins goal by 2020, but that it won’t provide a new target date for these goals.
Ford reiterated its full-year guidance for $1.30-$1.50 in per share earnings. This is somewhat encouraging but we have little visibility into the components that will produce it.
Management reiterated their commitment to the $0.73/share in annual dividends. We note that this approximately $2.9 billion payment will exceed the free cash flow from its automotive operations this year. Ford Credit upstreams sizeable payments to Ford Motor parent company, so the dividend isn’t immediately at risk. But investors worry that a sharp downturn in auto profits would threaten the dividend, especially as Ford wants to maintain its investment grade credit rating.
With the shares trading at $8.98, valuation is unchallenging. Assuming that Ford Credit is worth its book value, the automotive business is being valued at 3.5x automotive EBITDA.
We continue to rate shares of Ford Motor Company (F) a BUY up to 20.