Please ensure Javascript is enabled for purposes of website accessibility
Turnaround Letter
Out-of-Favor Stocks with Real Value

Ford Motor 4Q Results: North America, Ford Credit and Cash Hoard Carrying All of The Weight

Turnaround Letter-recommended car maker Ford Motor (F) reported lower fourth quarter and full-year results compared to a year ago.

  • North America Automotive and Ford Credit produced healthy profits, but Automotive in the rest of the world generated an $828 million loss. The full-year results showed a similar picture.

  • Ford is working to reverse its large losses, but progress is slow. Management is not providing much detail about how it will achieve its profit goals or even provide specific guidance on its expectations.

  • Reversing even some of the $2.6 billion in higher commodity and foreign exchange costs would go a long way toward improving Ford’s profit picture, but these are out of the company’s control.

  • Ford’s $23 billion cash hoard is helping support the $2.4 billion in annual dividends that are not covered by operating cash flow, but this can’t go on indefinitely.

  • While our patience is wearing a bit thin, we see a path to stronger profits. Ford’s low valuation and all-encompassing turnaround plans encourage us to retain our Buy rating.

Ford reported fourth quarter 2018 adjusted earnings of $1.2 billion, or $0.30/share, down 22% from $1.5 billion, or $0.39/share, a year ago. Adjustments included $1.3 billion, or $0.33/share, in pension and retirement accounting charges, costs for layoffs and closing the Chariot shuttle service acquired in 2016 for $65 million.

Ford’s overall fourth quarter revenues grew 1%, to $41.8 billion. Automotive revenues of $38.7 billion increased slightly from a year ago.

Compared to consensus, Automotive revenues were about 6% better while adjusted per-share earnings were in-line. Earlier this month, Ford pre-announced earnings that were lower than the consensus at the time.

Operating profits of $1.5 billion were down 28% from a year ago. Operating margins of 3.5% were significantly lower than the 4.9% margin a year ago.

For the year, operating profits of $7.0 billion were 27% lower than in 2017.

North America and Ford Credit are doing fine…

North America Automotive and Ford Credit produced healthy results in the quarter, continuing the recent trends.

North America Automotive revenues of $25.8 billion grew 7% and operating profits increased nearly 11%. Sales of more-profitable trucks, as well as higher prices per vehicle, helped boost profits. For the year, revenues grew 3.3%. While operating profits of $7.6 billion fell 6%, higher commodity costs of about $1.1 billion weighed on the results.

Ford is refreshing its North America product line, including re-introducing the mid-size Ranger line of trucks. The segment appears reasonably well-positioned in North America.

Ford Credit’s pre-tax profits in the fourth quarter ($663 million, up 9%) and full-year ($2.6 billion, up 13%) were the highest in eight years. Credit metrics and capital levels remain strong.

… while the rest of Ford is lagging badly

While representing only 33% of Automotive sales, the “rest of the world” produced $828 million in operating losses in the quarter. This was $692 million worse than last year’s fourth quarter. Full year results were just as bad: $2.2 billion in operating losses, down from break-even last year. Other key metrics, including revenue growth and market share, were weaker. Outside of North America, Ford’s automotive businesses are getting failing grades.

Ford China is hemorrhaging: bold changes needed

Ford China lost $1.5 billion in 2018, compared to a modest profit in 2017. Weak execution as well as a difficult market have hurt Ford’s results. To improve its operations, Ford separated its China business into a stand-alone unit led by the newly-hired Anning Chen, the capable former head of Chery Automobile. The company is launching new models as well as adjusting its production and cost structure.

The Chinese market has vast excess capacity. Some credible estimates put the industry’s capacity at 45 million units, compared to vehicle demand of about 30 million units. This supply glut, combined with modestly declining industry demand, is exerting powerful headwinds on Ford’s efforts to return to profitability. And, Chinese companies are introducing more sophisticated and original cars, further raising the competitive bar.

It is not clear when Ford will return to profitability in China.

Outside of China, mostly questions

At 21% of Ford Automotive revenues, Europe is its second-largest market. Full-year operating losses of $398 million were $765 million worse than in 2017. Despite better pricing, over $620 million in higher commodity and foreign exchange costs dragged down profits. Ford would be particularly hurt by Brexit, the exit of Britain from the European market. Also, the company faces an over-capacity market with only a 7.2% market share, competing against strong local rivals.

To help reach its goal of a 6% operating margin (about $1.9 billion in operating profits) in Europe, the company announced that it is cutting jobs, exiting some markets and terminating some unprofitable car models. Ford also is entering a joint venture with Volkswagen to cross-sell more vehicles. The 6% margin goal is laudable – but it will likely take a few years and more aggressive changes than have been announced so far. Perhaps they should exit all of Europe? Major improvements in commodity and currency costs would help considerably.

Ford’s full-year $678 million loss in South America is at least the fourth consecutive year of large losses in this region. The region comprises less than 4% of Ford’s automotive revenues. We question why Ford remains committed to this minor market. A closure would free up resources for higher-priority markets. Removing this cash drain could help reduce Ford’s debt or bolster its cash reserves for the inevitable recession.

Similarly, Ford’s Middle East & Africa segment, at only $2.7 billion in annual revenues, produces small and volatile profits. Its place in the company’s future is unclear.

Excluding China, the Asia Pacific region produced a $443 million profit in 2018, although down 13% from 2017. While the cost allocation among Asia Pacific markets isn’t disclosed, it appears that Ford is doing something right in these non-China markets.

The Mobility segment, which houses the various services and autonomous vehicle operations being developed, generated a $674 million loss for the year, larger than last year’s $299 million loss. While these projects are important, Ford is behind the curve, and the urgency of autonomous vehicles appears to be waning as the technology, regulatory and societal hurdles are much higher than the early hype implied. It may not make sense for the company to invest what amounts to 10% of its entire annual profits on these initiatives.

No specific guidance or targets for 2019 – creating a frustrating “trust me” approach

On the earnings conference call, Ford’s CEO, Jim Hackett, broadly described how 2018 was a foundation-laying year for the company’s global redesign. He also said that Ford has a “clear vision to improve profitability and returns” in 2019, but offered no specific guidance - only that more details would be forthcoming in future months. We think Hackett’s underlying mandate and mission make sense: to fundamentally redesign Ford’s business to make it inherently more profitable, faster-moving and require less capital to operate. But, without numbers, we find this “trust me” approach rather frustrating.

One clear source of improvement, although outside the company’s control, is its commodity and currency costs, which are exacerbated by import tariffs. Unfavorable changes in 2018 hurt operating profits by $2.6 billion.

Ford’s balance sheet is sturdy but operating profits need to increase

Ford has a $23 billion cash hoard aside from Ford Credit’s cash. This is many billions more than they currently need. However, as the company’s cash flow doesn’t cover the $2.4 billion in annual dividends, profits need to grow. Credit rating agencies see this cash drain and remain somewhat patient, although Moody’s is on the cusp of downgrading Ford to below investment grade.

With the shares recently trading at $8.71, Ford’s valuation is unchallenging. Assuming that Ford Credit is worth its book value, the automotive business is being valued at less than 3x automotive EBITDA.

For Ford to prosper, not to mention remain intact in any upcoming recession, it needs to take bolder, more concrete action faster. While our patience is wearing a bit thin, we see a path to stronger profits. Ford’s low valuation and vast turnaround plans encourage us to retain our Buy rating.

We continue to rate shares of Ford Motor Company (F) a BUY up to 20.

Disclosure Note: An employee of the Publisher owns F shares