Higher Expenses And Currency Fluctuations To Compress Ford’s 2014 Profits

Ford Motors (NYSE:F) caught the market with surprise as it announced a cautious profit outlook for 2014. The automaker now anticipates next year’s pre-tax profit to be in the region of $7 billion to $8 billion, down from an estimated $8.5 billion in 2013. ^[1] Ford cited incremental costs associated with the launch of new models as the reason why its profits will remain subdued next year. The automaker will roll out 23 new models globally in 2014, including the revamped version of its best selling F-150 pickup.

Ford also expects currency fluctuations in South America to eat into its profits. The Venezuelan currency could drop to 12 bolivars per dollar, from the current exchange rate of 6.9 bolivars per dollar, according to the company. If this turns out to be true, it can have a negative effect of $350 million on the company’s pre-tax earnings. ^[2] The latest outlook puts to risk the automaker’s goal of achieving operating margins of 8-9% by mid-decade. Shares of the company tanked 6% after the announcement.

We have a $18.66 price estimate for Ford, which is about 20% more than the current market price.

The one-time costs associated with model makeovers will affect Ford’s North American operating margins. Next year, the automaker estimates the margins to drop to 8% to 9%. These figures are still pretty solid since anything above 10% is considered excellent in the automotive industry. Through the first three quarters of 2013, Ford’s North American operating margins stood at 11.2%. ^[3]

The competition is immense right now as rival automakers such as GM and Chrysler have emerged out of recession and are reviving their respective product portfolios. Automakers have no option but to keep spending in order to gain any competitive edge.

Spending Is Good

Cutting down on research or capital expenses may seem like a tempting option in the face of tightening cash flows but history shows that automakers who continue to reinvest their money into product development and model upgrades are the ones who eventually profit from it.

Take GM for example. The automaker introduced a total of 20 new or refreshed vehicles under the Chevrolet brand this year. The new introductions are helping the company sell more vehicles and realize a firmer pricing. GM’s North American margins stood at an impressive 9.3% in the latest quarter. For the first nine months of the year, GM’s North Americans are up 20 basis points to 8.0% despite incurring extra expenses associated with model makeovers. ^[4]

Mercedes is another example. Extra expenses associated with model makeovers compressed its profits in 2012 and in early 2013. But now, the company is in a healthier position, with operating margins rising to 6.6% in the third quarter. Furthermore, the margin outlook remains positive. During the first quarter, the automaker’s margins had plummeted to 3.3% on account of higher expenses related to model introductions.

Similarly, Volkswagen stepped up its spending on building newer technology post 2008, when most automakers decided to trim their spending. Now, the automaker is one of the most profitable companies in the world. The automaker isn’t finished yet. It is spending a staggering 84 billion euros (~$116 billion) over the next five years to develop new vehicles and cleaner technologies, in order to meet its target of becoming the largest automaker in the world by 2018.

The above examples highlight that the extra expenses generally hurt profitability in the near term. In the long term, automakers stand to gain from these investments if their products are well received by the customers. Therefore, Ford’s decision to pour in investments should be taken in a positive light. It highlights that the automaker is ready to take up the challenge offered by its rivals and and is not shy of spending money.

Overall, it has been a pretty good year for the automaker. Ford’s North American sales have consolidated, its European losses have shrunk and its sales in China have surged. Shares of the company have gained more than 20% since the start of the year. ^[5]

See full analysis for Ford Motors

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Ford Cautions About Earnings Growth, December 18, 2013, wsj.com [↩]
2. Ford says profit to slow a gear in 2014; shares slump, December 19, 2013, economictimes.com [↩]
3. Ford 10-Q [↩]
4. GM 10-Q [↩]
5. Google Finance [↩]