Ford’s Investments Will Impact Short Term Profitability But Promise Long Term Rewards

In Q1 2014, Ford Motors‘ (NYSE:F) earnings dropped by nearly 40% on the back of high warranty costs, currency losses in Venezuela and high freight, and labor expenses to overcome the harsh winter conditions in the U.S. ^[1] Since then, the company has gained momentum with U.S. sales in May up 3% year-on-year and China sales up 14% year-on-year. ^[2] We expect this trend to continue as the company plans to rollout 16 new or refreshed models in the U.S., including the revamped version of its best selling F-150. However, given the extra cost associated with the changeover of the F-150, the automaker has been cautious on the 2014 outlook. ^[3] Ford anticipates its North American operating margins to slide to 8-9% this year, as a result of these extra expenses. ^[1] There could also be some pressure on its pricing as the company battles opportunistic pricing from the Japanese automakers such as Toyota and Honda. Now that the yen has devalued by more than 25% in the last twelve months, Japanese companies have the cushion to cut the prices of their vehicles.

Nevertheless, the company is making several investments in order to boost its profit generating capacity. These include the discontinuation of its E-series line of pick-up trucks in the U.S., which will be replaced by the Transit line, the best-selling light commercial vehicle in Europe for the last 40 years. This move is part of the efforts to consolidate the North America and global vehicle lines. Additionally, the company is making investments in factories in order to grow its production capacity in North America and Asia-Pacific, and introducing pick-up trucks with aluminum bodies in order to comply with the fuel-efficiency standards required by the U.S. regulators. Below, we take a look at the rationale behind these investments and analyze the impact they might have on the company’s bottom line.

We have a $17.66 price estimate for Ford, which is in line with the current market price.

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Transit To Replace E-series

On the face of it, the decision to replace the highly successful E-series seems an odd one. It was the highest selling commercial van in the U.S. in 2013, recording over one-third of the total sales of the entire category. ^[4] The E-series has been the best selling commercial van for 32 straight years, selling more than 8 million units. ^[5] But the Transit series comes with a similar pedigree albeit one that it has built up in Europe. In addition, the Transit affords the company much more flexibility: it can be offered in front, rear or all-wheel drive. It is a lighter vehicle and offers a near 25% improvement in fuel-efficiency on account of its low weight. ^[5] It comes in multiple body styles, roof heights and engine options, thereby increasing the range of options available to the customer. Most importantly, switching to the Transit line will enable the company to cut down on expenses, while being able to offer more frequent product refreshes and cope better with increasing regulatory expenses. Even though, the different safety standards required by U.S. and European lawmakers mean that the same car sold in both regions has different dashboards, the standardization of the manufacturing and design process should help the company achieve a greater economy in its operations.

Ford announced plans of a $168 million investment in Ohio Assembly Plant, where it will begin the production of its 2016 F-650 and F-750 medium-duty trucks in early 2015. ^[6]  The company will also undertake a $500 million investment to make engines at the same plant. The new engines will be used in Ford’s best selling F-150 pick-up trucks. ^[7] These investments will allow the company to boost the production of its Super Duty models, from the F-250 to F-550.

Aluminum Body Trucks

Ford’s F-series accounts for nearly one-fifth of its U.S. sales. But the company will be losing the production of about 90,000 F-series pick-ups as it undertakes a re-tooling of factories for aluminum bodied trucks, that it hopes will boost profitability in the long run. ^[8] In order to compensate for the loss in production, the company is building up the inventory of F-series pick-ups with its dealers. It is offering 100 days worth of supply in advance, much higher than the industry average of 60 days. In addition, Ford is also offering heavy discounts on the same. In order to keep margins from being affected too much, these discounts are somewhat lower than those being offered by competitors such as GM.

The shift from steel bodies to aluminum bodies will help lower the weight of Ford’s pick-up trucks, thereby boosting fuel efficiency. Additionally, the new lightweight trucks will come with a 2.7 liter turbocharged engine, making it the lowest in-class displacement power train. ^[8] The drop in production and the discounts on available inventory will affect the company’s sales and profitability in the near term, but a refreshed product should help it get back on track in the coming year, maybe even allow it to boost its market share.

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1. Ford Motors’ CEO Discusses Q1 2014 Results, Seeking Alpha, April 2014 [↩] [↩]
2. Ford’s China Sales Rose 14% In May, Wall Street Journal, June 2014 [↩]
3. Ford Sees ‘Building-Block Year’ After ’13 Profit Gain, January 29, 2014, bloomberg.com [↩]
4. Commercial Van Sales In America – December 2013 YTD, GoodCarBadCar, January 2014 [↩]
5. How Ford Plans To Phase Out The Best Selling E-Series, Autoblog, December 2011 [↩] [↩]
6. Ford Motors To Invest $168 Million In Its Ohio Assembly Plant In Avon Lake, Crain’s Cleveland Business, March 2014 [↩]
7. Ford investing $500 million to make new engine at Ohio plant, Reuters, March 2014 [↩]
8. Ford to Forgo 90,000 F-Series Trucks in Move to Aluminum, Bloomberg Businessweek, June 2014 [↩] [↩]