One More Reason Why Ford Will Report Lower Than Usual Profits In The Second Half of 2016

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We have written previously about why we expect Ford Motor Company (NYSE: F) to report lower than usual profits in the third and fourth quarters of fiscal year 2016. The combined impact of the defective door-latch vehicle recalls and the potential fallout of Brexit will result in lower pre-tax profits. However, even without the impact of these two factors, we were expecting lower than usual profits from the U.S. auto maker for the coming quarters. The reason for that is the launch of the 2017 version of Ford’s Super Duty pick-up truck.

Costly Revamp

The usual accounting method employed for new vehicle launches means that all expenses related to a vehicle can only be recorded when the product is sold. This means that design, engineering and testing expenses related to the new pick-up truck will show up in Ford’s income statements when the vehicle is launched. However, this is not so unusual. More notable is the fact that Ford’s outgoing Super Duty pick-up was made on tooling and machinery from at least twenty years ago. When new tooling and machinery is developed, companies usually capitalize the costs related to building those items, i.e. they add them to their assets and slowly expense them over the life time of the product as depreciation and amortization. Once the investment is paid off, these costs no longer appear on the income statement. This was true of the outgoing Super Duty truck, but the new truck will be made on the same aluminum stylings used for the 2016 version of the F-150 series of trucks that led to the closure of two Ford factories for re-tooling in 2015. The costs of building the new tooling and machinery for the Super Duty truck will be expensed in small installments from the transaction price Ford can command for the new version of these trucks.

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Lower Profits

Usually, new model launches are more profitable as the newer models can be sold without incentives for a short period of time, leading to higher transaction prices and thus higher margins. In the case of the Ford Super Duty, those higher prices will be offset by the higher costs that will recorded for them in the third quarter as well as running into the next few years until the investments related to its manufacturing process are paid off. To be sure, these costs won’t be as high as what the production of the aluminum bodied 2016 version of the F-150 pick-up cost Ford. That process involved a series of negative events, including: 1) the shut down of two factories; 2) production decrease of at least 90,000 units lower than usual; 3) higher inventories at dealerships; 4) higher incentive payments and dealership compensation; and, 5) increased over-time shifts and thus higher labor costs. Another factor that can offset these costs is the strength of the U.S. truck market, which can allow Ford to command slightly higher prices. But the likely impact is that the profits in the coming quarters will be lower.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Ford Motor

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