Here’s How Ford Motors Can Be Impacted By A Mexico Import Tax

Ford Motors (NYSE:F) has been investing heavily in Mexico, building new factories in the region to take advantage of the lower cost of manufacturing due to the lower wage rates in Mexico. In April this year, the company had announced an investment of $1.6 billion in a new plant in Mexico to produce small cars, where production would start in 2018. However, with the recent changes in the U.S. political landscape and president-elect Donald Trump’s proposed 35% import tariff on Mexican goods, the economics of this plant have become clouded. Ford is looking to move small car production to Mexico where labor costs are significantly lower than the U.S. This makes commercial sense for low margin small cars, to boost profitability of this segment. However, an additional import tariff of this magnitude can reverse this benefit and affect Ford’s profits negatively. We believe that, as an increasing number of automakers shift production to Mexico to take advantage of the low production costs, punative import tariffs could significantly impact their margins, if they (as is likely) unable to pass this tariff on to consumers.

Negative Impact On Margins, Higher Price Point

In 2015, Ford built 433,000 vehicles in Mexico which is around 14% of its North American production. The company is now looking to add 500,000 units of annual Mexican capacity from its new investments in Mexico, starting 2018. According to our estimates, Ford’s total revenue from its North American car division in 2016 will be around $21 billion. If we assume conservatively that at least 20% of this revenue will come from cars produced in Mexico (given that  Mexico accounts of nearly 14% of North American production) that would account for around $4 billion and a 35% tariff on this amount would be around $ 1.4 billion. This is nearly one third of Ford’s estimated net income of $3.72 billion for 2016, as per our estimates.

Our conservative estimate indicates a significant impact of the import tariff on Ford’s bottom line. Given Ford’s production capacity in Mexico and the planned increase, this impact could be much higher. If Ford plans to pass on this tariff to the consumers, it would increase the average price of its vehicles, impacting the company’s competitive position and market share.

While imposing an import tariff on cars imported from Mexico is currently just an intention of the president-elect and it will need approvals to be implemented, it puts Ford Motors in a difficult position. The uncertainty around the new policies might impact Ford’s stock price in the short term. However in the longer term, the company’s ability to make necessary changes to keep production costs lower despite new policies will be critical to drive profitability.

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