Ford Posts Lower Q2 Earnings Due to Deteriorating European Markets

Ford posted its second-quarter 2012 financial results early yesterday (26 July), coming in below Wall Street estimates owing to continued difficulties abroad, especially in the European and Asian markets. Ford posted a USD1.04-billion after-tax net income for the quarter, down 56.6%, or about USD1.4 billion, from the second quarter of 2011, according to the company. Revenues were down for the quarter, dropping 6.5% year-on-year (y/y) to USD33.2 billion from USD35.5 billion in the same quarter 2011. This was thanks largely to a decrease in production, with wholesales falling from 1.519 million in the second quarter of 2011 to 1.447 million in the most recent quarter. This decline in production came as Ford struggles with a continued economic recession in Europe, and faces extremely tough competitive situations in China and other parts of Asia. Through the first half, Ford's performance came in worse than the year-ago period, with net income falling 50.8% at the half to USD2.436 billion, half what it was at this point in 2011, with global revenues falling 4.2% from the first half of 2011, from USD68.6 billion to USD65.7 billion. The company continued to generate positive but smaller cash flow as well, to the tune of USD800 million for the quarter, boosting the company's gross cash on hand to USD23.7 billion.

"The Ford team delivered another solid quarter driven by the strength of Ford North America and Ford Credit," said chief executive Alan Mulally in a statement. "We have faced challenging situations in other parts of the business before, and successfully addressed them through our One Ford plan," said chief financial officer Bob Shanks of the company's European situation in particular. "We will continue to use our plan as the guide to address challenges and opportunities in our valued European operations," Shanks said.

North America again proved to be a source of strength for Ford in the second quarter: the company achieved a near-record pre-tax operating profit of USD2.010 billion there, thanks to continued strong sales and better pricing mobility. Better pricing, volume, and mix were offset by higher commodity prices and structural costs. Interestingly, the gains in net income came despite only a mild improvement in revenue from the year before, coming in at USD19.7 billion, up just USD200 million from the second quarter of 2011 as Ford has struggled to boost production to match demand. Also in the positive column is contribution being made by Ford Credit, the company's captive financial arm. Ford Credit posted a pre-tax result of USD447 million, down from the USD602 million it made in the second quarter of 2011, but still a strong showing that helped offset significant losses in much of the rest of the world.

Unfortunately, North America was the only place in the world that Ford performed well in the second quarter. Ford was barely profitable in South America, with second-quarter results ringing in at just USD5 million, a dramatic decline from the USD267 million earned in the year-ago period. Ford cites competition, unfavourable exchange rates, lower sales volume, and higher costs for the slowdown in South America. Revenue was down as well, falling USD600 million to USD2.3 billion in total for the quarter. Ford's Asia-Pacific Africa region swung from breakeven in the second quarter of 2011 to a loss in the same period of this year, falling from a USD1 million net profit in the year-ago period to a USD66 million loss in the most recent quarter, despite higher wholesales and greater revenue. Revenue jumped from USD2.1 billion to USD2.3 billion in the quarter, and wholesales grew by 24,000 vehicles to 250,000 for the region. The company still points to competition and start-up costs for expansion in the region as the main culprit keeping profits elusive.

Ford's European operations posted the worst results however, with a whopping USD404 million loss on dramatically lower revenues of USD7.1 billion, as opposed to a USD176 million profit on USD9 billion in revenue for the second quarter of 2011. Wholesales fell by 63,000 units for the quarter as the company put the brakes on production in order to try and reduce dealer inventory stocks that have become bloated in the region. Ford said that the outlook for Europe is not a positive one either, with the real possibility that the region could turn in a stunning USD1 billion loss for the year. Company spokespeople say that the executive staff is acutely aware of their difficult situation in Europe. "We are reviewing all areas of our business to address the near-term challenges, while ensuring we build a strong foundation for our future," said Shanks, adding: "It is premature to discuss details of what our plans may be in response to the situation in Europe, but we will continue to communicate our plans at the appropriate times with all of our stakeholders."

Outlook and Implications

Ford's second quarter is not what most people expected, with the failing European markets having a far greater affect than was generally known. It was known that Ford, like just about every other automaker is struggling as European markets continue to wallow in recession, with fears of increasing financial instability in the market being exacerbated by austerity measures in many markets that are decimating consumer confidence. The surprise to many is how poorly Ford is doing—it was generally believed that General Motors' (GM) Opel division was in dire conditions, having replaced the top executive there earlier this year and moving on several other top managers in recent weeks as the company works to reorganise and dig itself out from a cost and capacity glut. To find that Ford may lose a billion dollars in the European market alone is surprising to many, and the sentiment is being reflected in Ford's stock price, which has fallen nearly 50% from the start of 2012, closing below USD9.00/share in trading yesterday.

Ford's issues are not unique to the company however, and are indicative of larger issues throughout the European market. Nearly everyone is having a capacity issue, as nobody has closed plants during the 2008/9 Great Recession downturn in Europe like was done in North America. No major restructuring was undertaken, and in fact new plants were still built in lower-cost areas like Eastern Europe and Russia, adding more capacity for the region while existing facilities with expensive labour were not dealt with as they otherwise might have been. This is a testament to the strength of the unions in these markets as well as laws in many countries that make it exceedingly difficult or even illegal to close plants. Whereas the automakers might have been able to enlist government help to do so in the previous recession, as they did with North American governments, now the situation has become much more difficult, given the backlash being faced against such measures and the layoffs already occurring across the region due to government austerity measures undertaken by several countries.

If there is a positive side to this, it is that the man who helped guide Ford back from the brink and through the worst global economic disaster in the last 80 years is still at the helm of the company, and still has the confidence and devotion of the entire organisation. Chief executive officer Alan Mulally has not spelled out exactly what the plan is to fix the European operations, but he has dropped a few subtle hints that have suggested where the plan may go. He has insisted that the issues are structural, and not market driven, meaning Ford will need to address issues of plant utilisation, labour costs, and product offerings in order to gain back profitability. That sentiment was echoed by the chief financial officer, who said that it is not a matter of slashing and cutting in order to return to profit, but one of revenue generation and addressing structural issues. Mulally also stated that Ford would be engaging "all of its stakeholders" in its endeavour to right the ship, suggesting to many that Ford will be taking on the strong unions in the region in order to come to a solution. How tough that becomes is yet to be seen, but Mulally has a very strong history of dealing with difficult unions at Boeing; his ability to get along with the United Auto Workers (UAW) leadership was as much a testament to the union leadership as his own negotiating tactics, but the European unions are likely to be much more confrontational given the support many enjoy among European governments. Regardless, this is not going to be a quick or easy process, and it may be well into 2013 before the results of it start to show up, but there will indeed be a process as Ford is not likely to give up on its European market anytime soon.