Ford's 1Q Shows North America Will Be the Story in 2012

 Ford Motor Company (F) reported first-quarter pretax results Friday of a $2.3 billion profit, or $0.39 per diluted share, which beat consensus estimates of $0.35. Revenue decreased 2.1% year over year to $32.4 billion, which still beat consensus of about $31.3 billion. We are leaving our fair value estimate in place as the recovery we anticipate for the U.S. market appears to be taking hold. Ford North America contributes nearly all of the company's automotive earnings.

Automotive operating margin did decline year over year to 6.4% from 7.7%, as there was a flat contribution from volume and mix while net pricing only increased automotive pretax income by $200 million from the first quarter of 2011. Materials and overhead costs more than offset the small improvement from pricing, which resulted in automotive pretax operating profit of $1.8 billion compared with $2.1 billion in the prior year's quarter. As for Ford Motor Credit, its results declined as expected to $452 million of pretax income from $713 million in first-quarter 2011. We expect the captive will continue to be hurt by a lower volume of vehicles coming off-lease, which can then be resold for profit. We expect this comparable to improve starting next year as 2009 was the bottom for U.S. new vehicle sales at 10.4 million units; thus, the supply of vehicles coming off-lease should gradually improve. Management also does not expect any production disruptions due to the PA-12 resin shortage following a March 31 supplier plant explosion in Germany.

This quarter showed a trend in automotive that we expect to mostly continue for the rest of the year--that is, North American results were quite strong but other markets declined from the prior year. In the first quarter, all geographic markets outside North America had lower results than a year ago, with only South America profitable. Europe lost $149 million, which was better than management expected, but the company continues to guide for a full-year loss in Europe of $500 million-$600 million. We expect Europe to be ugly for nearly all automakers for the foreseeable future because governments kept their cash-for-clunkers subsidy programs in place for several years, even into 2011. Ford plants generally run three shifts in Europe, so actual capacity utilization is likely far below the two-shift 93% figure given on Friday's call. South America is forecast to be profitable for full-year 2012 but at a lower level than 2011. Automakers from both developed nations and emerging markets are flooding Brazil with capacity, which is leading to pricing competition. Ford South America did post year-over-year gains from volume, mix, and pricing of $77 million, but these were more than offset by a negative materials cost contribution of $118 million and a $93 million unfavorable foreign exchange contribution. Segment operating margin declined severely to 2.3% from 9.1% in first-quarter 2011. We agree with management that the second half of this year should see Ford South America posting improved results as the new Ranger truck and new EcoSport small SUV will be profitable new programs in the region by that time. Ford's Asia Pacific and Africa segment is also guided to be profitable for the full year thanks to the Ranger launch in the Thailand factory and other new models. For first quarter, however, the segment saw major headwinds from materials and overhead costs, which offset the strong $143 million year-over-year improvement from pricing.

These international results are not ideal, but we think it is important to focus on the improvements shown by Ford North America. The segment had its highest quarterly profit since at least 2000, when it was first reported separately, and its operating margin increased 120 basis points year over year to 11.5% despite market share declining 80 basis points to 15.2%. The reason for the $300 million increase in North American auto operating profit to $2.1 billion is that modest gains in volume, mix, pricing, and lower freight costs more than offset higher engineering and other overhead costs. Management has made it clear that Ford North America is the key reason why it expects consolidated pretax operating profit to be flat in 2012 over 2011 but automotive pretax operating profit to increase. Full-year U.S. industry sales (after we back out 300,000 units for medium- and heavy-duty trucks) are forecast to be between 14.2 million and 14.7 million vehicles. This outlook is higher than our range of 13.8 million-14.2 million but not an unreasonable assumption.

Also noteworthy is that the company announced a voluntary pension buyout offer for all approximately 90,000 U.S. salaried retirees and former U.S. salaried employees. The funds for the buyout will come from pension plan assets rather than from Ford's $23.1 billion automotive cash and marketable securities balance. However, the company did contribute $1.1 billion to its plans during the quarter and has previously said it will contribute about $3.5 billion in cash this year. The exact acceptance rate of this buyout offer is too uncertain at this time but the total salaried participant liability is about one third of the U.S. plan's $48.8 billion projected benefit obligation. The buyouts are expected to be completed during 2013. It is possible that eventually a buyout offer could be extended to the hourly participants, but this would first require delicate negotiations with the UAW. The salaried plan has been closed to new hires since 2004.

Finally, the balance sheet remains strong with net automotive cash at $9.3 billion compared to $9.8 billion at year-end. Automotive cash slightly increased sequentially but automotive debt increased by $600 million, mostly due to a $500 million draw on loans from the U.S. Department of Energy. Total liquidity was $32.9 billion at March 31. Ford has recently seen a lot of positives in its capital allocation and capital structure. The first quarter saw the company resume its dividend (last paid in 2006) and Ford received an extension of its credit facility with $9 billion committed through November 2015. Also, this week, Fitch upgraded Ford to investment-grade, which Morningstar has already done, and the company should eventually see lower borrowing costs for its auto operations and the captive. Lower captive financing costs will likely lead to more vehicle sales as Ford can offer consumers more attractive lease offers and finance more consumers.

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