Ford's Future Outside of Europe Very Bright

 Ford Motor Company (F) reported third-quarter results Tuesday morning that far surpassed consensus expectations. We see the excellent performance in North America as evidence that our investment thesis of a recovering United States market driving earnings is still in place. We are leaving our fair value estimate unchanged.

Ford posted record third-quarter consolidated and automotive pretax profit with earnings per diluted share excluding special items of $0.40. Consensus was for EPS of $0.30 and revenue of $30.9 billion. Third-quarter revenue declined 3% from the year-ago period to $32.1 billion. The earnings were again almost entirely driven by North America. Ford North America posted what we consider outstanding results with an operating margin of 12% compared with 8.6% a year earlier. It should be noted that the year-ago quarter included a $350 million commodity hedging charge and we calculate 2011's third-quarter North American operating margin to be about 10.6% excluding this charge. For this year's third quarter, Ford incurred a $100 million gain on commodity hedging; excluding this gain, we calculate North American operating margin as 11.4% rather than 12%. Gains and losses from commodity hedging are not recorded as special items.

We find this year's third-quarter North American results encouraging, given that Ford's U.S. market share declined to 14.8% from 16.3% during the same quarter in 2011. The results show the importance of volume as the U.S. seasonally adjusted annualized selling rate (SAAR) was 14.7 million in 2012's third quarter compared with 12.7 million during the comparable 2011 period. The higher volume offset the negative market share impact by $200 million. Another approximately positive $400 million pricing contribution and approximately $500 million from commodities, materials, warranty, and freight helped Ford's largest division post an operating margin comparable to the best automakers in the world. This was also the third-straight quarter that Ford North America's pretax profit exceeded $2 billion and margin exceeded 10%. Also important is that North America's year-to-date earnings of nearly $6.5 billion through the third quarter are higher than the segment's full-year 2011 profit of $6.2 billion.

This strong North American performance was crucial, given that the rest of the world was not very positive for Ford. Its South American division still feels the squeeze from a dramatic volume decline and the strong dollar against the Brazilian real. This segment posted only $9 million of profit compared with $276 million in the year-ago period. The region's unit sales volume did increase by 400,000 units year over year to 5.8 million vehicles, but Ford's wholesale volumes fell 12% due to low availability of new products. Materials and commodities also weighed on segment results as did a $223 million unfavorable contribution due to foreign exchange.

Ford Europe, as discussed in detail in  our Oct. 25 note, will have full-year losses in 2012 and 2013 exceeding $1.5 billion each year. The third-quarter loss in Europe was $468 million and the segment has lost just more than $1 billion through Sept. 30. Management guided on the earnings call that Europe will have $300 million in lost contribution margin from not restocking dealer inventories as the company normally does after the summer shutdowns. Current inventory levels for Ford Europe's dealers are about a 39 days' supply compared with the normal 50 days, but CFO Bob Shanks said the new normal going forward will be about 40 days. The Asia-Pacific/Africa segment generated $45 million of profit in the quarter while Chinese unit sales increased 35% year over year to 148,000 units. Asia-Pacific/Africa generated more than enough improvements from volume, mix, and pricing to offset higher structural costs and higher material costs. Ford Motor Credit continues to see much lower earnings, as previously guided, due to far fewer lease terminations in 2012. The finance arm's third-quarter profit declined 36% from third-quarter 2011 to $388 million. The captive is expected to pay a dividend to the parent of $600 million for full-year 2012.

We continue to see Ford's future outside of Europe as very bright, especially since the key U.S. market is, in our opinion, still well below normal sales levels but growing each month. Its balance sheet remains strong with total liquidity of $34.4 billion at Sept. 30 and automotive net cash increasing $400 million from June 30 to $9.9 billion. Credit lines account for $10.3 billion of the total liquidity and we like seeing that Ford continues to address its underfunded pension by contributing $2.5 billion year to date as of Sept. 30.

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