Poor Bill Ford – William Clay Ford Jr. that is. His car company reports a quarterly profit that leaves analysts' consensus estimates in the dust, and how does the market respond? Like someone handed it a hot radiator cap. Instead of flocking to the stock, investors headed for the exits, pushing the shares down by almost 5 per cent. Why the glum response? It might have something to do with the fact that almost all of Ford's profit came from its financing arm, not its actual car business, and even the profit it did report had more to do with accounting than Ford's operational efficiency.
At first glance, the auto maker's results appeared outstanding. It reported a net profit of $1.2-billion (U.S.) or 57 cents a share and a profit on continuing operations of 61 cents a share, well ahead of the 50 cents most wall Street analysts were expecting and up 160 per cent from the same quarter last year. Ford also raised its profit outlook for the full year by 15 cents to between $1.80 and $1.90 per share (excluding one-time items), which is still below the consensus estimate. Revenue rose more than 5 per cent to $42.8-billion.
So why the thumbs down from the market? Take a look under the hood. As the analysts at Goldman Sachs put it in their research report on Ford, the company has an “attractive paint job, but underneath [it's] a bit of a clunker.” The biggest issue was that virtually all the auto maker's profit came from its financial services arm, Ford Credit. Instead of the $900-million pre-tax profit that analysts were expecting, Ford Credit made $1.5-billion, twice what it made last year in the same period.
And what about the automotive business, the one that Ford has been involved in for the past 100 years or so? The company had a loss of $57-million in its automotive group. Even if you exclude $140-million in one-time items, Ford only made a profit of about $83-million – miles away from the $500-million or so most analysts had projected – on sales of more than $36-billion. In case you're keeping score, that's a return of two-tenths of one per cent. Cash flow was weak at $100-million, down from $700-million in the same period last year. Is it any wonder investors aren't excited?
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The main culprit is the bags of money that Ford and its fellow auto makers have to shovel out the door in order to convince people to buy their cars and trucks. At last count, Ford was providing rebates or discounts of more than $3,500 on every car it sells – and during the latest quarter, it sold 1.75 million vehicles. That works out to an incentive program worth about $6-billion in the most recent quarter alone. Ford isn't the only one hooked on what one analyst has called the automotive version of crack cocaine, of course. U.S. competitors General Motors and DaimlerChrysler are as bad or worse when it comes to incentives.
Some investors might wonder what the big deal is about Ford's profit coming entirely from its financing arm. After all, a profit's a profit, isn't it? It is – but many industry experts are concerned that the company can't seem to make any money on its main business, and is relying too much on low interest rates and easy credit to keep its balance sheet looking healthy. As UBS put it in a research note. it's “hard to get excited about these gains as they essentially borrow earnings from future periods.” Ford Credit makes up just 20 per cent of the company's revenue, with autos at 80 per cent.
And Ford's profit improvement didn't just come from its financial unit, it also involved some favourable accounting moves. For example, UBS estimated that the company's profit was boosted by about $200-million from a reduction in loan-loss provisions. The amount booked in the latest quarter was more than 75 per cent lower than in the same quarter a year earlier. Another thing that raised warning flags for some analysts was that Ford provided a profit target in June of between 40 and 50 cents a share, only to turn in results that beat that estimate by 30 per cent – but all the upside came from the financial unit, where returns are supposed to be more predictable.
The biggest issue, however, as Goldman Sachs pointed out, is that the reliance on credit to carry the entire ball creates a substantial risk for Ford. The amount of profit reported by the financial side was ‘well above normal,” Goldman said, as a result of short-term factors such as lower reserves and an “unsustainably steep yield curve” (the difference between short and long-term interest rates), combined with a low tax rate. Until Ford shows that it can make decent amounts of money actually selling cars and trucks, it will be hard for investors to get very excited about the company.