Investors in Ford (NYSE:F) were unpleasantly surprised by the first-quarter earnings report released last week. Earnings took a hit as a result of a range of one-time charges related to weather, warranties and adverse currency moves.
With uncertainty regarding the CEO position having been resolved after appointing Mark Fields as the new CEO, investors can look forward to a well-positioned Ford for 2015. Next year should become a very strong year on the back of growth, cost cuts and new product introductions. Shares do offer value when showing any significant weakness.
Headline Results Reveal A Troubled Start To 2014
Ford generated first-quarter revenues of $35.9 billion, up a percent compared to last year. Actually, deliveries were up by a little over 6% to 1.59 million units, as average wholesale prices fell to roughly $22,500.
Charges and lower operating earnings put pressure on reported earnings. GAAP earnings fell by 39% to $989 million, with diluted earnings per share falling sixteen cents to $0.24 per share.
Earnings took a beating on a variety of items. For starters, Ford recorded $400 million in warranty costs in the U.S., as ever more complex cars and increased use of technology raises the warranty risks of the manufacturer. The harsh winter, which resulted in higher freight costs, shaved off another $100 million in earnings, while notably, the currency devaluation in Venezuela was expensive, costing another $400 million.
Asia Drives Growth
Ford's growth has been driven by its Asian, and especially its Chinese, operations. Revenues were up by 18% to $2.6 billion, as unit shipments increased by 32% to 350,000 vehicles for a modest average wholesale price of $7,400 per vehicle.
Operating earnings came in at $291 million, resulting in very decent operating margins of 11.1%, as Ford's market share in China improved by 90 basis points to 4.5%.
Its North American operations performed a little less well compared to a strong first quarter last year. Revenues slipped by 5% to $20.4 billion. Operating earnings dropped to $1.50 billion as operating margins fell by 380 basis points to 7.3%. A lower market share, a smaller U.S. market and higher costs related to weather and warranties explain the drop in earnings.
Another major disappointment came from South America, as revenues dropped by 17% to $1.9 billion. Lower volumes explain roughly half of the revenue decline, with the remainder coming from depreciating currencies. As a result of inflation and higher costs, Ford reported a huge $510 million operating loss, resulting in operating losses being equivalent to 27% of total revenues.
The troubled European business performed relatively well, although it is still bleeding cash. This is after the market grew in the quarter, while Ford managed to boost its market share. Revenues rose by 18% to $7.8 billion, driven by healthier volumes. Operating losses more than halved to $194 million, resulting in operating losses of 2.5% of revenues. The loss is partially driven by $122 million in restructuring costs. Note that despite the revenue increase, Ford is continuing to downsize its operations.
While the first quarter was soft, the vehicle production guidance for the second quarter is decent. Production is expected to increase towards 1.7 million cars, up from a produced 1.61 million vehicles in the first quarter.
This does not mean that Ford is out of the woods yet. The company is seeing some struggles in recent times, notably in South America and North America. North American operating margins are seen at 8%-9% this year, which means that things will have to improve throughout the year after reporting margins of 7.3% in the first quarter.
South America will no longer be able to break even this year following the first quarter, while Europe and Asia can create some unexpected upside.
During the quarter, Ford managed to bolster its industrial balance sheet, which excludes the asset and liabilities of the financing business of the car maker. Ford ended the quarter with $25.2 billion in cash, while holding $15.7 billion in industrial debt, resulting in a net cash position of $9.5 billion.
This strong balance sheet alleviates any short-term earnings concerns. Ford continues to aim for operating earnings of $7-$8 billion in 2014, as 23 new global vehicles are expected to impact the profitability of the business in the short term.
Despite the modest sell-off in the wake of the earnings release, Ford still trades just below $16 per share, valuing the car maker at $63 billion. While net earnings are seen between $4-$5 billion this year, this values the business at roughly 14 times earnings. Excluding the solid net cash position, the valuation drops to 12 times earnings.
After recently hiking its dividend by 25% to $0.125 per share, investors stand to receive a 3.2% dividend yield.
Short-Term Challenges Ahead Of 2015
The harsh winter, currency devaluations and warranty charges all depressed earnings in the short run. Notably warranty charges are necessary and a prudent move by Ford after witnessing how much scrutiny General Motors (NYSE:GM) received lately. GM showed no urgency in response to its faulty ignition switches. Profitability is also under pressure due to higher incentives being offered on older models, as Ford has to sell its inventory ahead of the launch of many new models.
The continuation of improving trends in Europe and strong demand in China, combined with the line-up of new models should position Ford well for a very strong 2015. Furthermore, one can assume that outgoing CEO, Alan Mulally has been cleaning up the house, taking so many incidental charges in the first quarter, so incoming CEO and Ford veteran, Mark Fields can start his tenure with a clean sheet.
In my eyes, Ford offers compelling value at significant dips.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.