Ford Remains A Buy On Decisive European Restructuring

| About: Ford Motor (F)
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Last week, Ford (NYSE:F) unveiled a new restructuring plan for its European operations. The company expects to lose roughly $1.5 billion in Europe this year, and a similar amount next year, of which about $500 million is attributable to one-time items (accelerated depreciation on factories that are closing and a reduction in dealer inventory). The highlights of the plan are the closing of two small factories in the U.K. in 2013, as well as the planned closure of a larger factory in Genk, Belgium in 2014. The company will cut roughly 5700 positions through these actions, in addition to previously announced cuts of 500 white collar employees. The annual savings is estimated at $450-$500 million. Ford expects to return to profitability in Europe by 2015 as a result of these cost savings, gains in market share and gross margin as a result of new product introductions, and a modest rebound in the overall market.

On the conference call explaining these actions, Ford's management team stated that the company's capacity reductions will concentrate production in efficient and flexible "mega-plants." Capacity utilization will return to healthy levels above 80%, resulting in significant savings. Early reports suggested that the restructuring would cost roughly 1.1 billion euros, but Ford executives declined to give a concrete figure. The company's estimates of accelerated depreciation and severance costs suggest that number is in the right ballpark.

In an earlier article about Ford, I wrote, "I expect Ford to announce a detailed plan for cutting losses in Europe by the end of the year at latest, most likely at the time of the company's Q3 earnings release in October." As it turns out, Ford's announcement came a week before Q3 earnings, presumably because the company wants to focus squarely on earnings (rather than restructuring) this coming week. Ford's management did note that Q3 earnings will be up over Q2, which has led several analysts to raise their estimates over the past few days.

Ford's announcement demonstrates that management is willing to make difficult decisions and accept higher losses in the short-term in order to be successful in the long run. The plan will improve Ford's results regardless of competitors' responses. However, for Ford to achieve its long-term target of a 6-8% operating margin in Europe, struggling competitors such as General Motors (NYSE:GM), Fiat (FIATY.PK), Renault (OTC:RNSDF), and PSA Peugeot Citroen (OTCPK:PEUGY) will have to make deep capacity cuts as well.

Thus far, there has been limited movement in this direction. Peugeot has announced plans to close a plant in Aulnay (just outside of Paris), but its recent deal for support from the French government throws those plans into question, and rules out any further downsizing. GM has deals with its unions that prevent it from cutting capacity before the end of 2014. The company is on the verge of extending that pledge through the end of 2016 in exchange for a pay freeze. GM is expected to close its Bochum, Germany plant at the end of 2016, while relying on buyouts to manage costs in the near-term. Fiat closed a plant in Sicily last year, but is still plagued by vast overcapacity. While the company has cut investment in its plants, labor union pressure has thus far prevented Fiat from shutting another plant. Renault is in slightly better position, but is still struggling to produce positive cash flow in light of a recent downturn in sales.

Ultimately, I think competitive pressures will force Peugeot to go ahead with its factory closure, and I expect at least one additional plant closure (not including Bochum) in the next 2-3 years, most likely from Fiat. Ultimately, Ford is one of the strongest European mass-market automakers. If the economic situation gets much worse over the next year or two, Ford's competitors will be in much bigger trouble (and ultimately at risk of bankruptcy). Europe's cash-strapped governments will not have the wherewithal to rescue the weakest automakers if industry conditions become significantly worse. Therefore I expect a fair amount of industry rationalization despite Europe's traditional pro-union (i.e. anti-factory closure) bias.

I view Ford's decisive action last week as a significant positive for the stock. Ford's North American performance has been very strong, and the company is likely to see further gains this fall as the next generation Ford Fusion expands its market share in the big midsize car market. Europe has been a major overhang on the stock, and as investors become more comfortable with Ford's plan to address those losses, I expect the stock's multiple to expand. I still believe that Ford will reach $12 by year-end, and continue to rate the stock a buy.

Disclosure: I am long F, GM. 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.