Ford Motor on Wednesday reported a disappointing second quarter, missing earnings expectations by a wide margin as higher warranty costs ate into profits. We’re downgrading the automaker and sending its stock back to the penalty box in response to the reemergence of these quality problems. Automotive revenue increased 6% year over year, to $47.8 billion, beating analysts’ forecasts of $44.02 billion, according to estimates compiled by LSEG. Adjusted earnings per share fell 35% on an annual basis to 47 cents, falling well short of the 68-cent estimate, LSEG data showed Adjusted earnings before interest and taxes , or EBIT, declined 27% from last year to $2.76 billion, missing expectations of about $3.7 billion, according to estimates compiled by FactSet. Ford Why we own it : We’re in Ford due to management’s focus on getting out of money-losing businesses, increasing product quality and quickly shifting production based on consumer preferences. All of these factors stand to support higher earnings and cash flow over time, which will in turn lend themselves to greater shareholder returns via dividends and buybacks. Competitors : General Motors , Tesla and Stellantis Weight in portfolio : 2.33% Most recent buy : Dec. 29, 2022 Initiated : Nov. 24, 2020 Bottom line It was a frustrating quarter for Ford and shareholders alike, with shares down about 11% in extended trading Wednesday. That puts the stock on track wipe out its gains this year when the market opens Thursday. We came into earnings expecting a beat-and-raise quarter after crosstown rival General Motors posted strong results Tuesday. We also figured Ford would answer the call and announce a buyback program thanks to its strong cash flow and one of the lowest price-to-earnings multiples in the entire S & P 500 . However, Ford went 0 for 2 on Wednesday as an old enemy in warranty expenses returned to bite the Blue Oval. There also was no traction on a buyback — despite a pointed question on the matter from Morgan Stanley analyst Adam Jonas — as Ford argues it has many high-return areas to invest in. As we have for months , we will continue to press management to repurchase stock. It’s a disappointing outcome because the quarter would’ve been fine without those elevated warranty costs, which were related to vehicles for the 2021 models or older. And it’s an even more unfortunate setback because Ford management said on its April earnings call that the company has made “real progress” on its goal of making better vehicles. And this is true. Ford noted on the call that it moved up 14 spots to No. 9 in JD Power’s 2024 U.S. initial quality survey. However, these quality improvements are for newer models. The ghosts of Ford’s lower-quality past continue to haunt the company, overshadowing what should be a profitable time due to demand for internal combustion engine (ICE) and hybrid vehicles and the continued strength of its commercial business Pro. With no signs of a buyback coming and warranty issues popping up again, we see no other option but to put the stock back in the penalty box, downgrade our rating to a 3 and reevaluate this position within the context of the recent broader market sell-off. Quarterly commentary Ford Blue , which represents the company’s gas-powered and hybrid vehicles, was a mixed story. On one hand, volumes increased 3% and revenues were up 7% year over year, beating estimates, thanks to strong demand for both kinds of vehicles. Through the first half of the year, sales of its hybrid pickups — covering both the Maverick and F-150 models — grew more than three times the rate of the overall hybrid segment. However, profits fell roughly 50% year over year and came up about $1.3 billion short of estimates. The main issue? An increase in warranty reserves on its older cars. This isn’t a new phenomenon for Ford. It’s an issue the company has struggled with for years, dating back well before CEO Jim Farley took over in 2020. While progress has been made under his leadership, we remain disappointed that this issue tends to pop up every few quarters or so. This time around, management attributed the issue to new technologies, field service actions and inflationary pressures for repairs. Going forward, Ford expects the technology related costs to normalize. Sales at Ford Model e , the electric vehicle division, delivered weak results. Volumes were down 23% on an annual basis. Revenue fell 37% from last year to $1.1 billion on the lower volumes and industrywide pricing pressure. But operating losses were slightly better than expected and roughly flat year to year. We take no issue with the volume declines because Ford is losing money on these cars and capital can be better spent elsewhere. Ford understands this. Its recent decision to add 100,000 units of capacity of Super Duty trucks at a Canadian plant previously set for EVs is a good example. The best story at Ford remains Ford Pro , the unit that houses the company’s fleet and commercial vehicles. It delivered another strong quarter as volume and revenue were up 3% and 9% year over year, respectively. Operating profits increased 7% on an annual basis, beating estimates. While EBIT margins of 15.1% were slightly lower than expected, they were still within management’s mid-teen target. The strong results were driven by demand from commercial customers for Super Duty trucks and Transit commercial vans. Paid software subscriptions continue to grow, now totaling 765,000 from about 700,000 in the first quarter. Integrated services revenue is on track for double-digit growth in 2024, and management is targeting $1 billion of software revenue next year, a revenue stream that carries attractive gross margins of more than 50%. Full-year guidance Despite the second-quarter shortfall, the company continues to expect adjusted EBIT to be in the range of $10 billion to $12 billion. But last quarter management said the business was tracking toward the higher end of the range, and that no longer appears to be the case. Again, the issue is due to higher warranty costs, which forced management to trim its EBIT outlook at Ford Blue to the range of $6 billion to $6.5 billion. Previously, it was $7 billion to $7.5 billion. Offsetting this is higher profits at Ford Pro, which is now expected to generate profits of $9 billion to $10 billion, up from a prior range of $8 billion to $9 billion. Expected losses at Model e of $5 billion to $5.5 billion was unchanged. On a more positive note, management raised its adjusted free cash flow outlook for the year by $1 billion to between $7.5 billion and $8.5 billion. With $2 billion in cash and $45 billion in liquidity at quarter end, we continue to believe buying back shares at the stock’s single-digit price-to-earnings multiple would be a good use of cash. The company continues to expect full-year capital expenditures to be $8 billion to $9 billion. (Jim Cramer’s Charitable Trust is long F. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Ford Motor on Wednesday reported a disappointing second quarter, missing earnings expectations by a wide margin as higher warranty costs ate into profits. We’re downgrading the automaker and sending its stock back to the penalty box in response to the reemergence of these quality problems.
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