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Morningstar | Ford's 3Q Contains Some Bright Spots but Improvement Probably Not Coming Until 2019

Ford's third quarter showed no results to require a fair value change, so we are leaving our fair value estimate at $12 per share. Adjusted diluted EPS of $0.29 beat consensus by a penny but declined by 34% year over year while adjusted total company EBIT margin of 4.4% declined by 190 basis points. The automotive segment's EBIT declined 25.4% to $1.4 billion as a $1.1 billion volume and mix tailwind (almost all from a mix shift to light trucks) could not offset a $1.2 billion cost increase from commodities, warranty costs, and other variable cost increases, as well as a $453 million headwind from foreign exchange in South America and Asia and continued poor results from Chinese joint ventures. We calculate free cash flow excluding Ford credit of negative $600 million. Ford Credit had a great quarter with pretax income of $678 million, up 13%, for the unit's best quarter in seven years, driven by better than expected residual values on off-lease vehicles and strong growth in volume and mix.

We've seen lots of media reports on the dividend's future, as well as received client inquiries on it. We continue to think Ford's regular quarterly dividend is safe. On the call, management stressed its long-standing philosophy that the dividend will be at a level that can be maintained at any point in the economic cycle, and seemed frustrated that its messaging on the dividend has been lost. The special dividend, in our view, is likely to take a year or two off in a recession. Ford Credit is very healthy and will be paying dividends back to the parent of around $1.5 billion and the company still has automotive cash of about $23.6 billion. We see no reason to cut the dividend, which is about $2.4 billion annually. Barring a recession, Ford's numbers should improve, especially in the back half of 2019, as launches of the new Escape, Ranger, Explorer, and Lincoln Aviator begin recouping their costs via sufficient volume.

We are glad to see management keep its 2018 adjusted EPS guidance of $1.30-$1.50 despite a weak Chinese market and North American steel and aluminum price increases that will likely remain a problem for the fourth quarter. Despite these price increases, which are an indirect result of U.S. imposed steel and aluminum tariffs (Ford sources its metals from America), North American EBIT margin came in flat at 8.8% while segment EBIT grew $136 million to $1.96 billion. Strong pricing from the F-Series pickup and the new Navigator and Expedition SUVs mitigated a $290 million segment headwind from commodity costs and $351 million in higher warranty spending. Total company commodity headwinds for the quarter were $403 million versus third-quarter 2017.

Ford China lost $378 million in the quarter compared with a $483 million loss in the second quarter and a $102 million profit in the third-quarter 2017. This segment is partly equity income from joint ventures and also consolidated operations for vehicles exported from North America into China, such as the Explorer and Lincoln vehicles. Third-quarter Chinese equity income was negative $38 million compared with a positive $241 million in the prior year's quarter. Ford's lineup there is stale and Chinese industry volumes fell 10% in the quarter due to the absence of tax stimulus and the government's crackdown on peer-to-peer lending. Ford will be launching 50 new vehicles in China by 2025, the new Territory SUV for western and central China is the latest new model, but we do not expect major Chinese profit improvement this year.

Ford is combating its China problems by gradually increasing local production to avoid 40% tariffs on U.S. auto exports to China, investing in Chinese led engineering, and has formed alliances for electric vehicles with Zotye. Ford announced on Oct. 23 that China will become its own standalone business separate from the Asia segment, with its CEO reporting directly to Jim Farley, president of global markets and (in our opinion) the next CEO of Ford. The company also announced on Oct. 23 that it has hired former Chery CEO and former 17-year Ford employee Anning Chen as president and CEO of Ford China starting Nov. 1. Chen also was former Chairman of Chery Jaguar Land Rover in China and has extensive engineering, purchasing, and operations experience. We like the move as he sounds like the type of executive Ford China needs right now. The unit lost its leader in January when Jason Luo abruptly resigned for personal reasons after only a few months on the job.