- Sales are likely to report in-line, but sales figures are questionable due to inventory figures.
- Revenue is also being driven by higher pricing, and emerging market growth.
- Further improvement to margins seems unlikely this year and investors should be cautious on second half commentary.
It’s actually really hard to get a solid read going into the upcoming Ford Motor (NYSE:F) earnings announcement. The company seems to be executing solidly on cost recapture with operating margins that are a lot healthier than the industry average. However, the level of growth anticipated by analysts in Q1’16 is what’s a little alarming (12.4% y/y growth).
Also read: Ford Stock A Good Long Term Opportunity
Some of this revenue growth is attributed to inventory build as opposed to dealer sell through to end consumer. Furthermore, credit metrics on autos have been stable, so much of the froth up going into earnings is attributed to pricing on financed auto loans, and inventory build-up. The revenue is generated from wholesale channels, so dealers are likely footing the bill to hold onto a higher number of cars. There’s supposed to be some pent-up demand for consumer credit in Q2’16, but without confirmation of vehicles exiting the sales channel, investors should be cautious on Q2’16 revenue.
As you can tell (blue line) the amount financed for new auto loans has increased quite healthily from Q1’15. I believe that’s what’s driving sell side models, as the average new vehicle pricing was $27,000, which now compares to $28,000 thus driving margins/revenue for Ford in Q1’16. The pricing was aggregated industry wide. Ford’s commentary of refresh in some of its product lines drove pricing last year to an all time high. Ford was able to increase transaction prices by $2,200 over the prior year in Q4’15. This implies that Ford is outpacing the rest of the industry 2:1 despite pricing sensitivity for cyclical durable goods in general.
Source: Credit Suisse Research
As it currently stands, Ford has built up a lot of inventory going into Q1’16. Again, building up inventories is okay over the short-term, because Ford technically sells into the channel at wholesale, in which they finance their dealers via their credit segment. Since Ford books the revenue immediately from wholesale transactions the extra inventory build-up still translates to higher sales for the company in Q1’16.
It just means that the remaining quarters in the fiscal year will have weaker comparisons, because of the incremental time needed for inventory to exit the channel. The company’s inventory is 38.3% above normal, according to Credit Suisse estimates, which implies 67 day’s supply for the industry or in the case of Ford, 87.129 days (rough estimate).
Source: Yahoo Finance
As you can tell, sales are expected to moderate quite significantly following Q1’16. So, the guidance on sales becomes a lot more crucial. Furthermore, Ford doesn’t provide full-year or quarterly guidance, so you will have to watch the preliminary monthly sales reports the company releases prior to the Q2’16 earnings announcement.
The year-to-date march sales grew by 8.6% (again a lot of that due to inventory build). The remaining improvement to top-line estimates will be driven by pricing improvements and mix shift to trucks (which have higher pricing). The remaining operating segments are also improving with Europe in recovery and China leading the operating segments. The Latin America segment is expected to decline by roughly 5% to 10% (commentary from FY’15 wasn’t specific). That being the case, the company is on track to deliver on top line results despite questionable implications for rest of year results.
The company is also an earnings themed story as the management team has consistently improved its cost structure in a lot of geographies. However, there seems to be an upper limit to what is realistically attainable this year.
Here’s what management stated at the Bank of America Merrill Lynch Auto Summit Brokers Conference:
We had our best operating margins since at least the 1990s. We saw a big improvement in our risk profile. We got all parts of Ford other than South America, profitable for the first time since I think 2010ish. So that was a great accomplishment for us and specifically for the European team because they finally got back to profitability. And it was in line with what we had expected when we launched the European transformation plan, back in 2012. We had targeted ‘15 for profit and they actually delivered that. And I think it’s kind of interesting about that, it was done despite the fact that Russia of course, subsequent to 2012 when we developed the plan, went into a very deep recession, driven by commodity cycle and probably sanctions on top of that.
Given the heavy dependence on low oil prices to drive truck and utility vehicle volumes and the un-compelling guidance on margins for the next-year, analysts have modeled 1.6% EPS growth this year. The company is expected to report an EPS of $0.46 in Q1’16, which is quite high from prior year. The EPS is expected to quite literally double in the current quarter from prior-year, so much of the earnings sensitivity is in 1H’16 as opposed to 2H’16.
Investors will need to watch this quarter closely as it will set the tone for the rest of the year. I’m not really concerned by the auto sales figures or the margins. But rather the remaining portion of the year as inventory levels are going to decline some point down the line. Hopefully it will be due to better than expected demand, but if not, the drop-off in sales is already modeled into analyst estimates. You can also watch Amigobulls' Ford stock analysis video.