Why Ford Is Unhitching Hertz

The spin-off is just the first step in the carmaker's efforts to rebound. But with its market share declining, it needs hit models fast

By Kathleen Kerwin

It looks like Ford Motor (F ) is getting serious about regaining traction. Its announcement June 13 that it plans to spin off part of its wholly owned Hertz car-rental subsidiary in an initial public offering is only the first act in the auto maker's efforts to build up its balance sheet and win back disenchanted investors.

Though the Securities & Exchange Commission filing is for a nominal $100 million in Hertz shares, Ford says it will eventually sell its entire Hertz stake. Analysts and investment bankers say the world's largest car-rental company could fetch as much as $6 billion, and its strong cash flow could attract a private-equity buyer.

MISSING A MILESTONE.

  "Ford is battening down the hatches," writes Merrill Lynch analyst John A. Casesa in a June 14 note to investors. "Like GM (GM ), it faces enormous pressure to increase spending on new models and new technology."

The carmaker jolted Wall Street in late April when it revealed that the best its auto operations can hope for this year is breakeven. It blames the rising costs of steel, oil, and health care, a weak U.S. dollar, and intense price competition in autos.

At the same time, CEO William Ford Jr. announced the company won't achieve its long-standing turnaround milestone of earning $7 billion pretax next year. Even Ford's $1.2 billion first-quarter profit was a 38% plunge from a year earlier. Shortly after that, Standard & Poors dropped Ford's credit rating to BB+ with a negative outlook, lowering the outfit's debt to junk-bond status.

STRONGER SECOND-HALF?

  Analysts are expecting Ford on July 19 to report weak second-quarter results for what is typically the year's strongest period. Thomson One Analytics' consensus of 15 analysts' estimates averages a $238 million profit, down 79% from a year earlier. One simple way to look at it: Ford cut its auto production by 5% from 2004's second-quarter level. And since carmakers book revenue when vehicles are shipped to dealers, low output translates directly into lower earnings.

Ford executives say they expect improvement in the second half of 2005, as the auto maker begins cranking out new models this summer. Even so, Ford plans to build only 730,000 vehicles in the third quarter, down 2% from a year earlier. For the full year, Ford is forecasting a profit of $2.3 billion to $2.7 billion. Thomson's analysts' average estimate is $2.1 billion.

Unless Ford can find a way to make money across most of its vehicle portfolio -- not just on a few hot segments -- it will face the same downward spiral that confounds General Motors. Barring a string of solid hits, Ford, too, will be battling its unions to close more factories so it can match its capacity to its dwindling market share.

SHRINKING SHARE.

  Lately, Ford's biggest profit engine has been its finance arm, Ford Credit. In the first three months of 2005, Ford Credit earned $710 million -- nearly 60% of Ford's total profits. But its managers keep warning that while the finance division's prospects are good, it won't be able to sustain the recent pace. Ford Credit Chief Financial Officer Dave Cosper cautioned investors early this year that 2004 "was a record year, and we're not going to continue at that level."

At least Ford's May 25 pact with Visteon, the parts operation Ford spun off in 2000, though costly, removed the sword that had been hanging over Ford's financial prospects. The deal calls for the auto maker to take back 24 factories from Visteon. Ford plans to close some plants, sell others, and buy out as many as 5,000 union workers. Ford says it will take a special charge of $450 million to $650 million this year. Still, the company says the deal could yield parts savings of as much as $700 per auto by the end of the decade -- an assertion some suppliers consider overly optimistic.

Ford's underlying problem is declining sales of cars and trucks, coupled with eroding profit margins. Since the start of the decade, Ford has lost 5.6 points of U.S. market share -- more than any other carmaker -- to hit its current 18.9%. Gas prices and the increasing number of crossover, or car-based, SUVs are taking their toll on traditional sport-utilities, which were Detroit's mainstay in the 1990s.

FEWER BLOCKBUSTERS.

  So far this year, sales of Ford's Explorer, Expedition, and Excursion traditional SUVs are down 24% -- even more than the 15% decline in that segment industrywide. Even Ford's top seller, the F-series pickup truck, which had record sales of nearly 940,000 in 2004, is down 6% this year.

Worse, profit margins on the truck sales that remain are being squeezed by prolific competition. Ford executives freely admit that the era of huge profits from traditional SUVs are long gone. "We knew the halcyon days would end," Bill Ford told reporters in April. "Back then, if you made a ton on pickups and SUVs and lost money on the smaller stuff" the company still minted profits.

The answer, he says, is to stop banking on a handful of home-run trucks and instead make sure that every vehicle in the outfit's portfolio contributes a decent return. Says CEO Ford: "We're going to hit a bunch of singles."

Still, at the moment, it's hard to see how Ford can recoup those lost truck profits in other segments. Last year's Mustang is a runaway hit, with May sales up 47% from a year earlier. However, sales for most of Ford's other new models have been ho-hum.

Take the Ford Five Hundred sedan, launched last fall to replace the fading Taurus. A solid, but unexciting entry in a crowded field, the Five Hundred's sales have been slow to gain momentum. Even now, that model, along with the Freestyle wagon version and Mercury's Montego, are selling at an annual pace of 190,000 cars -- still below the 200,000-plus Ford hoped to sell and the 250,000 cars annually that its factory could build.

THIS YEAR'S MODELS.

  Perhaps the best news for the company: The Ford Fusion, Mercury Milan, and Lincoln Zephyr family sedans arriving this fall (all a bit smaller than the Five Hundred) are drawing a positive buzz from analysts and the motoring press. "Our biggest improvement is going to come when the Fusion and its sister products hit the road," says CEO Ford.

Whether those gains are enough to put this auto giant back on the path of profitability and restore its standing with investors is another question.

Kerwin is a senior correspondent for BusinessWeek in Detroit

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