Ford's Turnaround on Track, but Not Complete

Ford (F) was primed to beat expectations when it reported its second-quarter earnings on Thursday morning, July 23. After all, two of its chief rivals are just out of bankruptcy, the company just received its best car-quality ratings ever, and its executives and workers seem determined to survive the recession without a government bailout.

Indeed, Ford reported a surprise $2.3 billion net profit for the second quarter, a huge improvement over its year-ago loss of $8.7 billion for the quarter. That was made possible by a $3.4 billion gain from the company's reduction of debt; on an operating basis, without that, Ford lost $424 million, or 21¢ a share. Still, the consensus estimate of analysts, according to Thomson Reuters (TRI), had been that Ford would post a second-quarter operating loss of 53¢ a share.

But the Dearborn (Mich.) automaker isn't out of the woods yet. Its car-making operations aren't profitable yet. And it hasn't had the benefit of being relieved of many billions in debt through the bankruptcy process, as has General Motors. But what Ford does have going for it is momentum, say analysts, that should position it better than its Detroit rivals in an economic rebound. "The company is doing a lot of things right," says Merrill Lynch analyst John Murphy.

Liquidity Not a Problem

Ford has, in fact, increased its total share of the U.S. auto market to 16.1% in the first half of the year, up from 15.5% a year earlier. (It reached 18% in June in part because of a spike in sales to car-rental fleets, as Chrysler was not selling any vehicles.) The big worry is how much cash the company is burning and the $25.5 billion debt it is carrying. Ford used up $3.7 billion in cash reserves in the first quarter. In the latest quarter, it cut that burn rate to $1 billion, and ended the period with $21 billion cash on hand.

Ford's debt will rise to $40 billion by 2011, according to a July 17 e-mail from Himanshu Patel, a New York-based analyst for JPMorgan Chase (JPM). At an event Tuesday previewing Ford's 2010 model line, Chief Executive Alan Mulally told reporters that the automaker was on track in dealing with its debt. "We have a sufficient amount of liquidity to finance our entire transformation," Mulally said. "As we continue our road to profitability, the cash flow will just accelerate the improvement of our balance sheet."

While GM and Chrysler slashed debt through court proceedings—inGM's case, from $70 billion to less than $17 billion—Ford has been doing it in the market. The company last April sliced nearly $10 billion off its debt load, a move that will save $500 million a year in interest payments, through a series of restructuring initiatives, including swapping some equity for debt. That task became easier as Ford shares climbed more than 500% since last November, when it reached a low of 1.01 per share. Ford shares closed at 6.40 on July 22. The shares have more than doubled this year, for the third-largest gain in the Standard & Poor's 500-stock index.

More Debt Retirement Possible

A few analysts have target prices on Ford shares of above 8 a share. Indeed, the momentum behind Ford's shares may move the company to issue more shares to retire more of its debt.

Ford, like all automakers, has been hammered by the 35% falloff in U.S. car and truck sales during the first half of the year. The industry is on track to sell 9.8 million cars and trucks this year, compared with an annual average of 16 million from 2000 through 2007. The company has been radically downsizing without the knife of bankruptcy court to speed things along, cutting employees, consolidating manufacturing at fewer plants, and reducing the cost of developing future products.

Ford economists are starting to project that auto industry sales next year could be as high as 13 million units, as pent-up demand returns to the market. If true, that rebound could accelerate Ford's targets for breaking even (by the end of 2010) and turning a profit (in 2011). Ford posted losses totaling $30 billion from 2006 through 2008, including a company record of $14.7 billion last year.

All-New Taurus on the Way

And Ford seems better positioned than GM, Chrysler, and even Toyota (TM) to benefit from an upturn in the auto industry. Merrill Lynch recently issued its annual report on the industry titled Car Wars in which analyst Murphy estimated that Ford will refresh and redesign its lineup of vehicles in its showrooms at a considerably faster rate per year—28%—than GM or Toyota. "New products are the lifeblood of market-share gains and Ford is very well-positioned to take advantage of a comeback in auto sales," said Murphy.

Ford this year will launch an all-new Ford Taurus sedan; a Lincoln crossover, the MKT; and a European van it hopes will attract both business and consumer interest, the Transit Connect. Next year, Ford introduces to the U.S. the Fiesta subcompact, which it already sells in Europe and Asia. Already, Ford is benefiting from higher retail prices, as buyers opt for more high-trim models with advanced technology and creature comforts. "Even with lower sales, we are seeing tremendous progress in our revenue per vehicle," said James Farley, Ford's chief of marketing.

Ford's total revenue this year is expected to reach just $112 billion, compared with $173 billion in 2007. That is due to not only the dramatic sales downturn, but also the sale of its Jaguar and Land Rover units. But Merrill Lynch estimates that Ford's new product lineup is strong enough to return the company to sales of $150 billion by 2011.

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