Ford Motor Co.'s Secret Weapon Pulls Through Again

Ah, Ford Motor Company's (NYSE: F) secret weapon. The entity responsible for some of the most misguided bear arguments out there, and also responsible for the vast majority of company profits outside of its North America region, is none other than Ford Credit. The interesting thing about Ford Credit is that it's an incredible source of profits for the company, but that can quickly turn sour if used vehicle prices plummet faster than expected. Let's take a look at the stronger than expected quarter Ford Credit posted, and if used pricing concerns remain.

Show me the money

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Just to put in perspective how important Ford Credit is to the company's overall business, here are a few figures to digest. Investors know North America is the profit engine, hands down, and the region generated $2.2 billion in pre-tax profits during the second-quarter 2017. South America and the Middle East & Africa regions posted respective pre-tax losses of $185 million and $53 million. Europe and Asia Pacific mustered together small respective pre-tax profits of $88 million and $143 million.

How does Ford Credit compare, you ask? Ford Credit generated pre-tax profits of $619 million during the second-quarter. Not only is that more than all of Ford's regions outside of North America combined, its $219 million pre-tax profit increase over the prior year was more valuable to the bottom line than any region outside of North America generated in total.

What's the problem?

Those bottom line figures put in perspective how important Ford Credit is to the automaker's profitability. But the drawback is when this competitive advantage turns into a disadvantage: that happens when used car prices plummet faster than anticipated, leaving Ford Credit on the hook with losses as it sends off-lease vehicles to auction.

"Lease residuals are flat. I think that's a victory. That's been one of the biggest headwinds of the business now for quite a number of quarters, but as it has been written about by many of you and others in the media, we are seeing less of a downward draft on auction values than what we had expected, and certainly that's reflected here." said Bob Shanks, Ford's Chief Financial Officer & Executive Vice President, during Ford's second-quarter conference call.

Aside from lease residuals, other Ford Credit metrics improved as well. Its managed receivables jumped 6% driven by retail financing and Ford Credit's average FICO score has moved 6 points higher year-to-date from 737 to 743. But the lingering question for Ford's secret weapon: is there concern going forward?

In the clear?

The answer is unquestionably yes, there are still concerns. Bob Shanks also noted on the second-quarter call that while residual values have held up in auctions better than expected, he still expects annual declines in auction values around 6% going forward. He also goes on to note that the values earlier in 2017 had to round down to 6%, and now the values round up to 6%. Those basis points make a huge difference, and as long as residual values decline slightly less than anticipated it's a serious victory.

That said, more off-lease vehicles are set to flood the market, and how residuals react to that is anybody's guess -- it all depends if the markets have enough demand to absorb the vehicles. Bank of America Merrill Lynch analyst, John Murphy, predicts 3.5 million vehicles to come off-lease this year -- compared to estimates of about 17 million new light vehicle sales for the full year -- and that number could rise to 5 million annually by 2021. That's a lot of substitute products that could easily pressure used car prices, and thus negatively impact Ford Credit.

While the jury is still out on if and when Ford's secret weapon will turn into a disadvantage, one thing is clear: it's still incredibly important to the bottom line and is currently printing money.

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Daniel Miller owns shares of Ford. The Motley Fool owns shares of and recommends Ford. The Motley Fool has a disclosure policy.