Fact: Business in the automotive industry is capital intensive and extremely competitive. Taking each revenue dollar down to the bottom line becomes more and more difficult as sales plateau, incentives rise, and competition heats up. That's why it'll be more important than ever for investors to watch product mix, launch cadence, pricing, and incentives -- the fourth quarter gave us a glimpse into those critical factors for Ford Motor Company (NYSE: F).
Bigger is better
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It's no secret that SUVs and trucks carry higher price tags and fatter margins compared to passenger cars. That's one reason why Ford is planning to change its product mix, and moving $7 billion in research and development capital from cars to light trucks which will shift that mix by 10 percentage points in favor of utility vehicles. Ford wants its F-Series and upcoming Ranger to cover a wider customer base in an attempt to offset weaker car sales and a plateauing market in general.
It makes a lot of sense when you consider the F-Series notched 896,764 sales in the U.S. in 2017, a 9.3% gain over 2016, and generated average transaction prices that were $3,200 higher than the prior year -- investors would like more of that, please. For comparison, Ford's overall average transaction prices were up $1,300, which was still an impressive double of the industry average gain. But with Ford's fourth-quarter adjusted earnings taking a 19% dip, a shift to higher-priced vehicles is a necessary move.
Pricing versus incentives
Higher average transaction prices are important, but what investors also have to note is the level of incentives. In the slide below, you can see the favorable pricing and how it contributed to Ford's bottom line, and how it was also mostly -- but not entirely -- offset by incentives.
However, that trend worsened during the fourth quarter when incentives cost $568 million and more than offset pricing gains of $493 million. Taking it a step further, Ford's year-over-year incentive change as a percentage of vehicle price -- lower number is better -- was 0.8% versus the industry's 0.3% during the fourth quarter. That's bad for Ford; however, for the full year, Ford's was 0.2% compared to the industry's 0.7%.
The question is: Does it get worse, or better, from here? We won't have an immediate answer as there are too many variables, but Ford gave investors a little glimmer of hope with its launch cadence.
Fresher is better
If Ford wants to help increase average selling prices and at the same time control or lower incentives, which would help bring more revenue to the bottom line, it needs newer vehicles. Newer vehicles require fewer incentives and deals to move off dealership lots, and they generate higher price tags. The good news is that Ford plans a strong increase in product launches in 2018, which should help support pricing and keep incentive spending at bay. More specifically, Ford will launch 23 new vehicles in 2018 compared to the 11 it launched in 2017.
Ford and its newly appointed CEO, Jim Hackett, have a lot of work to do convincing investors it can turn around the profit erosion seen during the fourth quarter. And while we await concrete details from management, which it says are on the way, it's a positive takeaway that at least Ford plans to shift development further from cars to SUVs and trucks, and will have a fresher product portfolio to support prices and hopefully control incentives.
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