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Hard Times for Big Auto

John Rosevear, The Motley Fool

In this week's episode of Industry Focus: Energy, host Nick Sciple chats with senior Motley Fool auto specialist John Rosevear about some news in the auto industry. Ford (NYSE: F) shares dropped on an earnings miss, but things probably aren't as bad as Wall Street is making them out to be. Meanwhile, rumors of Ford and VW's partnership have crystalized into fact -- find out what both of these companies get from teaming up, and what to watch in the future. Plus, it's time for United Auto Workers and the big three auto giants to negotiate. John and Nick explain what this means for big auto, and what investors should keep an eye on. Tune in to learn more!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on July 25, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today's Thursday, July 25th. We're going to take a quick look at Ford's earnings, discuss an expanded partnership between Ford and VW, and take a look at the negotiations between United auto workers and the big three automakers in the U.S. and how those are starting to play out. I'm your host Nick Sciple. Today I'm joined by Motley Fool senior auto analyst John Rosevear via Skype. How are you doing, John? Very exciting time to be watching the auto industry!

John Rosevear: We live in interesting times! [laughs] The auto industry is living in very interesting times right now, Nick. It's quite something. It's going to be an interesting few quarters here!

Sciple: Yeah. We're talking about new technology, EVs, autonomous, you've got some geopolitical things with tariffs, you've got China's auto market starting to slow down for the first time in decades. Lots of stuff to talk about. The news of the day, though, is Ford just reported earnings last night. Shares were down around 7% this morning on the news. John, can you give us the highlights of what happened and what's going on with the company today?

Rosevear: At first glance, the number looks terrible. Net income was $148 million. That's down like 86% from the second quarter last year. What the heck happened? The thing is, though, Ford had warned us that over the next few years, they're going to pile up about $11 billion in one-time restructuring charges because they're doing they're executing the company redesign that they've talked about for a few years now. They're doing significant restructuring all over the world, dropping products, closing factories, changing things around drastically. A lot of that is accounting write-offs. It's accounting charges. It's not real cash, but there is some cash involved there. 

More to the point, though, why the stock is down, I am guessing -- we never know -- it's because technically, they missed. Even excluding the one-time charges for restructuring, which we'll get to in a minute, they earned $0.28 a share, which is not bad. It's up a penny from a year ago. But Wall Street was expecting $0.31 a share. We know what that means. Ford missed. 

I talked to Ford CFO Tim Stone yesterday afternoon right after the earnings were released. I was still working through the press release, actually, when we had the call. And he said one thing that made a big difference was that Ford marked to market an investment they had made in 2016 in a cloud software consulting firm called Pivotal. In 2016, they invested a little over $182 million in Pivotal. I have not dug into the details here yet. The 10-Q just came out. But Tim told me that they marked the value of that down by $181 million. So it's almost a complete write-off. He said without that markdown, they would have earned adjusted earnings, excluding the one-time items, of $0.32 per share, which would have beat Wall Street by a penny. So, this might just be a big overreaction. 

If we dig into the numbers, what we see is that this ongoing redesign effort is actually showing some signs of progress. It's early days yet and it's going to be a couple of years before we can really see it shine, assuming the economy holds on us. But one of the things I saw, in all of Ford's regional business units, pricing improved year over year. That means Ford is getting more money for its vehicles on average. In some cases it's fairly small. In some cases, it's quite significant. It was enough to push Europe to a profit from a loss last year. The net improvement was, they made $126 million more. $53 million profit vs. a loss last year. And what happened there was, they kept costs under control and sold a more profitable mix of vehicles at strong, good prices. More commercial vehicles, fewer small Fiestas. Their all-new Focus, which they did not introduce in the United States, is doing very well in Europe. Their wholesale shipments were up 3% in what has been a sluggish market there. 

They lost a lot of money in South America, but less than they might have, again, because of pricing gains. China has been a disaster for them, but it's looking better and better. All the key metrics were up year over year. Product mix was better. They're selling more Lincoln's, which is interesting. Lincoln is getting traction in China. This has been a quiet story, the Lincoln luxury brand. 

Pricing improvements, again. They're making great progress on costs. And for once, Ford was actually helped by exchange rates. We usually come out and say, "Ford did great, but then exchange rates cut it back." [laughs] I don't know if they've had bad luck hedging that or what. China, they're still losing money there, but it's turning into a good story. You can start to see daylight down the tunnel.

Ford Credit, their captive financing arm, continues to be, on an EBIT basis, a profit monster. $831 million, up 29%. They've just let that loose, and it's generating a lot of money for them. They're in good shape with debt. They restructured some debt in the quarter. Their guidance for the year is toned down a bit, but they're still expecting 2019 to be better than last year and for the progress to continue in the next couple of years. So, overall, it wasn't a bad story. 

I think, as the analysts and the smarter financial media get their heads around what really happened here, I would think the stock would stabilize, although I'm never completely confident predicting what's going to happen from day to day in the market. There are so many curveballs here. But, yes, they quote-unquote "missed," but this isn't something you need to worry about if you're a Ford shareholder, and this is about what we expected.

Sciple: John, the Pivotal software thing seems interesting to me. Their earnings were negatively affected by something that a lot of folks might not even be aware of. When you had the conversation with the CFO, any idea why now was the time to write down nearly the entirety of that investment? What was behind the scenes there?

Rosevear: No, I didn't, I didn't poke at it a lot. We were digging into the restructuring stuff. I had 10 minutes with him. [laughs] We talked about other stuff. I was hoping that he would address it during the conference call. He really didn't. Again, I'm sure there will be more details about it in the 10-Q. I don't know what happened at Pivotal. I know that back in 2016, when they made the investment former CEO, Mark Fields, who was in charge at the time, told me that they were working on a project called Ford Pass, which was -- and still is, I guess -- an app that was going to allow somebody to access all of the mobility services that Ford was tinkering with and thinking about and planning, everything from parking discounts to, longer-term, robot taxis someday. This was back, again three years ago, when they were in the phase of tinkering with new mobility and new technology ideas to see what would stick. They were throwing a lot of things up on the wall. Ford Pass was one of those things. It may just be that Pivotal has faded out here of their picture. I'm not sure what happened exactly, but we'll find out. Watch The Motley Fool, because I'll write it up when we find out. [laughs]

Sciple: Yeah, I know you'll be talking about it somewhere, John. Speaking of new technology and positioning for the future, we've seen an announced broadening of the partnership between Ford and VW. Earlier this year, they announced plans to collaborate on trucks and commercial vehicles focused on Europe. Ford is going to build a truck for VW. There have been rumors that this partnership might expand more broadly, particularly into EVs and autonomous vehicles. 

Rosevear: Well, they weren't just rumors. Ford executives were dropping very loud hints that they were going to try and go in that direction. Yeah, we knew something was being brewed. It has all become public in the last couple of weeks.

Sciple: On July 12th, we finally got the public announcement that yes, this is something they're going to go forward with. Can you give us an overview on what the nature of this collaboration will be, and maybe what's driving Ford and VW to partner up now today?

Rosevear: The easiest way to think about it is that VW has put a lot of money and effort over the last few years into electric vehicles. Ford, via a company it invested significantly in, a start-up called Argo AI that was created by veterans of Uber's self-driving program and Waymo, the Google self-driving car project, made this start-up. And Ford invested a lot of money in it. Took what was at the time a majority stake, and basically transferred their whole self-driving software team to Argo, and said, "OK, Argo, you're in charge of the software side of our self-driving effort." And Argo has made good progress. And VW has not made nearly as much progress on self-driving as perhaps it would like, although it has made a lot of progress on electric vehicles. I think this is the two companies looking at each other and going, "Hey, I'll share some of this if you share some of that." [laughs] That's the best way to think about this deal. 

Ford would like to get an electric commercial vehicle out in Europe ASAP. They are maybe, on their own, not quite ready to do that. In Europe, the emissions regulations are tightening significantly. They need an electric vehicle out there. Ford, because of its strengths in commercial vehicles, would like that to be probably a commercial urban delivery van. One part of the deal is that they're going to use VW's MEB toolkit. This is a German abbreviation for modular electric vehicle drive or something like that. What this is, think of it as Lego bricks to make electric cars with. They can assemble them in different ways and make small short-range cars or large long-range vehicles and so forth. It's pre-engineered building blocks, is the way VW does this. It's not quite like what we think of when we think of a traditional vehicle platform. It's something a little more clever and a lot more flexible. 

But VW has invested bazillions of euros -- I'm not going to try and quantify it, but it's a lot of money -- in ramping up a supply chain to produce MEB-based vehicles, millions of them every year, within about five, six years. Starting, they hope, by the end of 2019 with the first one, which will be a hatchback for Europe. If you imagine an extra sleek-looking Volkswagen Golf, you'll be very close to what that vehicle looks like. 

But in any event, Ford is going to, in its own factory, use the MEB architecture to produce what we believe is a commercial van. Their goal is to deliver more than 600,000 of these in Europe over the course of six years. So this is going to be a significant seller. You're talking 8,000, 9,000 a month there. Which is real numbers for a commercial vehicle in Europe. This is probably going to be part of the transit family. This saves them a lot of costs, a lot of work around developing an electric supply chain, which they may not have in Europe, etc. They can just, bang, go do it. They've got to learn MEB. They've got a tool in line for it. And all of that is going to take a couple of years, but by 2023, this thing's going to be out and rolling, and that will help them a lot in the European market where Ford plans to maintain a significant long-term presence. They are restructuring Europe, but they sell a lot of vehicles in Europe and they just want to make more money selling them. They're not going away. GM basically bailed on Europe. Ford is not bailing on Europe at all. The flip side of the issue is autonomous vehicles. What's going to happen is, VW is making an investment in Argo AI. At some point, they will become equal partners with Ford, and the remaining ownership stake will be for Argo employees. They are not, they say, seeking additional investors. VW will contribute its own, basically, autonomous software team, which is positioned in Audi, which legally it's a subsidiary of Volkswagen Group. The Autonomous Intelligent Driving Company is the English term. I forget the German term for them. But, this is VW investing in Argo and buying shares from Ford at the same time. They will use Argo's system independently, but they will jointly participate in the development of the core system. And since Argo is thought to be fairly advanced on this -- it's always hard to tell where the various self-driving players or contenders or wannabe contenders really are, but the smart people who watch think Argo's ahead of many other shops. They might be close to where GM Cruise is, give or take, plus or minus, depending on how you judge it. And Cruise has widely been thought to be winning the battle for second place behind Waymo, who is pretty much universally acknowledged to be the leader. That's the old Google self-driving car project. They've been at this for 10 years now. [laughs] So, no surprise that they've showed results.

Sciple: So, with this partnership, we're seeing the battle lines in autonomous being crystallized. Argo, VW, Ford is going to be a team. Obviously GM, Cruise, and Honda are a group. Toyota and Uber have collaborated on some work as well. Cruise this week came out and said that they're no longer going to meet their announced deadline to roll out their autonomous service this year. 

Rosevear: That was pretty much the most surprising thing ever. Basically, what they have all said, all the way up to Mary Barra, GM's CEO, is, "Once it passes our safety hurdles, we will release it." And what they said a year and a half ago or whatever was, "We think that might happen in 2019." What they're saying now is, "We now think that won't happen in 2019." So it's not really a surprise. It's a hard problem. [laughs] 

Sciple: Right. I think it's just, people who were very optimistic about this, and we've seen the engineering problem really start to hit a little bit of a wall. We really rapidly were able to do the lane keeping and the lane following sort of thing, but as we move into more and more complex environments, optimism has slowed some. That's to be expected as the problem becomes exponentially harder, the more complex environments you move into. This is a significant development here. We'll see how things continue to play out. 

Alright, on the back half of the show, I want to talk a little bit about the beginnings of negotiations between the United Auto Workers and the big three Detroit automakers in the U.S. Those negotiations just began last week and it's the beginning of negotiations that will set the wages and benefits for what are 158,000 auto workers and will lay out the investment plans for these companies moving into future years. The current contract expires September 14th. However, it's pretty common that these deadlines can get extended if negotiations are ongoing. As these negotiations get under way, how significant is this for U.S. auto industry? What should investors be following?

Rosevear: It's always a big deal. This happens every four years. It's always something to watch carefully. The good news is, it has been many, many years since it didn't end more or less happily. [laughs] Which is to say, all parties might be grumpy about the agreement, but at least they have an agreement. This is unlikely to result in widespread strikes. But there is a real bone of contention here. The automakers have had good success and good sales over the last few years. The union guys -- men and women, I should say, because there are plenty of women now -- the union folks want more money. Meanwhile, the industry might be inclined to say, "Jeez, we're spending all this money on new technologies. It's very late in the economic cycle. We may be facing a recession before long. I don't know about that." So, that's going to be the lively subject of discussion. The union folks are worried, well, electric vehicles are going to be easier to build, so they'll need fewer workers. And then they think, if everybody goes autonomous, we'll be building fewer vehicles, because more people will be taking taxis. They've been listening to the tech press on all this stuff over the last five years, like the rest of us have. They're like, well, we want to preserve as many jobs here as we can, and we want to get paid. [laughs] It'll be a tough negotiation. I don't think this is going to result in a big strike and a big disaster. I don't think it's going to result in a significant cost increase for the Detroit automakers, because they have fought so hard to get their U.S. costs down to something closer to globally competitive levels, while still honoring their agreements with the United Auto Workers. It's going to be a wrestling match. Again, I think it will be resolved amicably because that's how these things have gone in recent years. But things could get heated for a while.

Sciple: Yeah. You've got the president of UAW, Gary Jones, come out and saying, the past few years, labor has taken some concessions to help out the automakers, particularly coming out of the recession 2008, 2009. They say, hey, these automakers are making record profits, and we're being asked to make concessions. But as you said, we're seeing some slowing in the automotive market right at the time when these negotiations come up, which really creates tension. Labor is looking back and how profits have been over time and the rewards that they have achieved, while management is looking forward to what could be real expenses to roll out these new technologies while the cycle still continues. 

I have seen some reporting that GM, if anybody is going to be a strike target in these negotiations, could be one that is targeted. They are moving to correct capacity issues by pulling products out of four U.S. plants, which has raised tensions with the UAW, who wants to keep those jobs in place. Any thoughts about companies that might be particularly at risk if there is going to be an escalation of tensions, and maybe if strikes do happen?

Rosevear: It was interesting to watch last fall, if you've been watching this industry for a while, when GM announced they're going to be shutting down, in particular, Lordstown, or not have any new products for it after discontinuing the Chevy Cruze Compact, which was built there for years. That's a big plant, a big assembly plant, it's very visible. Yes, they were going to try and place as many of the employees from there as they could in new jobs, but some of those jobs are a couple of hours' drive away. That's hard on a family.

Meanwhile, Ford, which was making its own restructuring in North America, hastened to say, we're not closing any plants. And some people who were watching were like, oh, Ford's trying to appease the Trump administration or whatever. I heard that and I said, no, Ford is telling the union to chill out. [laughs] That's what that was. That was Ford telling UAW, "It's cool, we're going to talk to you. Don't worry about it. Everybody will have a job here," or at least, every plant will stay open. They may cut shifts here and there. 

The UAW, of course, hates to see plants closed. That's why unions exist. They hate that. I don't know if they're going to strike GM. I do get the sense that things between the UAW and Ford have been a bit more graceful and a bit less contentious over the last year than they have been between the UAW and GM, where GM might have been a little heavy-handed. This is me reading the situation from a distance, but I've watched a couple of these rounds in the past and that's my sense of this. 

Usually what they do is, they start negotiations with everybody, and then they pick one automaker to hammer out what they call the pattern agreement, which is they go into really intense negotiations with one of the big three, get an agreement, and then try and get the other two to buy into essentially the same agreement so that all their workers get roughly the same deal. My sense, I'm not sure who they picked to do the pattern agreement this time. I'm not sure if that has happened yet. It sounded like they were leaning toward Ford. If they're going to pick a fight with somebody, my sense is that you're probably not wrong, it could be GM. But, these things can go in a lot of different directions. You think everything's going along fine and then they hit some little thing that turns out into a big thing and then the UAW does one of these 12-hour walkouts or something. [laughs] Which is their way of reminding the automaker that, yes, our gun is here, and it's loaded. [laughs] We can hurt you. But of course, that hurts them, too, because they don't get paid during a strike. 

I think this will all end happily. Or at least, like I said, not too awful for everyone. I don't know how they'll get there. It is possible that we could hear some heated words, and even some, likely, very short-targeted labor action between here and there. If they get really frustrated, they will do a walk out. The UAW's style is not to do a big, extended strike like they used to do in the 60s and 70s. These days, what they do is, they pick one plant that makes really important parts or a critical product or whatever, they walk out for 12 hours or something. It makes the point. It's, "Remember we have power, too." [laughs] So, I don't know. I don't know how it's going to go. But it's going to be a complicated negotiation for both sides.

Sciple: Yeah. Again, like we mentioned off the top of the show, it's another one of those balls that management has to keep in the air right now. If you're a major auto executive, you've got issues like Brexit in the U.K., you've got the cycle, obviously, looking like it's starting to slow down around the world, particularly in China, and then you've got these negotiations coming down the line. Something to follow. Not a super easy time to be an auto executive. We'll be paying attention.

Rosevear: Just one takeaway I want to give you before we end. It doesn't get a lot of attention from investors, but managing labor relations is a very big part of being a senior auto executive in any of the automakers around the world. They all battle these battles. There are some countries where the unions have a lot of power. In Germany, you have a union representative on your board of directors by law. Investors don't look at this, mostly because there haven't been huge strikes in recent years, but there's always the potential. There's always the potential.

Sciple: Yeah, something to continue to follow. We'll have you on, John, and we'll have you writing articles on fool.com for us to keep track of everything that's happening in this industry. 

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Dan Boyd for his work behind the glass! For John Rosevear, I'm Nick Sciple. Thanks for listening and Fool on!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. John Rosevear owns shares of Ford and General Motors. Nick Sciple owns shares of Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool recommends Uber Technologies. The Motley Fool has a disclosure policy.