Ford Motor Company (F) Q2 2022 Earnings Call Transcript

Ford Motor Company  (NYSE: F) Q2 2022 earnings call dated dated Jul. 27, 2022

Corporate Participants:

Lynn Antipas Tyson — Executive Director, Investor Relations

James D. Farley — President and Chief Executive Officer

John Lawler — Chief Financial Officer

Marion Harris — President and Chief Executive Officer, Ford Motor Credit Company

Analysts:

John Murphy — Bank of America — Analyst

Adam Jonas — Morgan Stanley — Analyst

Rod Lache — Wolfe Research — Analyst

Emmanuel Rosner — Deutsche Bank — Analyst

Colin Langan — Wells Fargo — Analyst

Joseph Spak — RBC Capital Markets — Analyst

Presentation:

Operator

Good day, ladies and gentlemen. My name is Chad, and I will be your conference operator today. At this time, I would like to welcome you to the Ford Motor Company Second Quarter 2022 Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the call over to Lynn Antipas Tyson, Executive Director of Investor Relations. Please go ahead.

Lynn Antipas Tyson — Executive Director, Investor Relations

Thanks, Chad. Welcome to Ford Motor Company’s Second Quarter 2022 Earnings Call. With me today are Jim Farley, our President and Chief Executive Officer; and John Lawler, our Chief Financial Officer. Also joining us for Q&A is Marion Harris, Chief Executive Officer of Ford Credit. Today’s discussions include some non-GAAP references. These are reconciled to the most comparable U.S. GAAP measures in the appendix of our earnings deck. You can find the deck, along with the rest of our earnings materials and other important content, at shareholder.ford.com.

Today’s discussions also include forward-looking statements about our expectations. Actual results may differ from those stated. The most significant factors that could cause actual results to differ are included on Page 22. Unless otherwise noted, all comparisons are year-over-year. Company EBIT, EPS and free cash flow are on an adjusted basis, and product mix is volume weighted. Looking at our IR calendar, we have two upcoming engagements. Tomorrow, BNP Paribas will host a fireside chat with John Lawler and Kumar Galhotra, President of Ford Blue; and on August 10, at their Auto Conference in New York, JPMorgan will host a fireside chat with Ted Cannis, Chief Executive Officer of Ford Pro. Now I’ll turn the call over to Jim Farley.

James D. Farley — President and Chief Executive Officer

Thanks, Lynn. Hello, everyone. The Ford team delivered a very solid second quarter in a challenging environment where we saw supply chain disruptions, a lot of new economic headwinds and uncertainty as a whole. Importantly, we achieved these results as we advance the Ford+ plan, which is the biggest opportunity to create value at Ford since we scaled the Model T. And at the core of Ford+ are three fundamental promises to our customers: distinctive and breakthrough products and experiences; and always on relationship with Ford every day, every hour, every minute; and ever-improving post-purchase user experiences powered by software.

Today, I’ll give you an update on Ford+ and the early results of our decisions to reorganize the company into three distinct segments: Model e, Ford Blue and Ford Pro. Now let me start with the progress we’re making to lead the electric vehicle and digital revolution. What’s lost in the industry’s arm race of claims regarding capital invested, the number of top hats we all have, the promises of future leadership is one fundamental question: who is and will be the best position to design truly distinctive and appealing products that people actually love? That’s the question. Now we’ve been overwhelmed with the demand for our first-generation EVs, the Mustang Mach-E, the Lightning and the E-Transit.

These products are in the market now, and we have strong multiyear order banks. We’re selling them as fast as we can make them. And you can’t say that about many of the EVs coming to market now. We believe that these great new products will enable us to grab an outsized share of the rapidly growing EV market, combined with our healthy and vibrant shares of our ICE and growing hybrid markets. This month, we expect to produce 14,000 EVs globally. That’s significantly higher than just a few months ago, and we have a clear path to reach a run rate of 60,000 EVs by the end of next year. And that will lead to a foundation to two million by late 2026.

In fact, our anticipated growth rate in EVs through 2026 is more than twice what we expect for the global EV industry in total. Now securing the raw materials to produce batteries at scale is critical to our plan. It’s estimated that, at best, 50% of all raw materials required to meet the combined announced targets for all EV OEMs is actually available, 50%. And this is why speed to securing supply is so critical and strategic, so is diversifying our battery chemistries to increase our flexibility, supply and profit and to support different customer use cases. Last week, we announced a series of MOUs and agreements to fulfill our ambition — ambitious needs that I covered, and we are working to complete definitive agreements where necessary.

Our Model e team moved quickly to capture these opportunities. To summarize, we’ve added battery chemistries and secure contracts, delivering 60 gigawatt hours of annual battery capacity, which will help us support fully the 600,000 units of that 2023 run rate of capacity. We now have lithium-ion phosphate, or LFP, battery packs coming for the Mach-E sold in North America next year and for Lightning in early 2024, creating more capacity for these high-demand products. We secured 70% of the battery capacity needed to support two million units by the end of 2026, and we struck a new deal with CATL on strategic cooperation for global battery supplies as well as deals for direct sourcing of critical battery raw materials in the U.S., Australia, Indonesia and more locations.

And we have a plan to localize 40-gigawatt hours per year LFP capacity in North America by 2026. These deals are a strong start as we fortify our EV supply chain that’s aligned with our sustainability and human rights principles. Now let’s talk about the progress we’re making in building out and always on relationship with customers and that ever-improving user experience enabled by software after the customer buys a vehicle. Now along with product execution, these are really the relevant sustainable advantages we see to create, in today’s hypercompetitive market, a difference where the real competition is not legacy OEMs, but pure-play EV companies, including emerging Chinese players.

For example, more than 55,000 Ford customers have already driven nearly 10 million miles with BlueCruise, our hands-free L2 system. That’s just one year after the capacity was launched, and we started OTA-ing this to our vehicles. We’re using the data we get through BlueCruise to continue to improve the customer experience. And as it happens, you can imagine a significant ADAS revenue and profit stream being created by giving customers the ability to work, watch a film or even take a nap during a long trip in their Ford. While the financial benefits of ADAS are clear, as is our Ford Pro services stack, they’re relatively small now, but we’re rapidly increasing the number of digital vehicles on the road as well as attach rates of the enabling services.

And over time, much of the SaaS revenue will be deferred on our balance sheet, providing an annuity-like revenue stream that is highly accretive, something this company and this industry has never seen. Now before I turn to Ford Blue, let me talk briefly about our connected EV dealer model in the U.S. Changes in the market have compelled Ford and our dealers to revisit how customers shop, buy and own, and how they will do this going forward. We’re moving fast as the transition to these digital EV platforms allows us to help our dealers provide better customer ownership experience post purchase, and in turn, enables them to expand the revenue and profit pools, expanding and improving their returns.

We’re working with our dealers to create a retail model better than what’s offered by any traditional OEM and better than the startups who are now scrambling to develop sales and service networks to support customers in an attempt to sustain and grow share in UIO. In the U.S. alone, if we can help our dealers increase service loyalty by just 20 points, that’s $2.4 billion incremental revenue for them every year. Now since March, we’ve conducted more than 30 workshops in the U.S. and Canada, reaching hundreds of our dealers.

I have personally been involved in many of these meetings. What is clear to me but not yet visible to the market is that our dealers are embracing this change. They know the competitive threat is real, and they want Ford and their dealership to lead and win. And we have more to share as this develops. Now turning to Ford Blue. The team is motivated by this sharpening focus on our ICE and hybrid products. We’ve added new talent and leadership to drive performance and focus in our trucks, our great family lineup and our enthusiast vehicles we’re so proud of.

We’ve revealed new vehicles like the Bronco Raptor, the Bronco Everglades, the F-150 Raptor R, which my kids think sounds great. In the third quarter, we’ll unveil an all-new seventh generation Mustang at the North America International Auto Show in Detroit. It is a stunning car, and I’m so excited to share it with the world. And also this fall, we’ll be introducing an all-new Super Duty pickup, the workhorse at Ford, and it sets a standard in our industry. There’s much more to come. Our design center is filled with new products and derivatives that will further strengthen our hit vehicles in the ICE and hybrid franchises like F-150 and Bronco and Maverick, the brand-new global Ranger that’s launching in Thailand, and our new Everest. In short, our hottest and freshest lineup in recent history is getting even better.

Now in commercial vehicle market, Ford Pro, our industry-leading global business, is leading the change into an electric software-driven world. Other OEMs are talking about large numbers of future electric orders. We’re actually taking orders for manufacturing and selling commercial vehicles now. Through the second quarter, we’ve sold more than 3,000 E-Transit in the U.S. That’s a market share of 95% in the full-sized electric van market, 95%. In fact, our next two competitors combined sold just 159 vehicles.

Beyond the vehicles, we’re also rolling out our Ford Pro charging commercial solutions and the very exciting and fast-growing e-telematics software solutions. And boy, are they paying off. And in Europe, where we continue to be the leading commercial vehicle brand, we already received 8,000 orders for our two-tonne E-Transit, and our new one-tonne E-Transit Custom goes on sale next year. Now our Ford Pro software business is growing quickly. Paid telematics subscriptions globally have grown over 40% sequentially for the last two quarters. Turning to quality. We made solid progress in initial quality, as you’ve seen in the recent J.D. Power’s IQS study, and our launches have improved.

However, we continue to be hampered by recalls and customer satisfaction actions. Yes, this affects our cost, but more importantly, it falls short on our most fundamental commitment to our customers. Quality is our number one priority. In fact, we recently brought on Josh Halliburton from J.D. Power to head quality. Now the team is focused on three critical areas: prevention, detection and remediation. We’ve instituted more robust engineering sign-off processes for the vehicles that are in the product development factory as we speak. We’re driving much more frequent alignment with our supply base on quality.

And when identified issues, we take actions quickly to resolve them, to protect our customer’s experience, including by making much more frequent use of over-the-air updates. And boy, has that worked for us. We have more work to do in this space, and we will keep you updated. Overall, we’re pleased with the progress this year, but we are not nearly satisfied. We remain clear-eyed and determined to move with speed and determination on a Ford+ transformation.

The underlying strength of our business supports our 2022 adjusted EBIT guidance range of $11.5 billion to $12.5 billion, unchanged from April. Before I turn it over to John, I want to end with this. There’s context that’s critical to how we think about implementing our Ford+ plan. Traditionally, the auto industry has cut costs, often indiscriminately. As an effect, of course, from lower auto demands through economic softness and shift for customer preferences. What we’re undertaking forward is totally different than that. We’re reshaping virtually every aspect of the way we’ve done business for a century. And we’re doing that for a new industry based on new technology, new skills and a new promise for customer value. And yet, cost reduction will happen in our ICE business because that’s primarily what is made up of Ford today.

But we’re modernizing to take out unnecessary costs, redesigning work and strategically investing across all of our auto businesses, ICE and hybrid, then EVs and then Ford Pro, while at the same time, transforming every function that supports them. Sweeping strategic change generates interest and speculation in the media, which we understand. However, we’re going to comment on Ford+ actions we’re taking and how they’re going to strengthen our company on our own schedule. John?

John Lawler — Chief Financial Officer

Thanks, Jim. During the quarter, on an adjusted basis, we delivered EBIT of $3.7 billion, an EBIT margin of 9.3% and free cash flow of $3.6 billion. Our cash conversion in the quarter was very strong and lifting our first half to 50%, with the target range of 50% to 60% that we set out at Capital Markets Day. We ended the quarter with strong cash and liquidity of $29 billion and $45 billion, respectively. And now these numbers include our stake in Rivian, which was valued at $2 billion at the end of the quarter. In Q2, we also successfully renewed our $17.2 billion sustainability-linked global credit facilities, which include a new $1.75 billion 364-day revolver, which provides for additional working capital flexibility.

Our strong balance sheet is a solid foundation for continuing to invest in our Ford+ priorities. Our results this quarter reflect the improved earnings and cash flow potential of our business, along with leverage created from disciplined capital allocation and a much more focused business model, including our industrial footprint. The tough choices we made during the global redesign to de-risk our business and exit unprofitable markets and products is paying off. From 2018 to 2021, our markets outside North America consumed nearly $9 billion of free cash flow. This year, these markets are collectively expected to be free cash flow positive.

We are confident in the underlying strength of our business and our ability to fund all the calls of capital — all the calls that we have on capital, especially those fundamental to growth and value creation. We can achieve this while maintaining the financial flexibility to navigate external uncertainties. And as a result, we’re increasing our regular quarterly dividend to $0.15 a share beginning this quarter. This returns us to the prepandemic dividend levels.

Now let me touch on the performance of our business units. North America delivered $3.3 billion of EBIT and a margin of 11.3%. Both of those measures were up year-over-year as an 89% increase in wholesales and strong net pricing and mix more than offset higher commodity costs and inflationary pressures. South America continues to benefit from our global redesign efforts, delivering its fourth consecutive profitable quarter. In Europe, we posted a modest profit as a large increase in wholesales helped us reach just above breakeven EBIT. The underlying trajectory of the region continues to improve.

However, the adverse effects of the near-term supply chain disruption are dampening its overall results. In China, we posted a loss as the local economy and auto industry were significantly disrupted by pandemic-related restrictions and lockdowns. Now Lincoln continues to be a profit pillar for the region, gaining share in the quarter, along with commercial vehicles. Our International Markets Group continues to be sustainably profitable as a result of its restructuring efforts. In Mobility, we are progressing our in-market pilots for moving goods and moving people and remain committed to autonomous driving. And finally, Ford Credit delivered another strong quarter with EBT of $900 million, reflecting strong lease residuals and credit loss performance. Now let me share with you our current thinking for the remainder of 2022. For the full year, our guidance is unchanged.

We expect to earn between $11.5 billion and $12.5 billion in adjusted EBIT, which is up 15% to 25% from 2021. This reflects 10% to 15% year-over-year growth in wholesales and assumes that semiconductor availability continues to improve. In addition, we’re projecting to generate adjusted free cash flow of $5.5 billion to $6.5 billion, with a significant portion of that coming from automotive operations. Relative to adjusted EBIT on a year-over-year basis, our range assumes significantly higher profits in North America, collective profitability in the rest of the world, strong but lower Ford Credit EBT, they’ll be in the $3 billion range, and modest improvements in Mobility and Corporate Other.

Other key assumptions include strong order banks and pent-up demand for our new and iconic products, continued strength in pricing, which includes the benefits of pricing actions taken during the year, commodity headwinds of about $4 billion, which we expect to offset with improvements in net pricing and mix, a continuation of other broad-based inflationary pressures, and we now expect the full effect to be about $3 billion, which is up $1 billion from our estimate last quarter. And of course, we’re aggressively working on offsets to these increases.

And finally, at Ford Credit, auction values will remain strong but decline in the second half as the supply of new vehicles improve. EBT will be strong but lower, reflecting primarily lower credit loss reserve release, fewer return off-lease vehicles and more normalized credit losses. Our results in the quarter, full year outlook and commitment to medium-term targets together demonstrate the power of Ford+ as we invest aggressively to drive growth and value creation. But before we turn it to Q&A, let me provide a quick update on our new financial reporting.

As we shared in March, starting in the first quarter of 2023, we will have three new business segments: Ford Model e, Ford Blue and Ford Pro, and will no longer report a combined automotive segment. With Ford Next, which is formerly Mobility, and Ford Credit, this will bring our total reportable operating segments to five. Now this change will not be a simple pro forma exercise. It’s much more fundamental. These are true segments with both operating and financial accountability, giving you added transparency on our business.

So to help you prepare for this change, we plan to hold a teach-in early next year prior to releasing our 2022 results. We will use our revised 2021 results as a template to reflect the new segments. As part of the teach-in, we also plan to cover business rationale, mechanics of the new reporting structure and how our earnings disclosure and our SEC filings will change. When we report our fourth quarter and our full year results for 2022, they will be based on our existing reportable segments, and we are targeting to also share at the same time 2022 results that are revised to reflect the new segments. And so if you have any questions about this, please don’t hesitate to reach out to Lynn and the rest of the IR team. So that wraps up our prepared remarks. We’ll use the balance of the time to address what’s on your minds. Thank you. Operator, please open it up for questions.

Questions and Answers:

Operator

[Operator Instructions] And the first question will come from John Murphy from Bank of America. Please go ahead.

John Murphy — Bank of America — Analyst

Good evening guys, I wanted to ask a somewhat mundane question first on the outlook and then get into some pricing secondarily. But first, John, when you look at it, the seasonality of Ford’s earnings traditionally is higher in the first half, lower in the second half. There’s timing of cost and volume that usually drive that. Why do you think it’s going to be different this year? And I guess maybe one of the big things that might be developing as we get later this year into early next year is that raw mats seem like they may be easing and fading, but the price/mix opportunities seems like it will be pretty strong. So that might help late this year and early next year. But just curious if you can comment if there’s some of that change in a seasonal pattern so we can be comfortable with our estimates in the second half or your outlook in the second half.

John Lawler — Chief Financial Officer

Yes. So John, it is different, right? Ever since we’ve had COVID and coming out of COVID, the patterns just haven’t held. When you look at the second half versus the first half, I think that would be the best way to help kind of frame this up. We do see continued volume, mix and pricing being strong on a half-over-half basis. And of course, we do expect to see commodities improve a bit as well in the second half on a half-over-half basis. And so volume, pricing and mix, let’s say, in the $3 billion range. Commodities could be as much as $0.5 billion. But the inflation that we’re seeing, that’s going to continue to run through. And we’re seeing that across the board from material costs, freight, fuel costs, etc. So we see that continuing, and that’s up, as I said in my remarks, versus what we had talked about at the end of the last quarter. And then, of course, FMCC is going to be down slightly half-over-half, let’s say, $0.80 billion to $1 billion as they approach $3 billion for the year. We’re also seeing headwinds in the second half, John, from currency, the dollar strengthening. And we have more revenue exposure overseas than we do costs. So we’re going to see some of that happen as well. And then we’re going to continue to invest in our growth, and that’ll be an area of engineering. We’ll also see increasing investments in connectivity and spending. And then, I guess, the last thing I would talk about just to make the half-over-half complete. We did have some onetime items come to us in the second quarter, roughly an insurance claim and a contract we renegotiated, which roughly would be maybe three-tenths, four-tenths of headwind. So that’s basically how we frame up the half-over-half. And basically, what we’re saying is that there’ll be some headwinds and some tailwinds, but we’re confident in our guidance of $11.5 billion to $12.5 billion.

John Murphy — Bank of America — Analyst

That’s very helpful. And then, Jim, just on these higher trim levels or pseudo special additions, I mean there’s Ford Raptor, I mean, the F-150 Raptor R, pretty great-looking truck. You guys put in the slide deck there, looking forward to driving that, hopefully, sometime soon. But it seems like there’s a real opportunity in Ford Blue, but there might be in Model e for these high trim level special — sort of special editions. I mean how much of an opportunity is there on mix go forward maybe in both divisions? And how do you think about going after that? Because that seems like that’s something you could be a lot more sustainable than maybe just the supply/demand imbalance we have right now that’s helping price.

James D. Farley — President and Chief Executive Officer

Thank you, John. We’ve always been really good on the truck side for those derivatives, but now our chances to expand that capability across all of our lineup. Ranger is a good example. We’re launching it in Thailand. We just launched Raptor, Tremor. There’s a lot we can do. Of course, Mustang is coming out. Maverick is our most affordable vehicle. You can only imagine the kind of things that we’re cooking up in our design studio with Maverick. And then, of course, on what we really do well, Broncos, you can imagine high-end versions, all sorts of things. Everglades came out, it’s very popular. And we do agree our E side, we don’t have to change the body to refresh Mach-E, for example. We are actually completely redoing in a good way our HMI and OTA-ing that to all of our EVs. But you can imagine with Mustang Mach-E all the cool things we could do. So — and it is a sustainable advantage, and we’re good at it. The tension point for us, though, is complexity. Ford is way too complex. So as we do this, we have to bring our complexity down to get our bill of materials kind of in line with competition. It’s great that we have all this pricing power forward. We do have a fresh lineup. We have lots of cool ideas. But we’re not satisfied with that because we cannot just continue to build this complexity in our business. So as we add those derivatives, we’re going to have to — we are planning much less complexity in our Blue business. And that is a theme that will run through Blue for years to come.

John Murphy — Bank of America — Analyst

Jim, if I could just follow up real quick on the Model e side to create a performance version of like the Mustang Mach-E might theoretically cost a lot less, but you might still be able to charge as much as you might on that delta on a Blue vehicle. Is that correct? And could we see sort of these specials or trim levels potentially garner even higher variable margin as we move into the Model e world? Is that a fair statement or not?

James D. Farley — President and Chief Executive Officer

I think the way we look at — yes. Good question. The way we look at this, John, is the days are kind of over where you have to change the upper body to build a supercar or to build an off-road car like kind of days are over, like, we don’t have to do that anymore with these digital products, with EV propulsion, with the motors, the software. We can really take our vehicles and make very different kind of vehicles off of the same body engineering. And that is a complete game changer for us in terms of capital intensity, i.e., lower.

John Murphy — Bank of America — Analyst

Thank you very much.

James D. Farley — President and Chief Executive Officer

And I’m really glad you brought that up because I try to emphasize this. Like we have to be really careful in our industry, and I’m constantly — we are constantly talking about this as a leadership team. We cannot have the complexity of top hats that we do on our ICE business. We have an opportunity as we go digital with these EVs to simplify our body engineering and put the engineer where customers really care. And it’s not a different vendor. It’s software. It’s a digital display technology. It’s a self-driving system and the AV tech. And of course, it’s going to be, some cases, more powerful motors.

John Murphy — Bank of America — Analyst

That’s very helpful, Thank you james.

Operator

Thank you, The next question is from Adam Jonas from Morgan Stanley. Please go ahead.

Adam Jonas — Morgan Stanley — Analyst

Jim, the Bronco Raptor, so badass. I don’t know if I put an order and now if I’ll get it by the end of the decade, but maybe I’ll try. Jim, this is one of the most positive Ford calls I can remember in a long, long time. Does Ford have too many people?

James D. Farley — President and Chief Executive Officer

No, As I said in my comments, Adam, we absolutely have too many people in certain places, no doubt about it. And we have skills that don’t work anymore. We — and we have jobs that need to change. And we have lots of new work statements that we’ve never had before. We are literally virtually — we are reshaping our company, like every part of our company. And on our ICE business, we want to simplify it. We want to make sure the skills we have and the work statements we have are as lean as possible. We know our costs are not competitive at Ford. But we are — that’s what I mean by we are not satisfied. But I just want to emphasize that in the past, at least in my career for 40 years, we kind of often and discriminately just taking the costs out. That’s not what’s happening at Ford now. This is a different kind of change where we’re reshaping the company, reshaping skills, investing in new technologies and simplifying investments in others, i.e., spending less. So — and we have — it’s kind of the old adage. Yes, I think every company probably has too many people. I just — we have to go do the workflows and decide how this works now going forward.

Adam Jonas — Morgan Stanley — Analyst

All right. Appreciate that, Jim. Just one follow-up on the dealers. They’re having an amazing time. Their new gross margins have more than tripled, and they’re making dealer grosses that are, in many cases, higher than what you’re making on selling the product, right? Like they’re making more money selling the product that you — the margin you’re making on actually making the product. And all they’re doing is just watching the things come off a truck, and they’re presold. So I know you guys spent a huge amount of time on pricing at Ford. Is there anything you can do to help even the score a bit on price? Because when I ask the dealers why isn’t Ford raising — or your peers raising some of the invoice more, even they don’t have a reason like we don’t know why they’re not doing it. And then they often say things that I don’t believe, which is that you can’t or you’re not moving fast enough or the systems aren’t there. So what are we missing?

James D. Farley — President and Chief Executive Officer

Sure. So bottom line is we’ve taken a lot of pricing. You could see it in our numbers. And actually, we all watch this very carefully at Ford. What is the dealers retained margin versus MSRP? And I have to tell you that ours is one of the best in the industry, i.e., our pricing and the retained margin at MSRP are as close at Ford versus any other brands. There are others that are in different places. I think your question is actually bigger than that, which is we have ups and downs in our industry. And how is this going to — how is our retailers going to shape as we change this company? And so — and again, on the electric vehicles, dynamic pricing is very important for us because we went to an ordering system. And with an ordering system, you have the certainty of orders, but you have to also be responsive on price. I’m not going to get into the details, but we think we have a way out of that tension point or conundrum. On overall, how I see dealer margins, as we talk to our dealers and roll up our sleeves, is we need — because I said our competitors are pure-play EVs and the Chinese that are absolutely coming. And that means we have to get this $2,000 out of our distribution cost to be competitive with them. And we think 1/3 of it is going to a low inventory model, not — I’m not saying like 30-day supply or 50. I don’t mean that kind of — like the customer orders a vehicle, and then we ship the vehicle to the customer. That’s what I mean by a low inventory model. We have to go to that. We think that’s about — worth maybe $600, $700 in our system. Another one is all the selling, SG&A and advertising costs. We have three tiers of marketing. We think that’s another $600 a vehicle. We’re going to simplify that. And we’re going to just shift where the e-commerce platform that we don’t have today — all of our e-customers have a very predictable experience, whether they’re in a dealership or in their bunny slippers, and they’ll have a very simple, transparent, very easy purchase process. And we’re going to invest. Our marketing model is going to be post purchase. That will be our differentiator, and that’s where we’ll invest. And I think that’s a different play than the pure EV companies. So I see dealer margins still being very competitive, but they are going to shift. The makeup of those margins going to change. Does that make sense, Adam?

Adam Jonas — Morgan Stanley — Analyst

It makes a lot of sense. Thanks, Jim.

Operator

Thank you, The next question will come from Rod Lache with Wolfe Research. Please go ahead.

Rod Lache — Wolfe Research — Analyst

Hello jim and john. So pricing has been a massive tailwind, and it looks like mix is becoming pretty powerful now too. Can you just talk to us a little bit about the interplay between affordability and volume? Just especially in the environment that we’re in right now and with still a lot of inflation on the horizon, do you think demand can return at this level of price? And are you willing to forgo volume to sustain contribution margins?

John Lawler — Chief Financial Officer

Yes. Thanks, Rod. So we have seen strength in volume — pricing due to the volume that we can produce as an industry and us at Ford relative to the demand that we’re seeing out there. So that has been a tailwind. In the quarter, we did see quite a bit of a tailwind from mix as well. Affordability is something that we keep in front of us all the time with the credit company, and we’re very thoughtful about where it’s headed from the standpoint to the consumer, what’s affordable,etc. But we have not seen demand come off at this point. But we have — as we increase volumes through the second half of the year, as some of the chip constraints ease and we see a better rate and flow, we do have provisioned in our second half incentives increasing as volumes come back. And we’ve always said that the relationship between volume and pricing is going to remain dynamic. And so I think what you’ll see is as volume comes back, you will see some pricing get back. You will see prices come down some. Question for all of us is how are we going to manage stocks? How are we going to move to the build-to-order process? How are we going to change the dynamics and not have as much of a push system and have more of a natural demand system and fulfilling that demand on a timely basis? So I think that’s the question for all of us, and we need to maintain discipline as we head into an environment where we could potentially see demand come off and/or we start to have higher supply, and therefore, prices will come well. But remember, following up on what Adam just said in the dealer margins, we still have — across the industry, dealer margins that need to come down first from a pricing standpoint, right? We did — as we’ve talked about in the past, we took an action which reduced floor plan for the dealers, which was a form of pricing for us. But overall, it’s still inflated. And I’d estimate somewhere between $1,300 to $1,700 of dealer margin compression is to come off first from a pricing standpoint.

Rod Lache — Wolfe Research — Analyst

That makes sense. And then just secondly, can you just provide any color you can on what’s happening from a supply chain perspective? Any thoughts on whether this Europe natural gas situation is something that is a major concern for you? And then lastly, any detail on the $3 billion of cost inflation in North America. It looked like a large number. Was there anything unusual in that number?

John Lawler — Chief Financial Officer

No, there wasn’t anything unusual, Rod. I’ll start with that. It’s across the board. It’s in the areas you would expect, material cost going up. We’re seeing increases in freight. It’s just across the board, and it’s driven by the inflationary pressures we’re seeing across the board in the economy. Nothing unusual.

James D. Farley — President and Chief Executive Officer

And on the supply chain, I’d to characterize it, I mean, chips are still an issue. Transparency is still an issue in the second quarter specifically. You know we had quite an issue in China with the Shanghai shutdown. And that affects — that could have affected our North America manufacturing system. The team did a great job. We had a daily call. We worked every issue. We built a digital model of all our supply chain down to supply chain in, and it was really helpful. And we got through it. Like Roseanne Roseannadanna said, “If it’s not one thing, it’s another.” It just feels like what’s next. As far as we’re planning everything we know could happen. The next possibility of the energy crisis in Europe, we played this out already. We’ve done our homework. We have about 550 active suppliers in what I would call the high-risk countries like Czech, Germany, Hungary, Austria and Slovakia. We think that the risk is between now and mid-’23 when they can manage through the energy issues. We have about 130 suppliers for our North America vehicle production in that 550 list, and we now have a 30-day buffer stock. So we are doing everything we can with the things we know. On the supply chain outside of — we have labor shortages and all sorts of moving. The suppliers have been working nonstop during COVID, so machine maintenance and a lot of other things. We see the output of the stress in the supply chain. And obviously, their costs have gone up too. And we’re working through all of that with our suppliers. So I think we’re well prepared for the things we can predict, but it’s always a new day.

Rod Lache — Wolfe Research — Analyst

Alright, Thanks guys.

Operator

The next question will be from Emmanuel Rosner from Deutsche Bank.Please go ahead.

Emmanuel Rosner — Deutsche Bank — Analyst

Thank you so much. My first question, I was hoping to ask you about the topic of EV profitability. So Jim, during the quarter at an investor conference, I think you essentially gave some pretty good color on where Ford is standing right now. And I think you spoke about the cost of the Mach-E being a disadvantage of $25,000 to $27,000 versus a similarly Continental or Edge. So I guess my questions would be, how do you plan on offsetting this over time? I guess what is the strategy going forward? And should we worry about large losses from EVs in the near term over the next few years as the EV volumes increase materially over the next few years?

James D. Farley — President and Chief Executive Officer

Well, thank you, Emmanuel. I will say there’s not going to be a lot of guesswork at Ford because we will financially report our businesses independently of each other. So it will be all out there for everyone to see. I don’t know about others. But at Ford, it will be extremely transparent. I’m not going to get into specifics because I think this is such a material topic. We need to spend time on it. We can’t rush to this. I will tell you that in the quarter, our announcement for LFP bringing that to North America is a big deal from a profit standpoint. That is a very important chemistry on our road map for profitability. We’re going to be installing 60 — 40-gigawatt hours in North America. That’s a lot. And we are not going to wait until that installed capacity is here. We’re going to be bringing those batteries to our highest volume vehicles like next year. So that’s one, but there’s distribution. There’s the size of your battery. You’re engineering for low labor content. And I just don’t think we’re going to do justice such as series and important topic in the earnings call. But you can expect a lot of engagement with Ford on this, and this is an incredibly important focus. This is one of the reasons why we created Model e, to be laser-focused on profitable electric vehicles. And again, you’ll see it all. John, do you want to add any comments on the segmentation reporting?

John Lawler — Chief Financial Officer

No. Yes, in segmentation reporting, you’ll see exactly where we’re at between the five businesses. And Emmanuel, we know how important that is. So when we have our Capital Markets Day early next year, we’ll unpack that in more detail, as Jim said, where we can spend some time on it and go through it and give it due justice.

Emmanuel Rosner — Deutsche Bank — Analyst

Okay. That’s fair. So let me ask you a separate topic then. So I think one of the hardest things for investors here is to try to perform a sensitivity for a downturn scenario as consumer comes under more pressure, risk of recession increase. What could that do for not so much volume because, obviously, we’ve been — auto has been operating at low volume for a while, supply-driven, but pricing. Any thoughts you could share with us either based on history or in the current context on how would you go about flexing down vehicle pricing in a downturn scenario?

John Lawler — Chief Financial Officer

Yes. So Emmanuel, we spent a lot of time on this, as you would expect us to be doing, modeling scenarios, looking at what that means for the business, looking at what we should be doing today to get out in front of any these types of issues if a recession were to come. But the way we’re thinking about it is if you step back and look at where we’re at today relative to where we’ve been as a company, heading into any — what could be a potential downturn, right, we’re in much better shape. You mentioned it from a demand standpoint. We have three years of pent-up demand, and we have a very strong product lineup. And so that’s a positive. We’re also at a point right now where incentives are low, right? They’re in the single digits versus what normally, at this point in the cycle, we’d probably be in high teens. And so of course, as volume or demand comes off, there will be some pricing that will need to be given back. And that’s a bit of a release valve, if you will. But it’s really important for us to be thoughtful about that, not only Ford, but as an industry. And then the other thing I would say, and I mentioned it in my remarks, our business is very different than what it was in the past. Our ICE product, clearly, it’s more — our lineup is more profitable as we’ve exited unprofitable vehicles. But we’ve de-risked the overall business. We restructured our markets overseas. And I think a great proof point for that is the fact that between ’18 and ’21, we burned through $9 billion of free cash flow overseas. We’re not in that position now. And we do expect this year, we’re projecting that our overseas markets will be free cash flow positive. So we’re just in a completely different position. We’re modeling it. We’re looking at it. We’re getting out in front of things, as Jim said, that we can today. But it’s a new day every day. But that’s how we’re thinking about it. We’re clear-eyed. We understand what we’re facing. We understand what could potentially be in front of us, and now we need to work it.

Emmanuel Rosner — Deutsche Bank — Analyst

I appreciate the input.

Operator

Thank you, And the next question will be from Colin Langan from Wells Fargo.Please go ahead.

Colin Langan — Wells Fargo — Analyst

Thanks for taking my question. I just wanted to circle back to the first question going from the first half to the second half. The outlook dividend point is about flat. You highlighted, I think, [Indecipherable] volume. I think the commodities is over $1 billion in [Indecipherable] Q1 and Q2. You highlighted about $1 billion of Ford Credit sort of — that’s about $3 billion is good news. You didn’t quantify the bad news. And currency, it doesn’t seem like something to be that material. Any sort of framing it, is that $3 billion inflationary cost predominantly in the second half? Is that [Indecipherable]?

John Lawler — Chief Financial Officer

Yes. So Colin, let me clarify. It’s really hard to hear you. It’s quite static-y. But Ford Credit will be about $3 billion in total profits for the year. So that’ll be down half-over-half. So that’s a headwind. And the inflationary costs on a half-over-half are a headwind. And so when you walk through it, yes, there will be some volume. We said that volumes in the second half will be up roughly in the low 20 percentage range versus the first half. And so you’ve got some mix improvement as well. So volume and pricing and mix are the tailwinds. A little bit of a tailwind on commodities, but the headwinds are FMCC profits. They’ll be down. We’ve got the inflationary pressures we talked about, will be an increase in the second half. We also have exchange that’s hitting us in the second half relative to the first half. So that’s a headwind as well. And then we had some one-timers in the second quarter that aren’t going to repeat. And of course, we’re going to continue to invest in the business. So there’s going to be spending-related costs. There’s going to be connectivity costs that will be increasing as well as we invest. So those are the puts and takes. Those are the tailwinds and the headwinds as you look at it from a half-over-half basis. And I hope that helps clarify things.

Colin Langan — Wells Fargo — Analyst

Okay. And to follow up, I know you clearly are going to give more details on the EV perspective and how you’re going to assess things. But you’re talking a pretty dramatic increase in raw material costs. I think even in your comments, you indicated that only about 50% of the materials are going to be available to produce all the EV targets, which kind of would imply that prices of these raw materials would actually remain high. Should you be thinking about pulling back on some of the EV investments if the economics at this point are unclear?

James D. Farley — President and Chief Executive Officer

No. No. We don’t plan on pulling back. If anything, the first generation of products has inspired us to go faster. I think I would just emphasize that how we look at this change in our industry, it’s not a change in propulsion. It’s much bigger than that. It’s a change to a vehicle whose differentiation will increasingly be software that you ship to the vehicle. We now have real experience on the first shippable software to these cars. The first is ADAS, for sure. And the second one for us is Ford Pro. We’re shipping telematics to the customer, driver coaching, energy management. Our attach rate for charging now on our E-Transits, where we’re 95% share, it’s like 30-plus percent. So there are a lot of services connected to these vehicles because of the software. And that’s a really big revenue opportunity for us. When you talk about the base walk to 8%, we’re not going to — as John said, we’re not going to go through that here, but I will tell you that LFP has a dramatically different exposure to raw materials than an NCM sell. Like there’s no nickel in it. So the chemistry strategy for the company and diversifying that is a very key part of our profitability walk. But I think the most important thing to think about is not that we’re investing or not in electric cars. We’re investing in digital products, and we can keep them longer because we don’t have to upgrade the upper bodies because they’re software-enabled vehicles. There’s so much we can do to change the profit profile of these vehicles. The biggest thing we have to solve for in all of that is the battery cost, and we can’t wait to take you through all of that.

Colin Langan — Wells Fargo — Analyst

Ok, Thanks for taking my question.

Operator

And the next question will come from Joseph Spak from RBC Capital Markets. Please go ahead.

Joseph Spak — RBC Capital Markets — Analyst

Hi, Thank you. The — I just want to — John, can we just go over — so $3 billion of other inflationary costs, it’s $2 billion higher than before. Are you — I know you’re working to offset it. Are you assuming you offset that delta in the guide? And maybe you could just let us know how much of that was already incurred in the first half.

John Lawler — Chief Financial Officer

So we had — it’s $1 billion higher than what we had talked about previously, Joe. So we’re looking at about $3 billion for the year, and that’s part of what we’re doing. We’re working to offset those inflationary costs, and that’s something that we need to continue to work through. We’re not all the way there, of course, but we’re working on it, and we do have the rest of the year to go, and it is a significant focus of our team, as we’ve talked about. But the cost efforts are a significant focus of the team as we remake the company in Ford+. So that’s a really important part of what we’re doing. And so it’s $3 billion for the year. We had said $2 billion. We’ve seen about another $1 billion come through, and it’s across the board.

Joseph Spak — RBC Capital Markets — Analyst

Okay. The second question is just on Ford Credit. So you’re pointing to a lower second half, which, if you annualize that, would get you to something in the low 2s. Is that a good base to think about next year and go forward? Because if we look at the pretax ROE in this business, it’s been well above average, and I think we understand why there’s been some unusual circumstances. But is that the right way that you’re thinking about it that to return to sort of more normal or historical returns? Or is there anything structural under — in fact, Ford Credit that’s changed the profitability profile?

Marion Harris — President and Chief Executive Officer, Ford Motor Credit Company

Joe, this is Marion here. Thanks for the question. You’re thinking about it correctly. So if you go

Back to pre-COVID, and balance sheet was quite a bit larger, we were at about $145 billion at that time. We were at a run rate of about $2.5 billion, $2.6 billion of EBT. And so that was the normal level. Our balance sheet is somewhat smaller now. And so I think what you’re seeing is a more normalized level of profits. We’re back at our pre-COVID reserve level. We’re not releasing reserves and as it relates to lease residuals, that’s pretty much worked its way through its book. So you’re seeing that more normal performance.

Joseph Spak — RBC Capital Markets — Analyst

Thanks very much.

Operator

And our final question of today will come from James Picariello from Exane PNB Paribas. Please go ahead.

James D. Farley — President and Chief Executive Officer

Hey guys, Just for commodities, at current spot rates, just as a theoretical exercise, right, if we take into account the lagging effect to your P&L, can you just think about maybe directionally just what commodities — what the commodities impact would look like for next year at current spot rates?

John Lawler — Chief Financial Officer

Yes. I think we do see it coming off some. Part of what complicates the commodity situation is as we go through in a year, we lock into contracts, and they roll. That protects us on the upfront when prices are increasing some, but it also has a lag effect when prices are coming down some. And so we’ll have to deal with that as we run through the year as well. And so I think, really, it’s going to depend on what happens with the overall macroeconomic environment. If we do see us tripping into more of a recessionary period, we should see those fall quicker like we have in the past. If not, I think that they’ll come down more moderately. So we’re planning and looking at both of those scenarios from a spot standpoint. It is good news as we roll through next year, but you can’t just take that spot good news and roll it through everything because we do have contracts that were locked into on a rolling basis through the year.

James D. Farley — President and Chief Executive Officer

Okay. Understood. And then just with respect to the cadence for the second half, I mean, how should we be thinking about the quarterly volume — the volume ramp in the back half? And can you provide color on Ford’s progress in shipping the unbilled inventory, I think, totaled 53,000 entering the quarter?

John Lawler — Chief Financial Officer

Yes. So 53,000 entering the quarter. The team did a good job on the drawdown. We’re down to 18,000 at the end of the quarter, and we’ll work to get those out over the second half of the year as we can free up the chips that impacted us. I think when you look at the volumes, in the second quarter, we saw an increase in volumes in North America, which helped drive the strong performance for North America. When you look at the second half, as we said, volumes would be up in the low 20% range compared with the first half. But that volume growth — there’s greater volume growth in the overseas markets in the second half than in North America. We have the Ranger launching in IMG. We have volume in the second half growing at a quicker rate in Europe. And then, of course, China was significantly depressed from a volume standpoint in the second quarter due to the shutdown. And so that’s what will be happening from a standpoint. But when you look at the volumes for Q3, they’ll be lower than they will be in Q4 because in Q4, we should see the rate fall, the chips improve as we go through the third quarter into the fourth quarter. So that’s how the volume is framing up in the second half relative to the first half, and then the walk from Q2 into Q3. So volume and mix in Q3 — Q3 is going to be less than Q2, right? It’s not going to be as strong as Q2. We have a couple of things hitting us in Q3. Volume and mix, most of the volume growth in Q3 relative to Q2 is going to be in Europe and China. And then we still have commodity costs hitting us, and we’re investing in connectivity. And our spending will — in the third quarter, Ford Credit, of course, as the second half is lower than the first half. You see that come through in the third quarter. And then we have the nonrepeat of the one-timers I talked about in the second quarter. So third quarter will be down compared to the second quarter. Volume increases will be overseas. And then as we get to the fourth quarter, volume in the fourth quarter on a sequential basis will be better than the third quarter.

James D. Farley — President and Chief Executive Officer

Very helpful, Thank you.

Operator

[Operator Closing Remarks]