Daimler AG (NYSE:DAI) is scheduled to announce its earnings on October 25. Although Mercedes-Benz has sold 5% more cars so far in 2012 than it did in the previous year, growth slowed in the last quarter to 2%.^[1] Moreover, the automaker will be disappointed that it has not been able to close the gap with BMW and Audi in the first nine months of the year. The two automakers continue to extend their lead with vehicle sales up 8.3% and 12.8%, respectively, in 2012.^[2] Mercedes-Benz was the biggest luxury automaker in the world until 2005, but currently trails BMW and Volkswagen’s Audi.

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Reinvigorating its existing line-up for a newer, fresher look will be pivotal to sustain top-line growth. Mercedes already launched a new version of A-class earlier in the year to appeal to the younger generation that prefers sportier and compact cars. The next generation C-Class should arrive in 2014 as well. Furthermore, Mercedes will launch 10 new vehicles by 2015 which will widen its portfolio to include a greater variety of compacts, coupés and SUVs.

Trucks Could be the Unlikely Hero

It has been a good year for Daimler trucks with sales up 20% through August. North American sales grew 27% while Russian sales surged by 80%. Daimler also started the production of Antos, the truck series it unveiled in July, which caters to the needs of the short-radius distribution industry. We estimate trucks constitute almost 30% of its total stock price.^[3]

Daimler also introduced its first set of trucks in India under the brand BharatBenz late in September. Although the sales will not impact the upcoming earnings, they are likely to become an important revenue stream for the automaker in the coming years. Under this brand, Daimler will roll out 18 new models, designed specifically for the Indian roads, in the next 18 months. To build the line of trucks, it has invested $850 million in a facility in India, which is the company’s largest investment outside of Europe.

Margins Under Scrutiny

Daimler’s margins could widen as the proportion of its vehicles produced from its Hungarian plant rises. Shifting production to low cost hubs such as Hungary where labor wages are one-fifth those in Germany should help reduce costs. Mercedes-Benz’s Hungarian plant was built at a cost of €800 million (or $1.07 billion) to manufacture its B-class compact car and the production began in March 2012. Daimler announced it could double the plant’s production to 300,000 vehicles annually by 2015. Margin improvement has been one of the priorities for the automaker. Daimler’s operating margins in the second quarter were 8.6% compared to 11.6% for BMW and 11.5% for Audi.^[4]

Mercedes-Benz could also be building passenger cars with its partners Renault and Nissan. The three companies formed an alliance back in 2010. The deal could see the alliance manufacturing an off-road vehicle for Mercedes and cars for Nissan’s luxury brand, Infiniti. Rising costs and a weak macro economic environment have forced automakers to make alliances in order to share costs and technologies.

However, in September, Daimler also warned that adverse market conditions in Europe and a Chinese slowdown could dent its second half profits. The Chinese auto slowdown has resulted in car makers reducing prices and offering greater discounts to entice buyers. Added expenses related to new launches such as the A-class will also impact its short-term profitability. Mercedes-Benz reported operating profit of €2.57 billion for the first six months of the year. Previously, the automaker had forecast the full year’s profit to be similar to last year’s €5.19 billion. So, although the company’s margins look set to expand in the long term, the short-term profitability could be hurt due to weak pricing caused by the deteriorating market conditions in Europe and the rest of the world.^[5]

We have a price estimate of $61 for Daimler’s stock, which is about 20% above the current market price.

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