Weekly Notes On The Automotive Sector: Volkswagen, Daimler And Tata Motors

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DAIMLER AG

This past week has been eventful in the luxury automotive market, with two of the companies in discussion to expand their offerings to relatively uncharted segments, and the third, a notably giant premium carmaker, being slapped with fines for anti-monopolistic policies in China. Luxury vehicle divisions Volkswagen AG‘s (OTCMKTS:VLKAY) Audi, Daimler AG‘s Mercedes-Benz and Tata Motors‘s (NYSE:TTM) Jaguar Land Rover faced probes from China’s antitrust regulator, due to alleged monopolistic practices of inflating vehicle and spare parts prices, which subsequently prompted these automakers to lower product prices in China last month. China probes possibly hurting profits, coupled with tepid sales outlook in the politically troubled Eastern Europe, weighed on automotive stocks, which performed weaker than broader indices this week.

Below we discuss key events from last week in relation to the automotive companies in discussion.

Volkswagen

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Volkswagen looks like it is on its way to overtake Toyota as the world’s largest automaker this year, crossing 10 million unit sales for the first time. But the German giant suffered a setback this week as China’s antitrust regulator, the National Development and Reform Commission (NDRC), fined the company’s joint venture FAW-Volkswagen 249 million RMB ($40.6 million) for monopolistic practices pertaining to highly inflated vehicle and spare part prices for its luxury division Audi. [1] The regulatory body also fined eight Audi dealerships a total of 29 million RMB.

This fine represents only 0.7% of the net operating profits made by Volkswagen last year in China, it’s single largest market. In view of the investigation, Audi has already reduced its auto spare part prices in the country by up to 38%. This reduction might not significantly impact revenues per unit and consequently margins, as only around 10% of the net automotive revenue comes from spare parts, and should be even lesser in China, due to the country’s relatively young fleet. In addition, Volkswagen is the largest automaker in China, and hopes to make up the deficit through economies of scale and improvement in operational efficiencies.

We have a $48.14 price estimate for Volkswagen AG, which is roughly 7% above the current market price. The stock price fell by 1.4% in the last five days.

See Our Complete Analysis For Volkswagen AG

Volkswagen also announced this week that it will halt production in Russia for 10 days, as political uncertainties in the region and negative consumer sentiment continue to drag down vehicle sales. [2] The company sold over 3% of its volumes in Russia last year, but volumes have declined by a high-single-digit percent so far this year in the country, prompting the company to cut down production at its Kaluga plant in Russia. Vehicle production could fall to 120,000 units this year in the country, down from the previously planned 150,000 units, operating at just over half the facility’s production capacity. Due to high operating leverage, Volkswagen’s profitability could be negatively impacted by lower volumes and higher fixed costs in Russia this year.

Daimler

Apart from Audi, Chrysler was also fined by the Chinese regulators for monopolistic practices. The third-highest selling luxury vehicle brand in China, Mercedes-Benz, has also been found guilty of artificially inflating vehicle and spare part prices, and could be the next to receive a multi-million pound fine for the same in China. Mercedes also reduced its spare part prices in China last month by an average of 15%, though it is likely that a higher proportion of local production and economies of scale could offset the possible decline in profitability in the country.

We have a $87.12 price estimate for Daimler AG, which is roughly 8% above the current market price. The stock fell 1.7% in the last five days.

See Our Complete Analysis For Daimler AG

Last week also marked the unveiling of the Mercedes-AMG GT, a sports car to be launched next year. This model is the second sports car entirely made by Mercedes-AMG, and will heat up the competition in the higher-end of the luxury vehicle market, competing with the likes of Jaguar F-Type and Porsche 911 Turbo. [3] While the GT won’t be a volume model for Mercedes-AMG, with an estimated starting price of nearly $180,000, the model will boost average revenue per unit for the company, which was around $102,445 for the company’s super-luxury division last year.

The GT being relatively more expensive could carry fatter margins and help Mercedes meet its mid-term target of 9-10% operating margins. Mercedes, whose operating margins stood at around 7.9% last quarter, lags behind both Audi and BMW, who consistently report 9.5-10.5% operating margins.

Tata Motors

Riding on strong growth for Jaguar Land Rover (JLR), Tata Motors’ stock has surged by over 20% in the last three months, while both Daimler and Volkswagen stocks declined. However, the Indian automobile company was the weakest performing stock out of the three companies in discussion this week, possibly hurt by rumors of fines from the Chinese regulators. China is JLR’s largest market, and in view of this investigation, the luxury vehicle division also reduced prices for two Range Rover models and the sports car Jaguar F-Type Cabriolet by up to 19% in the country. Tata’s standalone Indian automotive division was also fined a massive $222 million last month by India’s antitrust regulator. Fines for Tata Motors in India and a possible fine by China are expected to dent the automaker’s finances this year.

Trefis price estimate for Tata Motors is $47.36, which is in line with the current market price. The stock price fell by 2.1% in the last five days.

See Our Complete Analysis For Tata Motors

Jaguar also unveiled the XE this week, its first compact luxury saloon in five years. The XE is set to be a volume model for Jaguar, which will compete with bestsellers such as BMW 3-series, Audi A3 and A4 and Mercedes-Benz C-Class in the lower-end of the premium vehicle market, following its launch in early 2015. The new XE is based on an aluminium monocoque, providing a weight saving advantage to Jaguar. In fact, the XE uses RC 5754, an aluminium alloy made predominantly from recycled material. In a bid to become more environmentally friendly and reduce CO2 emissions, Jaguar plans to use this alloy in the coming models as well, aiming to use 75% recycled material by the end of the decade. In the long run, by using recycled material and an integrated manufacturing model, JLR could considerably enhance profitability.

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Notes:
  1. China fines Audi and Chrysler for price fixing, ft.com []
  2. Volkswagen to halt production at Russia plant for 10 days, wsj.com []
  3. Daimler press release []