Daimler Pre-Earnings: Strong Mercedes Volume-Growth And Cost-Benefits To Boost Margins

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DAI
DAIMLER AG

Daimler AG is scheduled to announce its third quarter results on October 23. According to the preliminary release, the automaker’s free cash flow this quarter has increased by over 80% from 2013 levels to €2.9 billion ($3.7 billion), excluding the effects of disposals and acquisitions. [1] Apart from creating value for shareholders, this additional cash will now boost Daimler’s efforts to aggressively invest in expanding its luxury vehicle division Mercedes-Benz, which forms over 60% of the company’s valuation by our estimates.

Through September, Mercedes-Benz still lagged BMW and Audi in terms of global premium vehicle volumes but has outpaced both its compatriots in terms of volume-growth so far this year. Mercedes lost its global luxury sales crown to BMW in 2005, and aims to regain the lead by the end of the decade. Apart from a relatively higher increase in global volumes, what bodes well for Mercedes is that the automaker is now closing the gap on BMW and Audi in terms of operating margins as well. One-time costs associated with the launch of new/refreshed models had lowered operating margins to around 3% a couple of years ago, but the German automaker has since sequentially improved profitability and looks to target the operating margins figure of 9-10% in the near-to-midterm, closer to the margins reported at BMW and Audi.

We have an $87 price estimate for Daimler AG, which is roughly 16% above the current market price. However, we are currently in the process of revising our estimates.

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See Our Complete Analysis For Daimler AG

Mercedes-Benz sold 412,018 units in Q3, up 12% year-over-year. [2] Volumes have remained strong mainly on the back of strong growth in the U.S. and China, the two largest premium vehicle markets in the world. The compact models A-, B-, CLA- or GLA-Class, which formed almost 30% of the net unit sales during this period, led the volume-growth for the brand, with sales growing by 25% compared to 2013 levels.

Strong U.S. And China Growth To Boost Mercedes’ Top Line

With volumes growing 8.4% and 30.5% respectively in the U.S. and China in the first three quarters, Mercedes makes a strong case for competing for the global premium vehicle sales lead. The reason we stress on the company’s performance in these two markets is because while U.S. is the largest premium vehicle market and also Mercedes’ largest sales-base, China is the fastest-growing luxury vehicle market. In order to maintain and further push its overall vehicle volumes, Mercedes depends significantly on sales in the U.S. and China, which together formed 37% of the net volumes through September. Both these countries present further growth opportunities for the automaker. Although the North American vehicle market is relatively mature, growth lies in potential upgrades to luxury vehicles and/or the replacement of ageing vehicles in the region. On the other hand, premium vehicle sales in China form only roughly 7% of the net automotive sales, less than the figure of 10-11% for the U.S., and with increasing disposable incomes, more customers might be inclined to purchase luxury vehicles. With increasing cash flow, Mercedes has looked to further its growth in the U.S. and China through expansion of local manufacturing and launch of new and revamped models.

  • Mercedes Closes On BMW In The U.S. After C-Class Launch

The C-Class is a high-volume model for Mercedes, and absence of its new model year from the U.S. lineup this year is one of the reasons why Mercedes lost out on the sales lead in the country to BMW through August. Following the introduction of the new C-Class at the end of August, Mercedes outsold BMW in the U.S. in September, growing unit sales by 10.6% year-over-year, with the C-Class constituting 23% of the net volumes. Apart from the incremental revenues contributed by the new C-Class in the country, we expect the model to also improve Mercedes’ profitability in the region.

The C-Class is the first sedan to be produced in the company’s U.S. plant in Tuscaloosa, Alabama, which manufactured only the sports utility vehicles (SUVs) M-, R-, and GL-Class before this. For this purpose, the automaker spent over $2 billion on the Alabama plant to expand capacity for the C-Class along with other models. Local production of this model allows Mercedes to save added costs such as import taxes and transportation expenses, and mark down the model prices due the absence of these additional costs, making the car relatively more affordable. By manufacturing closer to the end customer, Mercedes could expand margins by sourcing materials locally and evading aforementioned incremental costs. The C-Class is the first Mercedes-Benz model to be produced in four continents, and being a volume model due to the high demand for compact luxury vehicles worldwide, could boost the company’s profits due to cost-benefits from local production.

  • Mercedes Aims To Further Build On Strong China Volumes

China is a crucial luxury vehicle market, expected to grow by at least 13% this year, and overthrow the U.S. as the largest premium vehicle market by 2016. So far this year, Mercedes has outpaced the overall expected growth in the Chinese luxury vehicle market, gaining market share on competitors. Daimler recently announced plans to extend partnership with the Chinese BAIC Motor, investing around $1.27 billion for localization of additional compact sedans other than the GLA in China. Both the companies will jointly invest around $5 billion through 2015 to increase automotive production in China.

Smaller-sized luxury vehicles are gaining popularity as they attract a wider consumer base, comprising people who intend to buy premium vehicles but have limited resources. Compact sedans are already the highest-selling models for luxury automakers in China. With just over 200,000 units sold in the country so far in the year, Mercedes still sold less than half the vehicles sold by Audi in the country. Further expansion in China, especially through local production of highly popular smaller luxury sedans could help Mercedes further encroach upon competitor market share in the country.

Higher Profits in Q3 On Revenue Growth And Cost Benefits

Daimler’s top line growth this quarter is expected to be fueled by the 12% rise in Mercedes volumes, with incremental sales from the newly revamped C-Class launched in the U.S. and China. On the flipside, tough economic conditions in South America and Eastern Europe could somewhat drag down the top line this quarter. The inflationary environment in Russia and Brazil could have dissuaded consumers from purchasing luxury vehicles. At the same time, as high interest rates and inflation tend to have a milder impact on affluent individuals, the target customer base for premium automakers, volumes might not decline substantially in these countries. Revenues, however, will be impacted by unfavorable currency translations, as Mercedes imports all of its vehicles into Russia, which constituted around 3% of the net volumes in 2013, thus exposing the company to the depreciation of the ruble against the euro.

In the preliminary release, Daimler has already reported a nearly 30% rise in Mercedes’ Q3 operating profits. Strong volume growth and higher proportionate sales of the relatively higher priced E- and S-Class models, which carry fatter margins, could push the luxury division’s margins beyond 8% this quarter, up from 7.26% in Q3 last year.

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Notes:
  1. Daimler press release []
  2. Mercedes press release []