Daimler Earnings Review: Mercedes’ Margins Expand On Favorable Mix And Strong Volume Growth

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DAIMLER AG

Fueled by the strong sales-growth for the luxury vehicle division Mercedes-Benz, Daimler AG reported a solid 10% year-over-year top line growth in Q3, and through the first nine months of the year. Mercedes, which formed 56% of the net sales, witnessed a 13% rise in sales to push the overall revenues for the quarter to 33.12 billion euros ($42 billion). [1] This is mainly as luxury vehicle demand remained strong in the two most crucial markets for the automaker – U.S. and China. In addition, while economic concerns still cloud growth in Europe, premium vehicle volumes rose in this region as well to boost the overall results for Mercedes. But what underscored Daimler’s strong financial performance this quarter was a 47% increase in net profits to 2.8 billion euros, bolstered by the strong margin expansion at the Mercedes unit. Operating margins for Mercedes stood at 8.5%, up from 7.3% in Q3 2013, the highest figure in over two years.

On the other hand, the trucks division, which forms one-fourth of the net volume sales, grew unit sales by only 1% this quarter despite a 25% volume rise in North America. This is because truck sales remain tepid this year in Europe, South America and parts of Asia. Europe sales this year are expected to remain low due to the large scale pre-buys of the Euro 5 trucks at the tail-end of last year. On the other hand, macro volatility in some of the emerging markets in South America such as Brazil and in Asia will drag down truck sales in Q4 as well, as the commercial vehicle market is impacted by economic conditions and the general business environment. This declining trend is expected to hamper full-year results for the Daimler International trucks and buses division, constituting almost 20% of the company’s net value, with over 90% of the volumes formed by trucks.

We have an $87 price estimate for Daimler AG, which is roughly 14% above the current market price. However, we are currently in the process of revising our estimates.

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U.S. And China Crucial In The Race To Topple BMW And Audi

Mercedes-Benz lost the global luxury vehicle sales lead to BMW in 2005, and presently sells fewer vehicles than both BMW and Audi worldwide. But the automaker looks to overtake the lead by the end of the decade through new launches and aggressive expansion into newer markets. Although the added start-up and developmental costs saw Mercedes’ operating margins fall to low-single digit percentages in 2012 and early 2013, the automaker’s product offensive strategy seems to be paying off. U.S. and China are the two most important markets for Mercedes, and the German manufacturer has expanded its production line in both these countries, particularly for compact models, gauging the high demand. Mercedes-Benz still lagged BMW and Audi in terms of global premium vehicle volumes through September, but has outpaced both its compatriots in terms of volume-growth, and could soon catch-up through accelerated sales of its compact models.

Compact Saloons Drive Growth For Mercedes

Compact vehicles A-, B-, CLA-, GLA- and C-Class together formed half the net volumes for Mercedes this quarter. Small-sized luxury cars and SUVs are not only volume models for the company, but also present large growth opportunities. Compared to the 9% volume growth for Mercedes in Q3, compact model volumes rose by 19%. Smaller-sized luxury vehicles are highly popular as they attract a wider consumer base, comprising people who intend to buy premium vehicles but have limited resources. In the U.S., the biggest market for Mercedes, customers could look to trade-in their non-luxury large sedans for entry-level luxury sedans. Large sedan sales fell 5% in the country in the first three quarters, while luxury car sales rose 3%. [2] Mercedes looks to grab a considerable portion of the compact saloon demand, and for this purpose, extended production in its U.S. plant to include the new model year of the C-Class.

The C-Class is the first sedan to be produced in the company’s U.S. plant in Tuscaloosa, Alabama, which manufactured only the 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. Apart being a cost-effective measure, the launch of the C-Class can now help Mercedes regain its luxury lead in the U.S. this year, after losing out to BMW in the first nine months. 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.

On the other hand, China volumes formed 18% of the net volumes, and continued to outpace volume growth in any other market for Mercedes. 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. However, further expansion in China, especially through local production of highly popular smaller luxury sedans could help Mercedes encroach upon competitor market share in the country. 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. In addition, the new C-Class, locally produced in Beijing, also started selling late in August in China, and its first full quarter of availability in the country in Q4 could boost Mercedes’ overall results.

Mercedes’ Margins Expand, As Expected

Apart from the strong volume growth for Mercedes, what bodes well for the brand is that operating profit margins expanded to 8.5% this quarter, up sequentially from 7.9% in Q2. Although this figure is still below the 10.5-11.5% operating margins expected for BMW and Audi this quarter, Mercedes could reach its near to mid term target of 9-10% operating margins in the coming quarters. Margin growth stalled for Mercedes previously as the brand’s product offensive strategy, including the launch of 30 models between 2014 to 2020, called for large start-up costs and research and development expenses. As the company looks to reap the benefits of local manufacturing and extends volume sales on the back of the new model launches, margins could expand further.

A favorable product mix is also one of the reasons why Mercedes’ margins could reach above 8.5% in the fourth quarter. Sales of the relatively more expensive S-Class sedan, which carries fatter margins, almost tripled this quarter to 28,200 units. The company also launched the S-Class Coupé and the S 500 plug-in hybrid at the end of last month in Europe, and stronger sales of these models could push Mercedes’ average revenue per unit higher in the last quarter.

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Notes:
  1. Daimler earnings release []
  2. U.S. auto sales, wsj.com []