Daimler Pre-Earnings: Strong Volume Sales Growth For Mercedes To Boost Top Line

Daimler AG is scheduled to announce its Q4 and full-year results on February 5. The luxury vehicle division Mercedes-Benz, which forms just over 62% of the company’s valuation, benefited last year from strengthening demand for premium vehicles in key markets, especially in the world’s two largest luxury automotive markets — the U.S. and China. While BMW and Volkswagen’s Audi still maintained their lead over Mercedes in terms of global vehicle sales in the premium market in 2014, Mercedes narrowed the gap with both its compatriots, increasing volume sales by 13% year-over-year. Mercedes’ gap with the worldwide sales leader BMW shrank to 91,000 unit sales from 114,000 in 2013. ^[1] Mercedes is in hot pursuit to take over the worldwide luxury sales lead before the end of this decade, and the company plans to launch at least eleven new models (with no predecessors) before 2020 as a part of its product offensive strategy. Revenues were up 10% through the first three quarters for Daimler, and as luxury volume sales remained strong throughout  the fourth quarter, the company could report another quarter of robust sales growth to wrap up 2014.

We have an $85 price estimate for Daimler AG, which is roughly 10% below the current market price. The stock jumped over 6% in the last five days.

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While Mercedes has resolved to accelerating new product launches through the end of the decade, high start-up costs and R&D expenses related to their growth offensive strategy will weigh on the profitability of the premium vehicle division, which formed almost half the operating profits for the Daimler Group in Q3.  Lower margins would stall cash flow growth for the company in the near to mid term, slightly offset by the growth in volume sales, which should add to the bottom line. One-time costs associated with the launch of new/refreshed models had lowered operating margins to around 3% a couple of years ago, but a favorable product mix and efficiency initiatives such as the ‘Fit for Leadership’ program has helped Mercedes sequentially improve its profitability. Operating margins for the German company stood at 7.8% through September, with the figure improving to 8.5% in Q3. However, the operating performance at Mercedes still lags that of BMW and Audi, which reported margins of 10.2% and 9.7% respectively through the first three quarters.

Compact Models And C-Class Fuel Growth In 2014

Mercedes’ top-line growth this quarter is expected to be boosted by high volume sales for its compact models. Unit sales for the A-, B-, CLA- and GLA-Class smaller premium vehicles rose by 24.7% to 463,152 vehicles in 2014, representing 28% of the overall volume sales. In addition, the C-Class compact saloon, the new version of which was launched last year, continued to be the top volume model for Mercedes, constituting almost one-fifth of the net volumes for the brand last year. Demand for smaller premium vehicles has remained strong in the last few months, as customers, with a higher purchasing power now owing to the declining oil prices, trade-up from non-luxury large sedans. What the C-Class underscores is Mercedes’ commitment to extracting meaningful volume growth by penetrating high volume segments such as compact sedans and SUVs, and simultaneously reducing its import tariffs and cost of production by manufacturing closer to the end customer. The C-Class is Mercedes’ first model to be produced in four continents, being manufactured in Germany, South Africa, the U.S., and China. Sales for the C-Class increased by nearly 50% in December, and with full availability of the model’s new versions, Mercedes expects additional sales momentum going into 2015.

Europe Growth Remains Strong For Mercedes

Apart from the U.S. and China, supporting our estimate for high premium sales this quarter is a rise in vehicle volume sales in Europe. Following the double-dip recession, automotive production in Europe returned to positive growth last year. Although the recovery has been patchy and slower than expected, vehicle volumes in the region rose 5% last year to over 13 million units, with more than a little help from falling fuel prices, tax breaks, and incentives. ^[2] In fact, Mercedes achieved a 9.4% year-over-year growth in unit sales in 2014 in Europe, with an impressive 21.5% rise in December alone, thereby outpacing growth in the region’s overall automotive market during the period. However, the Euro Zone economy has not recovered as expected in the last year, and with crude prices reaching historical lows, there is the fear of deflation looming, which could slow economic growth in the future. Although a weakening euro would have a positive impact on earnings in foreign countries (converted back to euros), with the caveat of possible deflation and slow economic growth in place, luxury vehicle sales might also slow down.

Mercedes has been able to improve its operating performance over the last two years, reaching 8.5% in the last quarter. While the automaker has outpaced both BMW and Audi in terms of volume growth last year, it will be interesting to see if the brand was able to squeeze-out more profits and get closer to its targeted 9-10% margins in Q4.

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1. Daimler press release [↩]
2. Europe 2014 sales rise on low-cost brands shift [↩]