Time To Reap Benefits Of High Investments For Daimler’s Mercedes-Benz?

Daimler AG‘s luxury vehicle division Mercedes-Benz is the third largest luxury car manufacturer in the world behind compatriots BMW and Audi. The German vehicle brand forms approximately 63% of the Daimler’s valuation, according to our estimates. Not only does Mercedes lag BMW and Audi in terms of volume sales, but also operating margins. BMW and Audi had margins of 9.6% and 9.7%, respectively, in 2014, more than Mercedes’ 8% margins. However, Mercedes has been closing-in on its competitors in the last year or two and is a serious contender for the global luxury sales crown before the end of this decade. High investments in manufacturing facilities, product development and model makeovers hurt the company’s margins previously, but the time may have come when Mercedes starts reaping the benefits of its large investments.

One-time costs associated with the launch of new/refreshed models had lowered operating margins to around 3% in the first quarter of 2013, but a favorable product mix and efficiency initiatives such as the ‘Fit for Leadership’ program has helped Mercedes sequentially improve its profitability. Mercedes improved operating margins to 8.3% in Q4 and 8% in the full year 2014, up from 7.5% in Q4 and 6.2% in the full year 2013. 8% might be a small figure in comparison with the figures reported by BMW and Audi, but Mercedes is slowly but surely getting closer to its near to mid term target of 9-10% operating margins.

We have a $96 price estimate for Daimler AG, which is in line with the current market price.

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Mercedes has also narrowed its gap with BMW and Audi volume-wise, increasing volume sales by 13% year-over-year in 2014. Mercedes’ gap with the worldwide sales leader BMW shrank to 91,000 unit sales from 114,000 in 2013. ^[1] The German number three 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. In order to stimulate additional demand this year, four new vehicles will be launched by Mercedes by July this year, including models from the Mercedes-Maybach brand, the sports car Mercedes AMG GT, the CLA Shooting Brake, and the sports SUV GLE Coupe.

Super-Luxury Models Could Boost Average Pricing

The resurrected Mercedes-Maybach brand launched first in China this year, with the S400 and S600 models launching there in February. The models are priced at more than 2x their prices in the U.S., mainly because of the high import tariffs and transportation expenses. However, foreign automakers do tend to scale-up the prices of their products in China, where demand for luxury vehicles and world-renowned brands remains high. In addition, Mercedes will also launch its sports car Mercedes-AMG GT this year, which was unveiled in September last 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. ^[2] While the GT won’t be a volume model for Mercedes-AMG, with an estimated starting price of $130,000, the model will boost the average revenue per unit for the company, along with the Mercedes-Maybach models.

If the average pricing of Mercedes’ super-luxury division (Maybach/S-/CL-/SL-Class) grows to $120,000 by the end of our forecast period, up from our current estimate of $94,000, and volume sales for this division grow at a CAGR of 8% through 2021, the price estimate for Daimler rises to $102.56, up 7% from our current estimate. The GT and Maybach models, being relatively more expensive, could carry fatter margins and help Mercedes reach 9-10% operating margins.

Volume Models To Boost Revenues And Margins

With the new wagon and sedan versions of the C-Class available in all markets, Mercedes will look to benefit from the high demand for compact saloons globally. The C-Class is a volume model for the German company, constituting nearly one-fifth of the net volumes for the brand last year. Demand for smaller premium vehicles is expected to remain strong in the near term as customers, with a higher purchasing power now owing to declining oil prices, trade-up from non-luxury large sedans. In the first two months of this year, sales of the C-Class have risen a massive 60% year-over-year to 63,878 units. Riding on this growth momentum in the early part of the year, Mercedes could be looking at a strong finish to 2015 in terms of volume sales growth.

Apart from a strong volume growth, the new C-Class could also improve margins for Mercedes, despite its lower price points. The C-Class is Mercedes’ first model to be produced in four continents, being manufactured in Germany, South Africa, the U.S., and China. What the new 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.

Speaking of SUVs, that’s another segment where Mercedes is looking to grow sales.

The company will launch four new or revamped SUVs this year, and will also start producing the compact crossover GLA-Class in China. Unit sales of premium SUVs rose 14.2% year-over-year in 2014 in the U.S., representing the highest growth in any vehicle segment. Premium SUVs still form only 1.2% of the country’s vehicle market, and with a growing demand for luxury vehicles, especially crossovers, this segment could continue to expand. Mercedes renamed its M-Class model lineup the GLE-Class last year, and recently introduced the GLE Coupe, combining the looks of an SUV and a luxury coupe. Crossovers have become popular in recent years as they provide both the functionality of a utility vehicle and the comfort and design of a car. The GLE Coupe will compete with the new model year BMW X6 (launched in December last year) in the U.S., aiming to add incremental sales for Mercedes.

Mercedes has made large investments in the recent past, in a bid to fuel growth in its volumes as well as margins in the longer term. Profit margins are rising for the German car brand, and with strong sales for super-luxury brands, the new SUV lineup, and the trusted C-Class, bolstered by lower costs of manufacturing, the 9-10% operating margins goal might be achieved within a couple of years.

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1. Daimler press release [↩]
2. Daimler press release [↩]