Can German Car Makers Retain Profitability As China Slows?

Can German Car Makers Retain Profitability As China Slows?

VW Most Exposed As Europe, U.S. Drag It Down.

“BMW continues to generate the most consistent and highest quality set of earnings across European autos”

German car makers have made huge profits from China, but as the market there slows down, investors are worrying that the good times may be over, and Volkswagen looks particularly exposed.

Investment bank UBS believes overall profitability for BMW, Mercedes-Benz and Volkswagen and its Audi premium subsidiary is sustainable, but weakness in China leaves what it calls “only limited room for error.”

In a report, UBS said VW is the most exposed to China with an estimated 55 to 60 per cent of its earnings derived there. Mercedes-Benz relies on China for 20 to 25 per cent of its profits, and BMW 35 to 40 per cent.

According to UBS analyst Philippe Houchois, BMW is best protected against China failings because of its stellar performance in traditional markets, Mercedes less so, while VW profits are most exposed as it struggles in Europe and the U.S.

“BMW sales continue to out-perform in Europe and North America, with some mix benefits in the U.S., which will accelerate late in the year with the new 7 series,” Houchois said in the report.

BMW’s new 7-Series flagship will be launched late this year to boost margins, which should also be helped by a new X-1 SUV and 5-Series sedan. BMW has also launched a face-lifted version of its biggest selling product, the 3-Series.

Pace of change
“(Mercedes-Benz parent) Daimler earnings are the most reassuring near term but estimates and valuation expectations are high and (Mercedes) margins suggest performance outside China is already at or above peer levels. VW’s high earnings dependence on China also reflects poor showing elsewhere, particularly at VW (brand) where earnings are well below potential in Europe and other key emerging markets, and the pace of change seems to be accelerating,” Houchois said.

Investment bank Morgan Stanley shares this worry about VW.

“It is clear that the short-term outlook in China has changed. Given that China generates 45 per cent of VW brand global sales and 36 per cent of VW group global sales, we believe VW is more exposed to China than any other (manufacturer). On current 18 per cent EBIT (earnings before interest and tax) margins in the China joint venture, and adding imports, royalties and parts, China generates at least 50 per cent of VW Group pre-tax earnings. Thus any further deterioration in China trading and margins could hurt VW (earnings),” Morgan Stanley said.

In April, VW overall sales fell for the first time in 4-1/2 years, with deliveries in the 12-brand company which includes premium brands Audi and Porsche, and more workaday outfits like Skoda and SEAT, sliding 1.3 per cent to 853,200. For the first four months, sales grew one per cent to 3.34 million vehicles.

Clear view
UBS, looking to the long-term prospects of the Germans, is impressed by BMW.

“BMW continues to generate the most consistent and highest quality set of earnings across European autos. The (company) also stands out in our opinion with a clearer view of the challenges facing the industry in terms of powertrain and new mobility,” the report said.

Mercedes-Benz was best positioned to weather storms in China. VW, although most exposed to China could have significant scope to increase core earnings from making cars in Europe and other parts of the world as markets recover and it implements new production methods though its so-called MQB system.

“We assume (MQB) alone can add in excess of 2.5 billion euros ($2.7 billion) net to VW brand earnings,” the UBS report said.

BMW’s automotive EBIT margin was 9.5 percent in the first quarter, similar level to the year-earlier quarter and at the upper end of its target range of between 8 percent and 10 percent. Mercedes-Benz’s margin jumped to 9.2 percent from seven percent a year ago, while Audi’s operating margin slipped to 9.7 per cent from 10.1 per cent. The VW brand’s operating margin rose to 2.0 per cent from 1.8 per cent.