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Germans Coining It In China, But Profits Likely To Accelerate

Chinese Propensity To Buy Flash Cars Greater Than U.S., U.K.
“BMW and Mercedes seen as superior to Ferrari, Porsche and Lexus”

German luxury car makers are now probably making over 50 per cent of their profits in China and accelerating sales there could propel Mercedes and BMW into double digit profit margins, according to Bernstein Research.

Bernstein Research analyst Max Warburton doesn’t see any major crisis on the horizon for China’s economy, and expects the number of millionaires to almost double by 2015, and the number of Chinese with incomes over $100,000 a year to climb by 94 per cent to 3.5 million over the same period.

Warburton quoted data which showed rich Chinese citizens have a much greater propensity to buy expensive cars than their counterparts in the West, with 206 super-premium cars being bought annually per 1,000 millionaires. This compares with only 78 in the U.S., and 120 in Britain. Even though there is this huge difference now, it is going to get bigger as premium sales grow 200 per cent from current levels by 2020 to 1.4 million a year.

According to Warburton, in the second quarter of 2010 BMW’s auto profit margin was 9.6 per cent, Mercedes 9.8 and VW, helped by its Audi premium subsidiary 6.0 per cent.

“What explains this? We think blow-out Chinese profits, driven by massive growth and aided and abetted by a big move in the Chinese currency versus the Euro, is the main factor,” Warburton said.

Sales growth has been spectacular in the last five years, with BMW and Mercedes moving from 28,000 and 13,000 in 2005 to 92,000 and 65,000 in 2009. Growth burgeoned in 2010 with BMW up 99 per cent and Mercedes plus 227 per cent in the second quarter. It’s not only the sheer volume of sales. Many of these are fully loaded, top-of-the-range 7 Series and S class cars.

Brand perception in China is also different from the West, with BMW and Mercedes seen as superior to Ferrari, Porsche and Lexus.

Profitability will decline
As the German’s sales in China are supplied more by production in China than Germany, so profitability will decline, but the government there seems relatively unconcerned about gas guzzlers, although luxury taxes are hefty.

Meanwhile, Citigroup Capital Markets said it expects China to contribute 30 per cent of 2010 net profits at VW helped by its Audi subsidiary, 30 per cent at BMW and 20 per cent at Mercedes.

But it did have reservations.

“China earnings are seen as potentially lower quality as Chinese consumers have more volatile perceptions of brand and product values, end-market conditions are more heavily government regulated, and competitive pressures could change materially from the current situation,” Citigroup said in a report.

Warburton said using more cautious assumptions, assuming profit margins fall as sales increase, China could help BMW and Mercedes maintain margins at more than six per cent.

“But in a bull case, China could sustain margins at recent levels, or, with a U.S. European recovery, help to power margins into consistent double-digit territory,” Warburton said.

“It seems logical to us to assume that (China) margins will fall to something like 15 per cent by 2015, from the 30 per cent we believe is being achieved at present on imports. This would mean that while Chinese premium unit sales double, profits may remain roughly flat, or grow only slightly.”


Neil Winton – September 15, 2010

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