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Mercedes Strong Profit Forecast Pleases Investors

Superior Pricing Undermined By Higher Costs Compared With Audi, BMW
Modular Strategy Might Start To Put That Right

Ambitious Long Term Plans Look Risky To Some

Mercedes had a nice surprise for investors when parent company Daimler announced that net earnings for 2011’s fourth quarter were up almost 60 per cent, and then came up with a bigger one, when it said profits in 2012 would be about the same as 2011’s.

Investment banks had expected profits to come under pressure in 2012, as sales stalled across Europe because of worries about the eurozone. Profit estimates for 2012 averaged around an eight per cent decline before Daimler announced that the company would be in the black this year “in the magnitude” of 2011’s numbers. For the longer term, analysts agree that Mercedes has a big problem of high costs compared with its BMW and Audi rivals, which could pay big dividends if addressed.

Net profit in the fourth quarter jumped 57 per cent to €1.8 billion compared with the same period of 2010. Daimler reckons earnings before interest and taxation this year should be about the same as 2011’s €8.8 billion. Mercedes has said it will increase sales to 1.6 million by 2015, and will be the largest selling premium auto manufacturer by 2020, with press reports saying the target is 2.7 million.  It sold 1.38 million vehicles in 2011.

Daimler’s optimism caught Berenberg Bank analyst David Cramer by surprise.

“Daimler’s 2012 outlook underlines a degree of confidence that we believe will have taken much of the market by surprise, us included. Daimler expects to see a significant increase in unit sales this year with positive momentum at Cars, Trucks and Vans. What’s more EBIT (earnings before interest and tax) is expected to be “in the magnitude” of 2011. We were not expecting management to provide so clear an indication on profitability for this year,” Cramer said.

Commerzbank analyst Daniel Schwarz had expected 2012 earnings to fall 8.1 per cent. Schwarz also pointed to Mercedes’ vans, led by Wolfgang Bernhard, and its 9.4 per cent profit margin.

“If you make Vans a 9.4 per cent margin business, imagine what the potential of the luxury car business could be,” Schwarz said.

Schwarz believed there was big scope for Mercedes Cars to cut costs and raise margins.

Price premium
“Customers are paying a 4.4 per cent price premium for an E-class compared  to a BMW 5-Series and 5.2 per cent relative to an Audi A6. The S-class premium is some 6.9 per cent relative to the 7-series and 12.3 per cent relative to an A8. Mercedes is in higher segments too: the average Mercedes Car Group model, including the Smart, generates revenues of some €42,000, the average BMW €38,000 and the average Audi €27,000,” Schwarz said.

Despite this BMW and Audi had generated higher margins for four quarters in a row.

“Adding the margin gap to Mercedes price premium we conclude that Mercedes loses some eight percentage points of its revenues on the cost side. If Mercedes would be as efficient as BMW and Audi on the cost side, EBIT margins would be 16 per cent?” Schwarz said.

Schwarz believed that foreign exchange hedging was a small part of the gap, while its product life cycle was a little less favourable.

“The biggest gap is in purchasing cost,” he said.

BMW and Audi have a head start on a modular strategy. Mercedes’ ramp up of a modular strategy will slowly close the gap with BMW and Audi, Schwarz said.

Max Warburton, analyst with Bernstein Research, believed that Daimler was making the right noises to convince investors that it was on the right track, but didn’t believe it was going to narrow the margin gap with BMW any time soon.

Going to take some time
“With inferior labour productivity, a narrower model range and arguably some brand and customer demographic issues, an improvement at Mercedes is going to take some time,” Warburton said.

Deutsche Bank analyst Jochen Gehrke pointed to the dangers involved in Mercedes’ ambitious long-term plans.

Gehrke said such a pace of growth for Mercedes was unprecedented, and although emerging market demand would be strong, it was unlikely to yield a 1.4 million increase. He pointed to expansion plans, probably with new factories in Alabama, Hungary, Mexico and China.

“Such an expansion plan is obviously risky, especially as Mercedes’ current profitability has to be seen in the light of its global price lead, which is weighed down by dramatically lower productivity levels than its two key competitors, Audi and BMW,” Gehrke said.

Neil Winton – February 20, 2012

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