Tuesday, 19 February 2008

Company Focus – Daimler AG – De-Coupled & Self-Determining a Bright Future

Last week Dr Dieter Zetsche had good reason to be proud, the raison d’etre of independence vindicated. From what seems only a short while since the untangling of Daimler-Chrysler, the de-shackled organisation has proven its theory of a de-restricted Daimler when given free reign will perform. The associated €500m cash burn in re-structuring costs more than off-set by the €2.2bn ‘relief’ of legacy etc responsibility; limited by a $1bn 5 year exposure guarantee.

In essence, the FY2007 results demonstrate that there has been a renewed sense of self, responsibility and accountability (generated by the CORE initiative) across company’s 5 divisions, all except the Finance division turning-in notable pre-tax YoY growth:

MB Cars - €2977m growth (€915m to €3,892m)
Daimler Trucks – €340m growth (€1,107m to €1,447m_
Daimler Vans, Buses & Other- €711m growth (€277m to €988)
Daimler Finance - €185m drop (€218m to €33m)

To demonstrate the tangibility of a singular Daimler, great effort has gone into demonstrating long-term stock-holding value; primarily by undertaking, and promising to continue, the share-buyback scheme rewarding previous investors and promising improved dividends and probable capital returns for present and future investors via the share cancellation/reduction policy. This action greatly assisting in raising the Equity Ratio for Daimler Group from 16.5% in ’06 to 26.8% in ’07 - this trend sustained with a recommended retained use of €10.4bn of the €12.4b net earnings, the remaining €2.0bn used for dividends.

Much of that revenue and profitability stemmed from strength in the MB Cars and Daimler Truck groups with additional income from investment dividends, disposal of EADS stock and other sources such as Japanese real estate sales. Looking at the core contributors…

2007 was a record sales year for MB Cars, and company forecasts expect even better for 2008 and beyond as premium segment car sales growth rates are projected to outpace mainstream segments in 5 of its 7 identified global markets: namely North America, Latin America, Eastern Europe, Russia, China and Japan. As MB had planned, much of the re-structuring groundwork for the division paid-off, assisted by increased global volumes, and improved product mix and better efficiencies/capacity utilization which effectively reduced both fixed operational overhead and variable (labour, parts) costs. These overcame the negatives of: a strong Euro vs weak Dollar & weak Yen & controlled weak Yuan; the need to financially and operationally support a weakened supplier base to ensure components logistics; increasing raw material costs. This last issue is set to escalate as steel producers agree to a general 65% increase in basic iron ore prices and a 71% in higher quality material. Steel producers obviously cannot absorb that level of rise, even with their higher efficient, consolidated mills and operations. Thus inevitably car-makers will have to partially absorb these costs. This critical economic driver will prompt further exploration in the viability of alternative materials such as aluminium alloys and green sourced plastic composites that will also assist in required CO2 reduction. MB Cars may be able to utilise and scale-up learning from Maybach and McLaren projects to eventually integrate across the whole vehicle range.

The Cars group saw a hit from the loss of 2 poor performing Smart models (Roadster & ForFour), but the new ForTwo city car showed the maintained interest of triad markets, as it becomes an urban mobile staple, that market favour extended since available in diesel, electric and soon to be hybrid versions. New Class has been warmly welcomed as the core product finally ‘splits’ into comfort vs sport characters, the latter given more freedom to chase BMW 3 series, Audi, Lexus etc models. The board will be hoping that MB can technically prove itself in Ride & Handling regards with an ideally broadened breadth of R&H ability; so as to seriously contend within the sporting sedan arena. As a consequence of improved platform ‘tune-ability’, E series will also offer more sporting credentials (to vie against 5 series and Jaguar XF) as the two MB cars share the same technology set – a demand that we believe is overdue but finally here. But it is the massive raft of new vehicle introductions that will underpin MB success over the next 2 years; these effectively replacing the complete present line-up of cars and adding a crucially important baby Cross-Over.

Beyond product, MB has made specific efforts to improve dealer and customer satisfaction, apparently leaping up the CSI ranks for both parties. Much of that has been to overcome previous product quality issues, so whilst S&M budget spend has probably had to wear much of the cost in the form of warranty costs, dealer upgrade costs and 3rd party incentives, we imagine that as product quality improves, so the S&M ‘contingencies’ overhead should diminish in the years to come and hopefully customer loyalty is re-build and reduces advertising and communications S&M spend aswell.

However, NA product actions will continue to be key and the high hopes for new GLK, bluetec diesel variants and critical appeal of new C class, on paper, bode well for a downsizing American consumer-base. As ever though, much will depend on the ferocity of peer group competition, and VW Group’s NA intentions could possibly squeeze MB if the fragile economics of the region continue – Audi in a better position from a parent group volume scale perspective.

Contrasting the NA ‘squeeze’, China, Russia and India are the obvious current ‘stars’; sales up by 53%, 65% and 8% respectively, and accruing undoubtedly high unit margins thanks to localised plant investment and dealer network expansion – today at 80, 38, 27 locations respectively.

The ultimate aim is to create a RoS of 10%, which given the low 2005 base of -1.5% and subsequent ’06 3.5% and ’07 9.1% (a strong leap indeed) looks achievable if the recent steel price rise shock can be contained with continued pressure on cost reduction in other areas.

For Trucks, the NA market should rebound from a ’06-’07 cyclical downturn caused by regulatory requirement and economic jitters. Operators should continue to buy into new products that conform to new emission regulation standards and provide much needed improved fuel-efficiency and residual value. Daimler Trucks, as one would imagine, endeavours to be technical leaders in the sector and thus gained from early adopter fleet buyers. Remaining regions are expected to maintain, and possibly slightly exceed ’07 volumes.

The Trucks RoS improvement goal of 3.1% (in ’04) to 8.0% (in ’10) looks feeble versus the cars figures, but of course the real margins available in trucks and the service support revenue streams dwarf passenger cars. Of course the BRIC+ sales will continue to add the 29%+ of ’07 revenues via:

The ‘sweating’ of current Brazilian market leadership with local and adapted trucks
Development of a Russian plant and distribution & service network expansion
Indian JV with Hero announced
Chinese (probable JV) negotiations under way.

Vans and Buses should experience improved uptake thanks to new variants of Sprinter and increasing public transport expenditure in Asian and Russian regions as a consequence of rapid economic growth and improved infrastructure and public mobility demands. Once again, given the major ‘mark-up’ available on vans and a much needed efficiency and standardisation programme should seek to balance customer specification demand vs engineering and manufacturing efficacy.

The Finance arm has had the major challenge of creating a complete new organisation to cover the NA market, given that MB Finance was previously integrated with Chrysler. (The Finance arm was of major interest to Cerberus given its own 51% share in GMAC and the obvious possibilities for operational integration). Thus the ‘hit’ of new set-up costs is not surprising, though the efficiency of the new operation and its lending terms and conditions, given the soft consumer market, is of interest to analysts. And as expected, the stated desire for globally homogeneous procedures, systems, and IT infrastructure will need to be championed if the division is to achieve the desired 14% RoE it seeks. The balancing act comes with endeavouring to integrate such common practice with the support partner companies working with MB Finance in the new entry regions such as India, Russia, China, Malaysia, Japan and the UAE.

In summary, Dieter Zetsche has spent the last 4 years evolving Project CORE to reach this watershed year. He and his team created the fundamentals across the board to set-up the company post ’07 and beyond, the de-coupling of Chrysler demonstrating the operational leaps the German group has made, both at home and overseas. The importance of MB Cars within the group is obvious and since it is about to experience what should be a 2-4 year ‘sweet-spot’ with an all new vehicle range, the short and medium term outlook appears bright indeed, and Daimler should continue to shine as the automotive sector’s star performer – at least until Porsche & BMW come back on track which should be around ‘09/’10. That leaves Daimler standing in the limelight if it can:

1. Contain the fierce 65% steel inflation on-cost
2. Continue product platform integration
3. Improve foreign plant capacities & utilisation
4. Hedge against the prime export market currencies
5. Truly achieve stated product quality and customer satisfaction goals