Thursday, 4 February 2010

Company Focus – Daimler AG – E-Class & Global SMEs Provide Welcome Momentary Respite, But No Time To Procrastinate On The Cash Cushion

Daimler Stock Price (NYSE @ 14.30 on 04.02.2010)
$ 47.93

Daimler's Mercedes marque was historically the choice of the successful yet perhaps more somberly minded small and medium-sized business owner, the E-class symbolic of repute, respectability and longevity. The S-class was born to simultaneously feed the 1970s emergent demands from captains of European industry and petro-dollar rich Arabia, Maybach in turn re-playing that role in the 2000s. As the once separate remits and capabilities of the E & S class 4-door cars started to overlap, Daimler 'diversified' the E-class into an ever array of body-variants and relative 'characterisation' (eg Wagon/Estate vs Convertible) which in turn generated the successful CLS 4-door coupe.

[NB. This is of course to say nothing of the evolution of C, A & B Class & >smart, all which have had their own varying degree of success].

But in recent months it appears to have been Daimler's historical CofG – the E-class – which has assisted corporate fortunes and been the foundational strength behind revenue in a slowly emerging, yet still fragile, post crisis market.

The styling of the new 2009 model car set out to provide the Merc veteran with a new personality, a far more aggressive 'face', more dynamic side-elevation and varying levels of rear arch 'haunch' relative to body-style that mimics the Bentley aesthetic signature.

However, whilst undeniably cosmetically progressive, the most powerful generator of E-class purchases in Q409 & Q1 2010 has been the thawing of corporate credit in the US and W.Europe and paradoxically the very opposite in China. In the west, after what have been a tortuous 2008/9, those SME business owners still trading (albeit at low levels) and the C-suite execs who've internally driven corporate restructuring, have respectively rewarded themselves, or been awarded by Boards keen to retain talent, the provision of a new E-class. Critically it has been the marriage of accessible liquidity/credit, the model's best in class residual value, and - if running a fleet - the ability to negotiate discounted deals across cars & commercial vehicles, that has tempted western business owners & CFOs toward Daimler.

Indeed businesses are themselves using the Mercedes choice as a hallmark of their respectability and stability during this still dour economic phase. And for business lenders themselves, they guide their clients to buy company assets that maintain worth, for the sake of the balance sheet, and are relatively liquid in case of the need for quick resale to provide working capital liquidity if necessary. The Mercedes E-class qualifies on both counts. In mixed parlance, it has returned to its historical role as the consummate company 'investment vehicle'.

Ironically, in China it has been the very opposite micro-economic forces which have generated the major boost in E-class sales over the last few months.

The PRC's administration has in recent history been engaged in generally loose fiscal policy throughout much of the decade, weakened regulation suited to the growth of state backed enterprise, then in turn the use of massive reserves (US$ & Yuan) to provide free-flow financing to new enterprise, sectors and commerce. The average 10% GDP growth demonstrates the success. But that success became supercharged and by late 2008 the stock-market bubble was intentionally deflated, whilst post-Beijing Olympics it was recognised that China had to slow its rapid growth to stem domestic inflation, which in turn damaged the country's engrained low cost-structure and thus squeezed what was internationally seen as an unfairly undervalued Renminbi. Thus domestic economic policy and international relations have set the PRC government the task of maintaining the historic FX related productivity-gap, so in turn having to control-cool the economy. The major sign of this is heavily reduced lending to private & semi-private enterprise, this January's data showing the effective negative level of credit/liquidity decline to come.

That knowledge was well understood throughout November, December 09, thus Chinese business owners and senior level executives have been spending company cash on 'motivational incentives' in the knowledge that doing so later this year may not be an option, the notion of being seen to be excessive during future spend-thrift times, a social faux pas.

Thus on a turnover basis, Daimler has pleasingly witnessed a 26% YoY increase in E-class unit sales, contributing to the 13% Q409 vs Q408 improvement in total vehicle sales.

In what by historical norms historically a terrible US market, Daimler's YoY sales decrease bettered that of the luxury market TIV, with a -15% fall vs -21% fall. However, the tail end of 2009 and beginning of 2010 witnessed sizable 46% general sales improvement in a January YoY comparison, of which E-class improved by 116% and C-class 33%, whilst in the SUV sector M-class improved 42% and GLK 38%.

In Europe, unsurprisingly given the level of German domestic stimulus and electioneering related assistance to the economy, the homeland performed relatively well for Daimler, down 'only' -12% YoY, whilst the remainder of Europe actually saw an increase of 6% YoY, perhaps highlighting the better credit terms Mercedes buyers generally enjoy given their typical socio-economic profiles.
The UK led the sales rally with an increase of 46% YoY, a reflection seen by some that the UK led into the recession but also leads out of a technical recession.

But it is China over 2009 that buoys the majority of Mercedes momentum with sales up by 65% (70,100 vs 42,600 units, with December showing a 200+% YoY increase for largely we suspect the reasons previously outlined. S-class also maintains its relative ownership of the luxury sedan market, with 40% of sales for the sector.

Asia-Pacific as a whole saw 2009 economic bullishness convert into a 13% improvement in Mercedes sales, with a massive 77% YoY growth for December, possibly reflecting a mix of general enthusiasmm and those who believed China's economic curve was 'topping-out' and so given the level of Asia-Pac'seconomicc inter-relatedness, the reason to buy in the good times before the naturally expected slowdown. Positively, India – less trade connected to China – saw a 500% M-B sales growth in January YoY, though notably from a miserly high double-digit base, adding little to the bottom-line, but demonstrating retained M-B enthusiasm amongst older customers.

[NB S. Korea's own NPS state pension fund's own increased diversification into western European infrastructure plays - such as its 17% of the UK's Gatwick Airport – indicates the region's own slowed expectation of SE Asia's slowing].

[NB. Relative too India, sociologically M-B must combat a level of cultural dismissal from the 30-50 age group which has a partially entrenched view that Mercedes symbolises the older 'inward-looking' businessman of yesteryear, and not the globally aware (often globally educated) entrepreneur or corporate executive of today].

February 18th sees Daimler's annual investor's and analysts press conference, whilst preliminary full 2009 figures are made available on 2nd March. Until then as seen above, Daimler are understandably trying to assist positive external perceptions with typical good news stories.

Daimler has perhaps been best positioned as the 'middle player' within the exec market: between an over-capacity BMW, an increasingly popular globalised Audi (esp China/India) and (momentarily) 'Toyota-tainted' Lexus. As such expectantly the best all-round performer; given its continued resonance in testing times. Thus the resulting sales picture, regionally & globally, is on par with expectation that it would “beat the market” and gain executive share of mind and hence share of market. And again, expectantly, Daimler has targeted its biggest EU nations (Germany & UK) as its pillars of rebound growth.

As highlighted in previous conference calls, one real concern is whether the company is having to effectively 'buy market share' through reduced profit margins given the level of discount the likes of BMW and Audi can muster relative respectively to volume-leverage on 5-series and margin-leverage enabled by VW's scale. The typical corporate line from is that Daimler will not de-value its relatively new offering, especially as its 'volume x contribution' mix at the one-year stage is in normal times the earnings peak of any new model.

Another concern pertains to the level of flexibility Daimler has to further push cost-containment measures on its procurement and assembly of C, E & S-class cars, the large percentage of which are manufactured in Germany. Whilst C-class will gain US production to reduce assembly & distribution costs and negate the volatile Dollar-Euro FX gap, this does not occur until 2014 as part of what appears an implicit pledge to the German government and public. In the meantime, Daimler can only wish that the Dollar-Euro gap continues to shrink so as to aid the differential and avoid the additional overhead of FX hedging insurance.

With what seems little flexibility in its conventional cost-cutting regime at the assembly level at home, pressure bears upon other production regions (at lower volume) to slim costs and boost margins. However, as inflation costs rise so savings on input costs - if indeed attainable given that suppliers know such regions are important to Daimler – may be limited if any. Faced with this homeland vs RoW 'catch 22'. This circumstance of reaching an immoveable cost-floor will push Daimler to seek greater alliance co-operation with other EU based but ideally global-reach or global-ambition players: hence the rational regards previous BMW &/or PSA alliance regards Mini, A-class & B-class does not disappear. In the short-term Daimler should still seek procurement cost-containment measures and initiatives across its full range of vehicles, probably able to cite and endeavour to pass-on any 'unofficially sanctioned' dealer-floor discounting percentages levels it has been forced to absorb.

Like much of its European brethren, Daimler's breadth as both passenger and commercial vehicle manufacturer is core to its business model, and though recently painful, will provides dual strengths throughout the upward cycle of economic recovery once firmly underway. This is yet to happen in a fully fledged, convincing manner, though positive signs have appeared – as seen with EU & US sales. Working aligned to the fragile recovery will of course be key, but as stated previously Daimler is in the position of offering SME owners and corporations 'safe-have' choices when renewing their executive and operational vehicle fleets. But we have seen so far only tentative signs, and so presently Daimler's position and immediate success is not secured.

The company faces the positional paradox of being operationally constrained due to unavoidable political-economic pledges, yet awaiting the beginnings of true regional and global macro-economic pull to assist its conservative yet potentially powerful business model. The real problem it and peers face, is the apparent forthcoming Chinese & correlated Asia-Pac slowdown. This would affect most regions except a seemingly self perpetuating India, where unfortunately Daimler's own sales exposure is still rather limited relative to other regional sales capacities and it must overcome the culturally acquired/inherited resistance previously stated.

Hence in the meantime Daimler must carry-on 'as is'.

No doubt continuing to fill the good-news vacuum by credibly presenting itself as the auto-sector's Delphic Oracle on the issue of advanced low-CO2 future vehicles. But it is not enough to bias focus upon high-brow R&D strategy, when analysts want to see credible, yet understandably diminished, on-the-ground revenue-boosting and cost-cutting efforts. Finding additional ways to streamline costs, divest of remaining non-core assets, and the forging of additional alliance connections will better 'cut the mustard' at present. Of the latter, perhaps the most obvious related to the contract manufacture of its commercial vehicles for others as its Dodge partnership possibly reaches a natural end due to FIAT-Chrysler.

Dr Zetsche, Mr Uebber as CFO et al have done well to cautiously steer the group through such trecherous waters over recent years given the collapse in luxury car sales. It's decision to go to the bond markets in 2009 to add to its cash-pile whilst the liquidity-window was open was a wise move, so adding to its cash pile, totalling Euro 13.4bn ($19.2bn) in mid 2009. This good news given the CFO's statement that only Euro 8-9bn was needed annually (though we suspect Euro 9-10bn).
By Q309 Daimler had Industrial Cash Reserves of approx Euro 8.6bn + Financial Cash Reserves of
approx Euro 2.8bn, in all totalling Euro 11.498bn. The recent sales surge in the US, UK and China is indeed welcome, both industrial and captive finance divisions benefiting, and will undoubtedly be directed straight to its cash coffers. But present indicators depicts that this recent boost in all probability will be short-lived.

Given an appetite for self-funding companies investors will be pleased by Daimler's liquidity security, the recent top-up welcome, but equities investors in particular want to see strategic and tactical see the foundations of the next growth phase, to come in due course, being built. The longer that takes, combined with the signs of a possibly extended recession, the greater pressure that Daimler's cash pile be given back to the shareholders.

E-class and US & Chinese company-buyers have demonstrated their regard for Mercedes-Benz, Daimler AG must seize the evident goodwill to demonstrate its future worth to its clients and capital markets.