Mercedes-Benz: Rewarding Shareholders While Driving Through Uncertainty (OTCMKTS:MBGYY)

Mercedes-Benz Reports Earnings

Although Mercedes-Benz (OTCPK:MBGYY, OTCPK:MBGAF) reported its Q1 earnings and added yet another piece to the puzzle of the situation automakers are facing.

Mercedes shares have performed well this year, with a YTD return of 12.5%. Moreover, the company seems to have been little shaken by its earnings, unlike other auto manufacturers, such as Stellantis (STLA).

At the same time, Mercedes warned investors about harsher competition, soft consumer demand, and low selling prices for BEVs. So, the market was somewhat prepared to see that, although the company reduced its share count by 3.1% YoY, its Q1 EPS of €2.86 was down 22.5% YoY.

Let’s dig a bit deeper and understand what happened. Mercedes-Benz makes up around 2.3% of my dividend growth portfolio and I am thus quite interested in the company.

Mercedes’ Main Financials

Mercedes has three main branches: Cars, Vans, and Mobility (financing branch). Mercedes Cars reported €25.7 billion in revenues, down 8% YoY in line with lower volumes (463k units, -8% YoY).

However, we see from the graph above that the company’s EBIT decreased by 44% to €2.3 billion. The cash flow before interest and tax was down 22% to €2.3 billion. This was mainly due to the decline in volumes, but, most importantly, to the big decline in top-end vehicle sales. We can see how the sales mix was particularly hurt by a 27% drop in top-end vehicles, those whose average selling price is over €100k.

Part of this big decline was linked to model transitions, with the changeover of the G-Class, the AMG derivatives of the E-Class, and the GLC. However, the S-Class saw a decline, too.

At the same time, the Mercedes Core segment performed better, increasing by 20k units. Not enough, however, to offset the impact of the underperformance in the top-end segment.

This leads us to spend a few words on Mercedes’ strategy, which was launched in 2019 and has, so far, positioned the company among the most profitable ones in the industry, second only to Porsche (OTCPK:DRPRY) and Ferrari (RACE).

Mercedes-Benz Reshaped Portfolio

In 2019, Mercedes announced a value-over-volume strategy, meant to flip by 180° the company’s sales structure, as shown by the three diamonds below.

Until 2019, Mercedes was focused on volumes, with its entry segment being the most important one under this aspect. Its strategy was meant to reduce entry-level sales by 25% in 2026 vs. 2019. At the same time, top-end sales are expected to be increased by 60%. The core segment should stay flat. This should make Mercedes sell a bit over two million vehicles per year but with a much more favorable mix. The main driver of the strategy was to unleash the wealthier consumer base’s desire for luxury cars. Back in 2019, nobody knew a pandemic was coming, as were the subsequent consequences, with a macroeconomic environment that rewarded high-margin strategies.

In any case, though the reshaping of the portfolio is still underway, Mercedes has become a cash-flow-generating machine, as the graph below shows.

However, this strategy was also conceived in a low-rate environment. Back in 2019, no one would have ever imagined that we would have seen 4%-5% interest rates. Since cars are discretionary goods, whose purchase can be postponed in case of tightening financial conditions, we are now seeing decreasing volumes across the industry. However, Mercedes’ sales decline is not evenly spread around the globe.

This is why I thought the question asked by Deutsche Bank analyst Tim Rokossa, during the earnings call was particularly on target:

This is a pretty busy auto morning. You see a couple of consistent themes from the reporting. Pricing seems to hold up very well in the mass market as well as in the premium market. The mix is not great, and the volume seems to be quite weak for everyone. On the positive side, this tells the industry remains very price-disciplined. We wanted that. It’s good. But at the same time, it is quite curious why everyone struggles on the volume side and talks about product availability being an issue and a lot better volumes to come into H2. Can that really be the case? And what are you preparing in terms of pricing for if everyone really needs to make up a lot of volume with all the newly available models launched in H2?

To tell the truth, these questions were left somewhat unanswered, with Mercedes’ executives stating that they are confident they will perform better in the second half of the year. As far as I see it, higher interest rates are starting to hurt consumers, who are simply postponing their new car purchases. This will lead to pressure on pricing because automakers see high fixed costs and thus need volumes as well.

Mercedes-Benz Cars Regional Mix

Mercedes’ sales took a big hit in two main areas. In Germany, units were down 16.6% to 50k units vs. 60k a year ago. In Asia, the decline was 37k units, 22k of which were in China. We have seen other German automakers struggling in China (Porsche and Volkswagen, for example) as Chinese consumers are now more and more oriented towards national brands while becoming more price-conscious.

The exposure to China is a major concern for me and if I hold a stock with significant sales in China, I try not to overweight it because of this reason. In fact, because of geopolitical tensions, I don’t see China as a predictable environment for Western businesses to flourish in right now.

Mercedes-Benz Vans: The Company’s Flagship

Alongside its top-end vehicles, which are currently struggling, Mercedes has a wonderful business in vans. This is a much more concentrated market (in Europe, the top-3 players hold 70% of the market), with fewer competitors and higher margins.

This business addresses commercial needs and offers several solutions for people’s transportation, too (the iconic Vito speaks for itself). Well, Mercedes-Benz Vans segment keeps on outperforming, with sales up 7%, although revenues were up only 6% to €4.9 billion. EBIT, however, was up 11% to €800 million and the company’s CFBIT increased by 53% to €688 million.

No doubt about it: Vans is a profitable business. Most importantly, if we break down the regional sales mix, we see that China is the best-performing market, with sales up 27.5% YoY to 7.6k units. North America performed particularly well, with 19.5k units sold, which is almost a 20% YoY increase.

This means Mercedes-Benz Vans operates in a market that is somewhat decoupled from cars. As said, it is a niche market, with fewer players and the investment in this segment seems to be paying off for Mercedes.

Mercedes-Benz 2024 Guidance

Mercedes-Benz’s management didn’t bail before the decrease in sales and reaffirmed its previous guidance, stating that Q1 had largely been predicted to be the weakest quarter of the year.

The guidance sees Cars sales at the prior year’s level, with Vans losing speed throughout the year. We will need to watch closely these trends because if top-end vehicle sales don’t grow as expected, Mercedes’ margins will inevitably be hurt. However, both Cars and Vans should report double-digit margins, with Vans two percentage points above Cars. Considering raw material costs are down while overall R&D is increasing together with investments in pp&e (capex), margins will depend on pricing.

Mercedes’ management talked about pricing during the last earnings call, distinguishing between solid pricing territory of ICE, whereas EV pricing is under pressure

We clearly target a mix improvement in the second half of the year. We want to hold pricing and defend it at the current levels. We clearly see raw materials improving further, generating further tailwinds. At the same time, we see supply chain-related costs generating further headwinds. […] As we discussed I think at the earlier occasions I mean the heat is rather on the EV pricing. The ICE pricing is in solid territory è […] On the ICE side, overall I mean the pricing is at a more comfortable level at a healthier level than on the EV side.

At the same time, Mercedes couldn’t hide that when needed, some discounts and commercial measures were adopted:

I mean pricing has been kept stable in the first quarter. Clearly, this is – I mean the sum of new pricing for vehicles to come to market. So the MSP evolution including year-on-year escalation update and the discount evolution on the other side. So we continued our Pillar 2 strategy value over volume in terms of product positioning on the MSP side. We used some flexibility. I mean here and there. I mean on commercial measures to stay tactically competitive and the sum of the two is a net positive.

Mercedes-Benz Executes Huge Buyback

Cash flow generation has been strong in the past few years, leading to over €33 billion in cash on the balance sheet, Mercedes has announced a €5.30 dividend to be approved shortly by its board (it should go ex-dividend on May 9th). This is just a €0.10 increase YoY, meaning the company is being disciplined entering 2024. But I also think Mercedes-Benz wants to more efficiently return money to its shareholders via buybacks. This is why it announced a €4.7 billion share repurchase to be executed from May 2024 to Q1 2025, which leads to an overall return of €7 billion since the company launched last year’s program

As a milestone, we expect buybacks to reach a total of around €4 billion by quarter three this year. And to finish with a total share of buybacks of up to €7 billion all-in-all, in the first quarter of 2025 before the AGM.

With €4.7 billion still to be executed, I bet a lot will be deployed right after the company pays its dividend in May when the price will drop accordingly, offering a better entry price. In any case, the buyback is still worth around 6.2% of the current market cap. Considering the company will distribute €5.5 billion in dividends, we can expect its market cap to drop to around €71 billion, once we go ex-div. This means the buyback will be 6.6% of the new market cap. Adding another 7.3% dividend yield, we have some nice returns. I have been saying for a while that healthy industrial companies can become the new go-to stocks for high-yield-seeking investors who don’t want to hold overleveraged companies.

Valuation

Mercedes-Benz’s valuation grade is currently an A+ on Seeking Alpha. After all, a fwd PE of 6.7 and a P/FCF of 3.6 are not demanding ratios. Even more interesting, the FCF yield is 13.2%, which is very high. Of course, these metrics reflect the cyclicality and the lack of confidence the market has with automakers. But as far as the industry’s competition goes, alongside its structural trend towards consolidations, I see Mercedes-Benz as poised to last and prosper due to its endurable brand value and attractiveness. As many SA readers may know, I invest in those automakers that position themselves as top-brand manufacturers (only Stellantis is an outlier, but for several compelling reasons I have elsewhere explained). Mercedes earns a well-deserved A+ when considering its profitability compared to the industry.

The issue with Mercedes and the industry is its lack of growth, at least in 2024.

I think if Mercedes can hold these multiples while investors are concerned with decreasing volumes, once demand picks up speed once again (be it in late 2024 or in 2025), it is poised for multiple expansion. I am targeting a fwd PE of 8.5, which could well lead to a stock price above €90 if the current EPS estimates are confirmed.

However, there is a caveat. Mercedes is about to go ex-div (May 9th, if approved). This means I would rather buy Mercedes after the dividend, to have a better entry price without having to pay right at the start of the investment the German dividend withholding tax (26.375%).

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.