European mass car manufacturer’s third quarter results induced more gloom and underlined the fact that the industry is producing pitiful profits and is likely to continue to exasperate investors for the foreseeable future, writes Neil Winton.
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Well, everybody but German luxury carmaker BMW, that is.
BMW continued to stand out from the pack and pleased investors with its results, although many shareholders worry about the medium to long-term implications of the falling dollar.
French manufacturers Renault and Peugeot-Citroen reported improved sales, but traditionally do not burden investors with possibly worrisome information about the state of their profitability at this time of year. French tradition demands that this takes place only at half time, and the full year.
Europe’s market leader Volkswagen was dragged down by problems in China, while Fiat Auto stumbled to another loss. GM Europe’s losses widened, Ford Europe was close to break-even. But it was DaimlerChrysler’s Mercedes subsidiary, usually the jewel in its crown, which upset investors the most.
Mercedes Benz reported that because of problems at Smart, the Euro’s strength, and quality problems generally, its profits were blown apart in the third quarter, and added worryingly that the problems were likely to continue at least until the end of next year.
Ironically, it was the Chrysler end of the business, derided by investors since the merger in the late 1990s as a doomed, albatross around the neck of the great German money maker, which bailed out DaimlerChrysler.
“Chrysler’s 3rd quarter margin of 2.8 per cent surpassed Mercedes’ margin of 2.5 per cent. When was the last time this happened,” investment banker Morgan Stanley asked. “We have slashed 1 billion euros from our 2005 Mercedes profit forecast, with sub-3 per cent profit margins for the next four quarters.”
After DaimlerChrysler announced the 3rd quarter results, rumours spread that it might be forced to dispose of the loss-making Smart car business, but the company denied this. Operating profit at Mercedes fell to 304 million euros in the third quarter from nearly 800 million a year earlier, and Mercedes management said this trend would be repeated in the 4th quarter and through 2005.
Losses at smart
According to investment banker Goldman Sachs, the problems are down to the dollar’s weakness against the euro, losses at Smart, and quality troubles at Mercedes.
“We are not surprised to see Mercedes’ earnings decline in the face of currency, higher quality costs and continued losses at Smart. However, we were surprised at the speed in which the situation unravelled during the third quarter,” Goldman Sachs said.
Failure to grapple with foreign exchange problems caused by the weakening dollar was the biggest problem.
“We believe the expiry of currency hedges was the single most important factor, suggesting that Mercedes will see further pressure on earnings in 2005 as the company’s effective hedge rate worsens further versus 2004,” Goldman Sachs said.
Europe’s Car Makers Third Quarter Results
| Q3’04 sales | Q3’03 | Q3’04 operating profit | Q3’03 | |
| Renault | €9.5 billion | + 8.9% | (doesn’t report quarterly) | |
| Peugeot | 10.3 billion | + 2.8% | (doesn’t report quarterly) | |
| VW | 21.5 billion | + 0.8% | €487 million | down 23% |
| DCX | 34.9 billion | + 2% | 1.3 billion | up 7% |
| BMW | 10.6 billion | + 6.3% | 990 million | up 7.6%(pre-tax) |
| Fiat Auto | 4.5 billion | + 8.1% | -270 million | -314 million |
| GM Europe | Market share 9.6% | 9.1% | -$439 million | -251 million |
| Ford Europe | $5.9 billion | $4.6 billion | -$33 million | -400 million |
(DCX – DaimlerChrysler)
(source – company information)
Goldman Sachs reckons that Mercedes’ profit margins, which averaged 6.4 per cent between 1999 and 2003 before crumbling to 2.5 per cent in 2004’s 3rd quarter, will start to recover in 2006.
“Even at current exchange rates we believe Mercedes can be fixed. Based on our assumptions about cost reduction in these areas we believe the division can return to 5 per cent margins in 2006,” Goldman Sachs said.
Slash and burn
While Morgan Stanley was slashing one billion euros from its Mercedes profit forecast, Deutsche Bank was burning a similar amount from its predictions for the European automaker’s profits for 2004, and estimating that even though sales would be worth almost 190 billion euros, the pre-tax profit margin would be a derisive, trifling 1.6 per cent.
Europe’s Mass Car Makers Are Barely Profitable
| Share | Europe sales | Pre-tax 2003 | Pre-tax 2004E | Pre-tax 2005E | Pre-tax margin04E | |
| Volkswagen | 17.7% | 58.9 | 900 mln | 1,000 | 1,100 | 1.7% |
| PSA | 14.2 | 36.7 | 1,480 | 1,330 | 1,450 | 3.6 |
| Renault | 10.1 | 30.9 | 570 | 1,210 | 1,250 | 3.9 |
| GM Europe | 9.7 | 24.7 | -530 | -1,010 | -150 | -4.1 |
| Ford Europe | 11.4 | 20.8 | -980 | 190 | 215 | 0.9 |
| Fiat | 7.4 | 16.6 | -2,030 | -1,320 | -900 | -8.0 |
| Total | 70.5 | 188.9 | -590 | 1,400 | 2,965 | 1.6 |
(source-Deutsche Bank)
(E-estimated)
Deutsche Bank now reckons that in 2004, cumulative pre-tax profits will be only 1.4 billion euros. This excludes the German-American DaimlerChrysler, and luxury maker BMW and Porsche.
“Our forecasts now suggest that they (Europe’s mass market manufacturers) will make only around 1.4 billion cumulative in 2004. This represents a decline from our forecasts in March of this year when we believed that profitability among mass market players would total 2.4 billion euros. In 2004 only 3 of the carmakers are profitable, while both Fiat and GM have been loss-making throughout a 4-year period. It is worth noting that since March we have upgraded our forecasts for Renault by 39% to 1.2 billion, and on Peugeot-Citroen by 24% to 1.3 billion,” Deutsche Bank said.
“On the negative side however, we have had to slash our forecasts on GM by over 1 billion (euros) and on Fiat by 650 million. Margins for the group remain wafer thin at around 1.6%, which given that total sales represent almost 190 billion euros is a paltry return.”
Don’t expect good news
Things aren’t going to get better any time soon. “Going forward, conditions are likely to remain tough. Although we believe that we may see a recovery at GM Europe as it reaches a near break-even situation, we see little evidence of significant earnings growth from the rest of the mass market industry in Europe.”
Competition from Asia and tough market conditions mean no mitigation in 2005.
“With the Asian OEMs continuing to take share, pricing deflation remaining rife and with limited volume growth expected in Western Europe, 2005 looks set to be another very difficult year, in our view,” Deutsche Bank said.
Morgan Stanley, in a report on third quarter performance and the implications for the future, said BMW, which expects to report record earnings in 2004, should improve on that in 2005 and 2006, despite worries about the implications of the weak dollar. New cars like the 1-series, X3, and 6-series coupe are flying out of dealerships. Next year, the new 3-series should continue to excite buyers.
Morgan Stanley’s other predictions include –
- DaimlerChrysler – Despite problems at Mercedes including delays with launches of the A class and M class, and Smart losses, profits at Chrysler are building and investors should buy the company’s shares.
- VW – Investors should avoid VW shares because profits from China are drying up, losses in North America are building, although Audi is increasing profits. Audi profit margins reached a 7-quarter high in the 3rd quarter of 5%.
- Fiat – Risks for the turnaround plan remain significant. Investors should avoid the shares.
