ANALYSIS: Can the premium car boom continue?

By Dave Leggett | 14 October 2011

Will the going get tougher for the premium Big Three?

Will the going get tougher for the premium Big Three?

The premium brands have been posting record sales as they have benefited from strong sales in car markets across the world – and especially in Asia. But does the latest economic turbulence pose a growing threat to them? Dave Leggett considers the issues.

As the Big Three global premium car brands, BMW, Mercedes-Benz and Audi again posted record sales for September, it would appear that the global premium market continues to boom. But with the negative economic data currently emanating from the Eurozone and the US, the chances of a global double-dip recession appear to be increasing and sustained growth can no longer be assured for the premium OEMs.

Analysts agree that the premium end of the global car market is holding up well. BMW Group, for example, is on course to meet its target of delivering 1.6m vehicles this year, versus 1.46m in 2010. Ian Robertson, member of the BMW board responsible for sales says that the company expects to maintain the upward trend to sales in the fourth quarter: “We made solid gains right across the globe and once again achieved record sales for September which contributed to a record third quarter. At the end of the third quarter we find ourselves well on course to deliver our target of more than 1.6 million vehicles in 2011. Throughout the fourth quarter we will continue to strive for a worldwide balanced growth and to continue our upward trend. We have exceptional new products such as the new BMW 1 Series and the Mini Coupé, which are already in strong demand and which will provide further momentum.”

China is key

Creative Global Investments analyst Sabine Blümel highlights the position of China as a major profitability generator for BMW. “China has been turbo-charging BMW,” she says. “Sharply rising sales in China have been a big driver of improved mix and pricing at BMW because they provide above-average unit revenue and profit margin for premium manufacturers,” she adds. “Unit pre-tax profit in China in 2010 for BMW's imported cars was EUR11,200 per car versus a global average of EUR2,700 per car.”

Blümel says that China is now the largest market for the 7-Series, the 5-Series and the X6; and the second largest market for the X3, X5 and 3-Series. In 2010, 40% of 7-Series went to mainland China, 26% of 5-Series GTs and 20% of 5-Series and X6 sales. In addition, BMW reports an extraordinarily strong engine mix and high option uptake from China. A significant slowing of demand in China would clearly have implications for BMW's bottom line.

“Emerging markets are very good for the premium makers in terms of profitability and growth prospects. These markets are very dynamic with emerging affluent classes having a high propensity to pay cash for new cars and opt for a relatively rich model mix,” Blümel says.

But the upbeat picture from the vehicle sales statistics is, however, subject to a reported softening of demand. Cheshi.com is a pricing guide tracking some 3,000 dealers across the country and says that BMW dealers are now offering up to 19% discounts on the price of a 3-Series model. Similar discounts are reportedly being offered by Mercedes-Benz and Audi dealers. Dealer networks are also said to be less developed in the Tier 2 and Tier 3 cities of China, making further sales growth more difficult to achieve, especially if the economy slows.

IHS Automotive reported this week that there have been a number of company bankruptcies in the eastern coastal province of Zhejiang, which is one of the richest areas of the country, and is also home to the largest number of premium car dealers in China. According to state-owned media outlet Xinhua, some 29 business owners have disappeared from Wenzhou, leaving behind a trail of debt. All the businesses involved are sizeable CNY100-million businesses, pointing to the first real sign of stress and overheating in the Chinese economy, IHS says.

However, IHS Automotive currently sees China's premium car sales as hitting 1.14m units in 2012, so the impact could be minimal as growth in other areas will lift sales. “The government is pushing growth in the western regions of the country and this may limit the effect of the downturn in Zhejiang, says IHS analyst Tim Urquhart. “However, high base levels in the Chinese passenger car market will limit the prospects for further accelerated growth for the premiums in the market, and there must be a concern that the Chinese economy may be adversely affected moving into 2012 as a result of declining global consumption of Chinese exports,” he warns.

The overall China market numbers still look positive. Car sales in China rose 8.8% in September compared to the same month a year earlier to 1.32m units according to data from the China Association of Automobile Manufacturers (CAAM). CAAM added that the mild rebound from May, when monthly car sales declined for the first time in more than two years, would extend through the fourth quarter as year-end promotions are likely to lure customers to showrooms.

But it does seem that after two years of massive expansion, China's auto market is returning to a more subdued growth pattern as the government has ended tax incentives and local government authorities have introduced initiatives aimed at easing ever-worsening traffic congestion.

Outlook for North America and Europe subject to macro uncertainties

Besides the 'spillover' for countries like China from global economic turmoil centred on the eurozone debt crisis and North America's weak economic recovery, those regions themselves are also, of course, important sources of sales for the premium brands.

The ongoing public debt crisis in the Eurozone is still some way from being resolved with the two main players, Germany and France, prevaricating over implementing a lasting solution, something that has played havoc in the financial markets across the region. In addition, the US economy's recovery from the last slump in 2008/09 looks to have stalled and there is continuing concern over high unemployment and political disagreements over the policy response.

These disagreements are hardly helping to instil confidence in consumers over the handling of the US economy, although passenger car sales in general held out relatively well in the US despite the raft of negative news regarding the economy. It's gone so low that there is underlying support from pent-up demand and the removal of inventory disruption earlier in the year. The premium OEMs are still generating strong growth in the US too, with Audi's sales rising 19.3% year-on-year during September, while BMW and Mercedes-Benz recorded strong growth figures of 11.4% and 9.0% respectively. Much depends on how the US car market shapes up in 2012. The forecasters have lately been revising their numbers down, but there is a high degree of uncertainty on how car sales will actually track.

The same kinds of uncertainties apply in Europe. But the German market has been strong this year, and that's been a plus for the premium Big Three. However, the German car market is likely to cool next year, as the pace of growth of the German economy slows from close to 3% growth this year to nearer 1% next.

Premium may be 'resilient', but uncertainties dominate

The emerging markets have clearly left the premium makers in a much better position than was the case in the market crash of 2009 when scrappage incentives fired up sales of small cars, and led some to question the viability of the premium brand model as the global economy reeled. But the big premium players were proactive in lowering their cost bases and increasing their production flexibility in the aftermath of that downturn, so are better placed to respond to any future downturn. IHS says it expects BMW, Mercedes-Benz and Audi to continue to post positive growth in 2012, but that there is little doubt there will be contingency plans in place for a sudden and rapid downturn in global demand.

And the high levels of profitability reported in 2010 and 2011 may well constitute something of a high-water mark.

Moreover, IHS also says that there is some support from model cycles, thanks to a number of significant new model launches such as the new BMW 3-Series.

“Regarding purely brand sales we expect BMW's sales to rise by 10% between 2011 and 2012 to a forecast figure of 1.37m units,” says Urquhart. “Audi's will rise at a slower rate from 1.19m units to 1.28m units due to model cycle factors, while Mercedes-Benz brand passenger cars are predicted to increase by around 9% to 1.29m units. However, these forecasts depend on a relatively stable global environment and little in the way of further macroeconomic shocks.”

If the going does get choppier for the big premiums over the next eighteen months, Sabine Blümel nevertheless has some words of comfort: “They are well-placed, from a business strategy perspective,” she says. “They have done the right things with model mix, market geography and trimming costs. And history suggests that premium is generally more resilient than volume,” she adds.

Urquhart broadly agrees. However, he also warns that the premium brands are not insulated from more general uncertainties. “Buyers of premium segment vehicles are subject to the same pressures as the mass market segments,” he says.

“And at the moment, we are all watching developments in the global economy very closely – there is a high degree of uncertainty concerning the outlook for the global economy and that will ultimately determine where car markets and premium segment sales are headed.”