Mercedes-Benz, owned by Daimler AG (OTCPK:DDAIF), is pouring in 2 billion euros ($2.7 billion) in China in order to raise local production.  Currently, about a half of Mercedes cars sold in China are imported and are subject to an excise duty of 25%. Raising the local production level will make the cars more affordable and boost overall sales. By 2015, the automaker plans to produce locally two-thirds of its vehicles sold in the country.
While Daimler was the global market leader in luxury cars, it is now playing catch up to its German rivals BMW and Audi. Success in China is critical to the automaker’s goal of reclaiming the title of the world’s largest luxury automaker by 2020. Daimler sold 206,750 Mercedes-Benz cars in China in 2012 but plans to raise that figure to 300,000 by mid-decade.
The growth rates of Audi and BMW in China have outpaced that of Mercedes in the last few years. This year has been no different. While Audi and BMW sales rose 18% and 15%, respectively, in the first half of the year, Mercedes’ sales remained flat. On the bright side, Mercedes’ sales in the second half of the year could improve since the automaker is poised to introduce its high-volume A-Class. As an entry level luxury car, the vehicle could appeal to a number of Chinese customers looking to own a Mercedes without overstretching their budget.
The Chinese luxury car market holds huge potential. In 2012, the market grew more than 20% to 1.25 million cars. Furthermore, a report released by McKinsey & Co earlier this year forecasts the figure to rise to 2.25 million by 2016 and to 3 million units by 2020, making it the biggest luxury car market in the world. Currently, the market is dominated by German autos BMW, Audi and Mercedes, which together account for three-fourths of the market. 
The capacity addition is consistent with Mercedes’ plan of introducing a total of 20 new or refreshed vehicles in China by 2015.  Producing locally also helps the automaker tweak the vehicles in order to better appeal to local tastes. For example, in China, a number of luxury automakers redesign their cars to make the rear seating more spacious and comfortable since it is common to be driven by a chauffeur.
Besides raising the production level, Mercedes also plans to add 50-75 new dealerships across the country annually starting from 2013. Most of Mercedes’ operations are concentrated on the east coast, making it difficult for people living in interiors to buy a Mercedes car. Audi and BMW, on the other hand, have better market coverage within China and is one of the reasons why these companies have performed so well in the country.
A combination of new models, better affordability and a mushrooming number of dealerships should enhance Mercedes’ Chinese sales.
We have a price estimate of $72 for Daimler’s stock, which is in line with the current market price.
Disclosure: No positions.