Daimler (OTCPK:DDAIF) is a leading player in the auto industry, dominating the luxury car segment. Daimler possesses one of the most powerful brands in the world, Mercedes. It also the owner of Smart brand and holds stakes at Nissan and Renault. Its results are phenomenal, yet investors are reluctant to reward its share price. I will try to mitigate the concerns and explain why I believe DAI is a great investment.
In a nutshell, Daimler concluded 2015 with revenue up by 15% (excluding FX 7%) and profits by 22%. Sales grew 13% in Europe, Daimler's biggest market, in the US 26% and in China 11%. During the last 5 years sales surged at an annual rate of 9% and profit soared 13% annually. Margins has improved as a result of better operational efficiency, economies of scale and a slight uptick in the average car price, partly offset by greater R&D expenditures and elevated costs in order to meet emissions level requirements.
Daimler started 2016 at the same momentum. In 1Q16 Mercedes-Benz has sold 483,000 cars, a 12.6% y/y increase. In March, Mercedes achieved highest monthly unit sales in the company's history. Also Smart's sales broke its own sales record during the first quarter of the year.
The table below presents the leading global automakers' revenues. Daimler's CAGR is 2nd only to Toyota (NYSE:TM), yet it is important to bear in mind that the Yen had depreciated 25% during 2011-2015, while the Euro lost only 10% in these years. Daimler also ranks the best for 2016 growth projections.
Daimler results are excellent, driven by its robust brand, Mercedes, that it accountable for 70% of Daimler sales (Mercedes is about to overtake BMW as the world's largest premium vehicle manufacturer). The luxury segment is a niche one, characterized by a small number of players in comparison to the broad competition within the mass market. Mercedes strong brand creates an economic moat and many significant operational advantages that build up the investment thesis. First, customers' loyalty is much better than for the mass market, as Mercedes (or any other premium automaker) clients attribute more importance to the brand (as they desire the accompanied status symbol). The following two polls placed Mercedes among the leading brands by retention rate. Retention and loyalty equal returning customer, recurring sales and consistent trade-in promotions. It should result also at a multiple premium and a lower attributed risk. Furthermore, building up a premium brand is extremely difficult, therefore barriers of entry are meaningful. Also, car's pricing is more resilient since Daimler must preserve its prestigious image for its own needs and for its affluent customers' wish.
After a record year consisting double digit growth, Daimler sales are projected to climb 3% this year, according to the consensus' estimates. Daimler guided a slight revenue growth and a net profit that is significantly higher than in 2015. The guidance and analysts' estimations might seem conservative, taking into account Mercedes phenomenal Q1 results, though it's probably reflected at Daimler's modest guidance for its Trucks and Buses division, in which it only assumed stable sales figures. It is also worth noting that analysts have raised their sales estimates from the beginning of the year, yet the stock dropped ~-15% YTD.
Despite the positive revenue and profit outlook, Daimler's free cash flow of the industrial business adjusted for special items should be significantly lower in 2016 than the comparable amount of €5.9 billion in 2015, driven by intensified investments in products and technologies. Clearly lower FCF isn't good news, yet one could find comfort that it is a result of a renewal and expansion of the company's fleet vehicles.
Despite the impressive and sustainable results, Daimler trades at undemanding valuation (will be explained later) and provide a great dividend yield. Why investors do not reward the company? I would suggest few explanations to try to mitigate the concerns.
China/global slowdown - investors are worried about the world's growth in general, and regarding China's landing in particular. During the two recent selloffs, last August and at the beginning of the year, Daimler (and other auto's manufacturer) tumbled 15-20%, underperforming the market by few basis points. As the Chinese market was the best growing market worldwide, and investors expect it to continue to lead, all auto companies around the globe suffered. However, Daimler's performance in China is amazing, as noted above (11% growth in 2015, Mercedes sales' surge 34% during Q1/16), superior to the total market and to the luxury segment as well. Even in Brazil, where the country faces a great recession and a devalued currency, Mercedes recorded in 2015 a 67% (!) increase in unit sales, in comparison to 2014. So clearly not all economies worldwide are robust, yet I think the market punished all automakers, contaminating Daimler despite its continuous solid numbers. The world really slows down, yet it is crucial to distinguish between the winners and the losers.
Other risk factors investors ascribe to the auto sector are its cyclicality and heavy losses during recession period. GM's (NYSE:GM) bankruptcy in 2008 is a good example for that risk. However, Daimler is much more resilient than other car manufacturers. Its profit margins are wider, it has a stronger balance sheet, an "A" credit rating and during the GFC it experienced only a relatively small loss (€2bn compared to above $10bn at GM, Ford (NYSE:F)). I claim Daimler's valuation deserves a premium on other auto manufacturer, as the company is healthier and less risky.
Daimler also has been punished after VW's (OTCPK:VLKAY) diesel scandal, despite declaring many times it hasn't break any law. The German regulator even stated that VW was the only company who cheated the emission testing. Few owners of Mercedes have filed a class action suit against Daimler for potentially using defeat device, despite no evidence that the devices exist. I believe it is pretty safe to say that Daimler is out of the woods in this regard.
The last (future) threat in my view is Tesla (NASDAQ:TSLA) (car-sharing apps aren't a threat since I don't see any Mercedes owner avoid buying a car and using Uber instead). I don't think Tesla should be categorized as a disruptive force in the auto industry, but I would consider it a serious prospective competitor, which has unique advantages that Daimler would struggle to compete with. Tesla, which sold last year 2.5% of Mercedes' units, will continue to gain market share, mainly in the US, but Daimler's brand, leading technology and economic moat should enable it to sustain chunky profits. That's a factor I would follow closely.
It is also worth noting that Daimler's share has a correlation with the Euro, a correlation that has strengthened in the last period when FX movements were highly volatile. Of course currencies play undeniable role within the auto sector, yet I wouldn't change my long-term view on Daimler based on sporadically FX revaluations.
Evaluating automakers isn't so simple, contrary to the common belief. First, many firms have a financial segment, which completely distorts the balance sheet picture, stems from the massive debt accompanied. Moreover, all auto companies that sell in China operate through JV with local partners, hence the results from it summarized to a single P&L item. Also, cross-holdings in other auto manufacturers are common, thus capital gains or income from associated companies also recur in the income statement. Therefore I believe P/E multiples are better than EBITDA multiples, since they incorporate all of the P&L items. Having said that, the best indicator is the free cash flow from the industrial business, a measurement Daimler defines as the parameter that is used to measure the financial capability of the group performance.
In 2015, Daimler's adjusted free cash flow of the industrial business amounted to €5.9 billion, implying an almost 9% yield, nearly twice the S&P 500 FCF yield. Although this amount is expected to be lower in 2016, it reflects Daimler's unappreciated cash generation capabilities. Even if we consider Daimler's industrial FCF at 2014, which amounted to €5.2 billion, a representative sum, it still provides a great yield. The automotive FCF yields of GM and Ford are also at similar range, yet the American automakers barely achieve any revenue growth (as noted above).
Which industries are valued at a single digit PE multiple? The majors I can recall are autos, airlines, technology hardware and financials. All these sectors are cyclical by nature, yet while hardware (incl. semis) and financials' profits decelerate, and airlines' net income are highly dependent on oil price, automakers are less valued because of their association to default risk, a threat that is far from Daimler as I've explained earlier.
So a PE multiple of 8X (2015 profits) is not only a discount from Daimler long-term multiple of 9.5, but also ascribes excess and unrelated risks to the company. Moreover, the STOXX 600 and the US Consumer Discretionary sector, which I view as reasonable benchmarks, trade at 5-15% premium to their historical level. Hence, based only on a possible alignment of multiples to their average, the stock's upside is ~25%.
Another indication to Daimler undemanding valuation is its fat dividend yield - 5%, while the automaker's 5yrs median div. yield was only 3.9%. The 5% dividend yield is common among defensive sectors such as utilities, or when investors assume that firms will cut their dividend, like at European banks or at the energy sector. Daimler is neither both cases, as its sales grow and dividend rise.
Through its major brand Mercedes, Daimler performs well across the entire globe. It features consistent growth, economic moat, conservative financial profile and solid execution, outperforming all of its peers. Many general and sectorial risks are attributed to the company, unnecessarily weighing on its stock price. Yet, a thorough analysis abates most of the threats and uncovers a fantastic company at a bargain price.
Disclosure: I am/we are long DDAIF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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