BYMOF - Mercedes-Benz: Vans Strategy Update Adds To The Bull Case

2023-05-31 18:17:57 ET

Summary

• Mercedes reported especially strong Q1 2023 results for its Vans division.
• A recent Strategy Update event for the Vans segment made it clear that this should not be a one-time thing.
• The Mercedes Vans strategy focuses on medium and large vans, strong pricing power, electrification, and industry-leading cost efficiency.
• The Strategy Update confirmed my bullish outlook on Mercedes.

(Note: all amounts in the article are in EUR. At the current exchange rate 1 EUR is around 1.07 USD)

Investment thesis

Mercedes ( MBGYY , MBGAF ) Q1 2023 results were strong, but especially so in its Vans division, where numbers were even better than the good numbers in the (larger) Cars division. The Strategy Update on May 15 made it clear that Mercedes is working towards establishing those good results as a new standard, and even improving them going forward.

In the past, the Vans segment has been a somewhat underappreciated part of the Mercedes-Benz business. The Vans segment is significantly smaller and profitability was usually lower than in the Cars segment, but the latter is clearly changing - adding additional weight to my bullish outlook on Mercedes which I expressed in a recent article, Mercedes: The Bull Case Is Getting Stronger .

A quick recap of Q1 numbers for the Vans division

Unit sales in the Vans division grew to 98,885 units in Q1 2023 , up 12% YoY. Drivers were cost reductions, higher sales prices, and a favorable product mix. There was particularly strong demand for large models that generate high profit margins, such as the Sprinter panel van or the V-Class.

Revenue and profitability growth outpaced unit sales growth considerably. Revenue grew 25% YoY to 4.6bn (Q1 2022: 3.6bn) and (adjusted) EBIT by 54% YoY to 719mn (Q1 2022: 466).

This resulted in a profit margin (return on sales) of 16.5%. In Q1 2022, the Vans division only achieved a profit margin of 9.6%. (Note - Mercedes often uses adjusted EBIT numbers in investor presentations. Based on adjusted EBIT numbers, the profit margins for Q1 2023 were 15.6% and for Q1 2022 12.6%).

For the first time, the profit margins in the Vans division surpassed the larger Cars division, which usually gets more attention - simply because of its size and because it produces the iconic car models. We rarely see vans at vintage car auctions, and it will not surprise anyone that the most expensive car in the world , a Mercedes-Benz 300SLR Uhlenhaut Coupe, is not a Mercedes-Benz van.

Both the Cars and the Vans unit operate at a historically unique high level of profitability. Just a few years ago, a double-digit margin in both the passenger car and van sectors at Mercedes seemed unimaginable. This is now the new standard - although Mercedes is still cautious in its 2023 outlook and says it expects the profit margin in the Vans segment to be between 11 and 13% for the full FY 2023.

The main reason for the new high profitability is the luxury strategy of CEO Ola Källenius. He has been pushing the sale of upper premium and expensive models for years.

Longer-term trends are behind the Q1 numbers

The Strategy Update presentation has several graphs that show how Q1 2023 was not a surprising outlier.

Over the last three years, the Vans division reduced fixed costs by 7% and, at the same time, increased the average sales price per vehicle by 24%.

This resulted in a significant increase in revenue, earnings, and margins, which outpaced the growth in unit sales.

The new Vans strategy is improving on the existing strengths

The new (or updated) strategy focuses even more on premium segments and customer loyalty, accelerated EV transformation and digital experience, and a lower cost base.

Premium segments and customer loyalty

The Mercedes Van portfolio is already focused on the upper segments of the market. Around 50% of sales are in the large van segment. Here, the Sprinter line dominates sales, although it has a price premium compared to competitors (see page 21 of the strategy deck ). The mid-segment makes up another 45%. And only 5% of sales are small vans.

The updated strategy reinforces this, which is much aligned with the overall focus the auto manufacturer also has in the Cars segment on upper premium and luxury cars.

Where Mercedes-Benz Vans really stand out is the incredible customer loyalty the vehicles command. The company, for example, claims to have a 74% repurchase rate in Europe for the Sprinter model.

Electric drive and digital experience

Mercedes released the first fully electric van in 2010, but so far the company has sold only about 40,000 electric vans in total. In Q1 2023 3,750 units were fully electric (Q1 2022: 2,925), a 4% share.

While the share of EVs is still quite small, but Mercedes wants to change this. The company aims for a BEV share of up to 20% in 2026. From 2020 onwards, more than half of all vans sold should be electric.

The model foundation is already there. In February, Mercedes presented the new eSprinter model. As was mentioned above, the Sprinter line represents around 50% of sales and enjoys an incredibly high repurchase rate, so this is a big step.

Another big step forward should be the new VAN.EA platform . From 2026 onwards, all new midsize and large vans of Mercedes?Benz will be built on a single modular architecture.

Lower total cost base and improved industrial footprint

VAN.EA is a key driver to keep the operating margin of Mercedes-Benz Vans in the double-digit percentage range in the coming years, despite increasing sales of electric vehicles.

Synergy effects in purchasing, development, and production with the Cars division are another key element for reducing costs. Up to 50% of the parts used between the divisions are already identical. The new VAN.EA platform should enable further cost savings.

How much does the Vans segment matter for Mercedes?

Mercedes is not a small company. So how much does it matter whether the Vans division performs well? As a way of comparison, BMW ( BAMXF , BMWYY ) also sells motorcycles, actually around 200,000 per year (this is the 2022 number ). But as motorcycles are much cheaper than cars, around 10% of unit sales comes down to just around 4% of the profit. In a recent article on BMW , I said therefore that in any discussion on the financial results of BMW Group, the motorcycle segment does not really matter.

As you can see from the graph below, this is not the case with the Mercedes-Benz Vans segment. Vans are quite a relevant business for Mercedes in terms of financial results.

With about 17% of revenue, the Vans segment has a decent size. Unit sales are even a little larger in comparison and makeup around 1/5 of the total. The difference is because the Vans division does not have a comparable luxury business like the Cars division has with the AMG and Maybach models that cost upwards of 100,000 euros.

But what is really significant is that in Q1 2023 the Vans division was, for the first time, more profitable than the Cars division with a profit margin of 16.5%.

Lower production costs are the main reason. Just two numbers - while R&D expenses in the Cars segment are a sizeable 8.1% of revenue, they are only 4.1% in the Vans segment. The same goes for investments in property, plants and equipment. Here the ratios are 2.6% of revenue for the Cars segment and 1.1% for the Vans segment.

Conclusion

The Vans Strategy Update has confirmed my bullish outlook on Mercedes.

The strategy by CEO Ola Källenius to move upmarket is clearly paying off - for the Cars and the Vans division. So far, the market is not rewarding this, in my opinion, and values Mercedes with a P/E ratio below 6. This is more in line with mass market auto manufacturers, but Mercedes has a significantly higher profitability.

Mercedes also has a dividend yield of around 7%. While the pay-out of 5.5bn in 2023 looks high, it was still only 37.6% of net profit. So the high dividend seems quite safe. In addition to the dividend, the auto manufacturer has announced a share buyback program with a total value of 4bn, which is around 4% of the current market capitalization.

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