(Author’s Note: Investors should be mindful of the risks of transacting in securities with limited liquidity, such as DDAIF and DMLRY. The Daimler International listing on Xetra, XE:DAI, offers stronger liquidity).
The company reported FY19, and it’s not every day that a 70%+ dividend cut doesn’t result in the stock price collapse. Not only a lack of collapse here, the stock actually went up 1-2% during earnings. While this indicates that the dividend cut was either expected or accepted, I feel that the fact that the company did cut the dividend as harshly as that is going to create a lot of questions and anxiety.
Let’s get into it.
As a Daimler LONG, with Daimler as the largest pure automotive (not auto parts, such as Autoliv (ALV), but automakers) holding, I obviously feel the effects of the dividend cut keenly. My overall reaction to the FY19 can be summed up in:
“More or less as expected.”
Now, the dividend cut was harsher than expected. I agreed with most analyst forecasts, which put it somewhere between €0.8-€2.2/share, given the huge one-offs from the emissions scandal and, first and foremost, Takata. €0.9/share is obviously a brutal cut, putting the company’s current yield closer to 2%, so this warrants a closer look.
No one familiar with Daimler’s FY19 should be surprised, but let’s go through the basics nonetheless.
(Source: Daimler FY19)
Please note how certain key metrics were actually fine. Namely, revenue and sales, which both were okay. Nothing great in terms of improvements, but okay.
As long as we adjust EBIT and FCF, things were fine here too. The problem was the non-adjusted results including one-time effects for the full year of 2019. These impacted FCF and EBIT as well as profit and net cash heavily. 5.262 billion euros to be exact. There were other effects due to FX and some cost changes and CapEx, but the FY19 results are characterized mainly by this part of the Group EBIT bridge, which works to push FY19-EBIT to $4.329B
With adjustments put back in…
(Source: Daimler FY19 Report)
Things actually look acceptable. Still a drop from 2018, but acceptable nonetheless for a major automotive manufacturer navigating a transition into EV.
Now, Daimler could have chosen to basically ignore the implied payout ratio of a maintained FY19 dividend. The company certainly has the cash available to do so, and I expect that many companies in today’s space would have chosen to suffer the increased debt that would have come from a flat dividend. Daimler did not. Instead, they chose to go the way of maintaining the company’s payout ratio of <50% of net profit. With a net profit of 2.4B for FY19, the 1.0B in dividends amounts to 41.6%, which is virtually unchanged from last year’s payout ratio.
What do I think of this?
While I’m unhappy, it’s also the responsible thing for Daimler to do. While I don’t like my lowered 2020 dividend, I don’t invest for 2 years – I invest for 20 years and above.
And if we look long term, there’s plenty about Daimler to like as a company and as an investment. Let’s go through some 2019 numbers/facts.
(Source: Daimler FY19 Report)
- Mercedes Benz is the number 1 luxury brand, and it’s defended its position once again. For the first time, it’s also the class leader in premium in China as well.
- Sales in MB cars are up for the full year, with inventories significantly reduced.
- Mercedes is targeting carbon-neutral mobility by 2039, with an all-new platform introduced to the market.
- Cars suffered from FX, higher tech expenses, write-down of Aston Martin valuation, as well as emissions and Takata.
- Sales and performance in Vans are growing to yet more record levels, but results here are weighed down by emissions and Takata aside from tech/FX.
- Trucks have launched the new Actros and managed a strong NAFTA performance. Sales are down slightly, but revenue is up, and the segment has been battling macro headwinds.
- Buses have been one of the company’s best-performing segments for a while now, and this continues in 2019. Sales are up, revenue is up, EBIT is up.
- Nothing did as well EBIT-wise as Mobility, however, which thanks to prudent risk management and efficiencies came in at a record-high €162B Euro contract volume and a €2.1B EBIT, a more than 30% EBIT growth YoY.
So, operational performance in overall segments wasn’t actually that bad, though it was down YoY. Daimler has also structured a new ParentCo, with new well-defined roles, streamlining, harsh job cuts and administrative reductions.
So, overall Daimler is on track to deliver its new long-term initiatives and transition into EV/other tech. That being said, there’s still plenty to be done in terms of both efficiency and growth CapEx. At the same time, the outlook for sales in 2020 isn’t all that great.
(Source: Daimler FY19 Report)
However, remember even with a “normal” or slight decrease in sales, Daimler is a company which in normal circumstances can deliver well over enough EBIT/Earnings to pay a competitive 5-7% dividend to its shareholders while growing the business.
That’s why Daimler despite expecting sales decreases guides for significantly improved FCF and EBIT for 2020. There also isn’t any huge growth CapEx in terms of PP&E or R&D for 2020.
(Source: Daimler FY19 Report)
Daimler intends to cut production of low-profit/low demand model lines, in order to focus on the high-demand models. This, as I see it, is long overdue, and MB has for too long offered what I view as far too much in terms of selections/varieties, which has hurt the appeal of previously core models.
Perhaps most importantly in terms of savings…
(Source: Daimler FY19 Report)
The personnel reduction is set to deliver €1.4B in bottom line savings as early as 2022. Daimler is growing leaner and meaner – again, something they should have done previously, but the new organization is something I really like. Daimler is of course also ramping up EV production. Some highlights:
- Launch of EQV this summer, EQA this year.
- More than 20 plug-in hybrids by 2020, and rolling out 48V tech.
- 9 Battery factories in 7 locations spread across 3 continents to meet the demands.
- The company’s xEV sales share will more than quadruple to nearly 10%, with pure EV vehicles more than doubling (company targets).
Now, with all those positives and expectations, where are we when we close 2019 and look to 2020?
Well, Daimler’s 2019 wasn’t a good year. While I expected a dividend cut, I certainly didn’t expect the company (nor did others, judging by the wide range of expected dividends) to stringently keep to its 40% payout ratio, thereby virtually decapitating (2%) the dividend.
As a result of this, the stock has likely lost its appeal to many investors, given it’s now an auto manufacturer yielding less than many high-DG pharma/industrial companies.
However, I argue there’s still a spot in a potential portfolio for Daimler due to the simple fact of forward sales, profit and dividend growth. This, admittedly, involves a long time frame, but I hold a 20-50 year investment period in my mind anyway. A year of bad results or as in this case – slightly negative results impacted by one-offs and a transition – certainly isn’t enough to make me sell or go negative on the primary luxury car brand in the world.
No, what we must look at is valuation – and we should treat 2019 results as an outlier year. Let’s look at the current valuation from the basis of some tangible multiples.
Rarely has the valuation for Daimler in terms of these been as depressed as it is. While the company is pouring capital into CapEx/PP&E to meet the transitional demands of the EV industry, the market isn’t giving the company credence for these – and for a good reason. The investments haven’t yet flowed down into profit or revenues.
If we look at Daimler from the 2018 EPS, the company is currently trading at a P/E-level of around 7 – this is above other manufacturers like Renault (OTC:RNSDF), but below others, and well below its historical norms. In every article on the company, I’ve pointed out that there are reasons for today’s compressed valuation – more so than ever now.
Using 2019’s EPS paints an unfair long-term picture of Daimler – needless to say the P/E is markedly higher as a result of the poor EPS and other items weighing things down.
When considering Daimler outside of current year results, the company is more undervalued than for the past 8 years. It’s also going through one of the largest transformations in its modern history. Valuing such a company becomes a tricky exercise, especially given the currently-reduced dividend giving you an only 2% yield. It’s a hard sell for growth investors since the company hasn’t actually dropped in value since the report.
In my last article, I wrote that:
Now, this is nothing new, per se, or a sudden thing that we just discovered. Daimler has been trading below book value for over a year at this point – so the market believes that the company’s headwinds, including sales and cash flow conversions, warrants a discount to this. We can’t really find any help in analyst PT’s across the market either, as they range from ridiculously high (€85/share) to ridiculously low (€32.65/share) outside even the current range. (Source: TIKR.com, S&P Global)
(Source: “Daimler – Still Buyable, But With Some Risk“)
At the same time, I can point out that Daimler still has quite low debt for a company of its type; it’s certainly undervalued, and the long-term appeal is certainly here. The upside to a standard/long-term P/E-ratio of 9-11 is still there.
To invest in automotive stocks – a caution
Investing in any sort of automotive stock comes with a great degree of cyclical risk. This is especially true for investing directly in car manufacturers. Parts companies like Autoliv tend to be somewhat more (though not completely) insulated from this cyclicality.
Many great investors, including many of whom I personally admire, including (among others) Chuck Carnevale, believe that automotive companies tend to be less compatible with the tenets of dividend/value investing long term precisely due to their inherent earnings/industry cyclicality, which produces volatility not only short but long term. This is similar to other cyclical stocks like mining stocks/metal stocks, which share some of these characteristics.
I believe this to be a valid concern, and I can even agree with the view.
I reconcile this by “wanting” to also be diversified into automotive to some degree, but I’m in no way an investor who has a great deal of automotive exposure – no more than 3.5% as things stand. I wouldn’t want my exposure much larger than this either.
The positives with automotive or cyclical stocks such as this are self-evident. When things are working well and when the companies enjoy tailwinds, earnings are through the roof and you can enjoy double-digit CAGR returns and 5-9% dividend yields from companies that are so inherently “safe” due to their market position. Daimler, Renault, Volkswagen (OTCPK:VWAGY) and BMW (OTCPK:BMWYY) are good examples of this. These are companies with fortress-like balance sheets and excellent market positions.
However, the flip side is that when things are bad, this can happen. Especially with European companies that tend to dimension dividends in accordance with short term earnings volatility, the end result is dividend income volatility.
I’m used to this for the simple reason that most companies in Sweden size their shareholder returns the same way. This year alone, I saw several cuts that really had nothing to do with long-term performance, but everything to do with short-term headwinds – much like last year, and every year since I started investing. I realize however that many investors desire higher stability in their dividends, which is something that, while not rare, isn’t as ubiquitous as it is in NA when looking at companies considered qualitative or safe.
For this reason, I want to caution potential investors, that while I do consider Daimler and other car companies I write about in accordance with the recommendations I give for all investors, that all investors may not share the goals or want the volatility these companies offer.
The continued thesis for Daimler is unchanged, even if people perhaps believe that it should be more negative following 2019. I don’t see it as such, even if the company cut the dividend.
There were reasons to do so which have been known since the Takata/emissions fine decision was made and information was given. The company remains one of impeccable quality over the long term, and I fully expect Daimler to maintain its market-leading premium segment position. Unlike other car companies, this is a profitable company even during a year when they have to pay down billions for fines and other things. With new management and corporate structure in place, the company intends to go leaner and focus far deeper on EV/Hybrid – which will be a demand, going forward.
The fact is, had Daimler chosen to maintain or only cut the dividend by ~10%, those who may be teetering/doubting now probably would not be doing so – and a decision by a cyclical car manufacturer to size the yearly dividend according to yearly profits due to one-offs shouldn’t be a basis to decide anything if your portfolio aim is long term.
However – the reason I provided the small cautionary portion of the article is to raise a bit of a red flag here – this can certainly happen. It can happen to other car companies, to other cyclicals, and if you invest in Europe, even to companies in other segments.
So, despite my bullish stance – size investments accordingly and consider your goals with care prior to investing money in any company – but especially cyclicals.
Thank you for reading.
I continue to be “Bullish” on Daimler in the long term despite a somewhat negative FY19 followed by a dividend slash. While the company currently seems unappealing, I consider a reversion to the mean likely in 2020/2021.
Disclosure: I am/we are long DDAIF, DMLRY, ALV, BAMXF, BMWYY, BYMOF, RNLSY, RNSDF, VWAGY. 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.
Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.