Mercedes-Benz is a gem: offering ~8% dividends to investors at

In my view, falling interest rates, stronger consumer demand, and capital discipline among OEMs could create an environment for outperformance in the automotive sector in 2024. In that respect, I’m particularly positive about Mercedes-Benz Group (OTCPK:MBGAF) (“MBG”). ) as a company We successfully pursue value over quantity and emphasize premium products of the highest standard. Moreover, the company’s stock is trading very cheaply, with an expected dividend of ~8% in 2024 on a P/E of <5x. In fact, based on the residual return model, I would argue that MBG stock could be undervalued by about 100%. We give a ‘Strong Buy’ recommendation in terms of commercial momentum and valuation.

For context, Mercedes-Benz stock has underperformed the overall stock market in 2023. Over the past 12 months, Mercedes-Benz shares are up less than 5%, while the S&P 500 (SP500) is up about 24%.) The Eurostoxx 50 index recorded a rise of close to 22% (special economic zone).

The weakness in the third quarter is likely to be temporary.

Before we address the outlook for MBG and its related shareholder distributions, let’s quickly discuss the latest data points, particularly the weakness in the third quarter that may have some investors concerned. In the September quarter, Mercedes-Benz shattered consensus expectations by reporting automotive EBIT margins of 12.4% and lowering guidance to 12-14% for fiscal 2023 and 10-11% for the fourth quarter, following a 14.8% margin. In the first to third quarters of 2023, it was 13.5% and 12.4%, respectively. Although the poor performance is unfortunate, we point out that most of the disappointment is due to ‘temporary factors.’ In particular, supply issues have caused MBG to miss out on around 5% of its mix-rich GLC and E-Class units, which amounts to an EBIT loss of around €1.75 billion on a pro forma basis for full-year 2023, according to my estimates. Adjusting Mercedes-Benz’s results for lower sales of its GLC and E-Class units, the group’s EBIT would have been little changed compared to the second quarter.

Sales and profits may increase in 2024…

With the disruption in the third quarter of 2023 believed to be temporary, I am optimistic about Mercedes-Benz going into 2024. In particular, I like both the macro setting and the commercial strategy of Mercedes-Benz. On a macro level, I see falling interest rates as a major tailwind for the auto business. Investors should consider that a significant portion of car purchases are financed through credit. Low credit should therefore stimulate consumer confidence and demand. Meanwhile, energy prices and overall inflation are falling, which supports operating leverage for a higher topline. In my opinion, €140 billion in revenue and €20-22 billion in operating profit should reflect very reasonable expectations for MBG in 2024.

In the context of MBG’s commercial strategy, I like how management is committed to value over volume sales and emphasizes its premium position in the automotive segment. In my opinion, the premium strategy will insulate the German automaker from the inevitable price competition from EV startups, especially new brands coming out of China. In this regard, we emphasize that the launch scheduled for next year will be aimed at the premium car market. MBG’s major launches planned for 2024 include updates to the electric G-Class, the AMG variant of the E-Class and GLC. And with the launch of the new AMG GT. In particular, all 2024 models from Mercedes-Benz are trending towards luxury products in the car market with RSPs exceeding €70,000. In addition to margin benefits, a larger share of premium vehicles compared to total sales will help smooth out revenue fluctuations across economic cycles as premium/luxury demand becomes more resilient.

… Ready for attractive shareholder returns

Given the favorable backdrop for 2024, we’re surprised to see that market participants are still pricing Mercedes-Benz stock at around 5 times earnings and an implied dividend yield of 8%. In addition to dividends, MBG also actively engages in share buybacks, which are estimated to be in the range of EUR 1-3 billion (incremental returns of 1-3%) in 2024. In this regard, investors should take into account that CFO Harald Wilhelm did not specify a target liquidity, but had previously hinted that the group would operate comfortably with a significantly lower industry liquidity balance compared to €28.5 billion by the end of September 2023. In any case, I view MBG’s 8% implied dividend yield as the low end of the possible range of shareholder returns.

Valuation: Target price set at $147 per share

In my opinion, companies with steady and relatively predictable business fundamentals like Mercedes-Benz are very easily and accurately valued through residual profit models. The model is based on the idea that valuation should equal the company’s discounted future profits after capital charges. According to CFA Institute:

Conceptually, residual profit is net profit minus the expense (deduction) for common shareholders’ opportunity costs in generating net profit. It is residual income or remaining income after taking into account all of the company’s capital expenses.

Regarding the Mercedes-Benz stock valuation model, I make the following assumptions:

• To forecast EPS, I’m basing my reference on consensus analyst forecasts, available through 2026 on the Bloomberg Terminal. In my opinion, estimates beyond 2025 are too speculative to include in a valuation framework. However, over a period of two to three years, analyst consensus is usually very accurate.
• To estimate the capital charge, I fixed Mercedes-Benz’s cost of equity at 9.25%, which is roughly consistent with the CAPM framework.
• We applied a perpetual growth rate of 2.25% after 2025, which we believe is consistent with the estimated nominal global GDP growth rate.

Based on these assumptions, I calculate my basic target price for Mercedes-Benz stock to be approximately $147 per share.

I acknowledge that investors may have different assumptions about these interest rates. Therefore, we have included a sensitivity table to test different scenarios and assumptions. See below.

Note on risks

Of course, investing in Mercedes-Benz is not without risk. Specifically, we argue that a worsening macro environment, including a less favorable rate-cutting environment, could negatively impact auto sales in 2024. Moreover, geopolitical risks such as the Ukraine conflict and Mercedes-Benz’s exposure to China are increasing business uncertainty. Lastly, investors should also consider that, as a cyclical business (automotive sector), Mercedes-Benz’s stock price is affected by investor sentiment volatility.

Investor Implications

Falling interest rates, strong consumer demand and capital discipline could lead to outstanding performance for the automotive sector in 2024. In the automotive sector, Mercedes-Benz has a particularly positive outlook as it prioritizes value and premium products while also pragmatically exploring the transition to electrification. . I view the Q3 2023 headwind as temporary and expect MBG to generate €140 billion in revenue and €20-22 billion in operating profit in 2024. Based on our residual return model, we argue that MBG stock could be undervalued by approximately 100%. .

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.