TIVP018: Mercedes-Benz (MBG): Can Benz Reinvent the Car? w/ Daniel Mahncke & Shawn O’Malley

27:34Third is the mobility arm. So financial services, handling leases, which is a big thing in Germany, we maybe talk about that later on, fleet financing and insurance, all of that stuff. It's a stable cash flow business. And it's especially important for customer retention. Because if you lease a car, you're way more likely to stay with that brand for a long, long time. I don't know a ton about cars. I do always wonder why leasing isn't more popular in the US. And so I took the very unscientific approach of just quickly Googling the differences in lease rates here. And it sounds like it's about twice as common in Europe to lease new vehicles than in the US.

28:12And I'm not totally sure what is behind that, but it strikes me as being much more practical in some cases. So I can't help but mention also here the Mercedes G-Class, which sometimes people refer to as just the G-Wagon. And to me, there's a status to owning any Mercedes. And then there's almost another level of status for those who own G-Wagons. And so my question for you is, would you say that they're as iconic as the S-Class? It's definitely the most iconic SUV ever. It's a bit hard comparing them if you would ask people today probably as many people know the g-class or the g-wagon um then they know the s-class so you you could probably say that yeah it's funny that it was originally built as a military car and i think it looks like that it just has this military look to it and it was built in the 1970s to be precise i think it was 1972 and the shah of iran which is kind of like the king of iran not anymore i must say that but back in the day it was called like that and he wanted one of those cars and since it has become kind of a luxury icon it's especially popular in the us but it's also popular in china the middle east and europe as well so it's a global car which is loved everywhere basically it's funny how the more companies we cover the more patterns start to emerge so we can see and this one reminds me of montclair where you have a luxury brand that started with a functional product like mercedes they kind of go mainstream and then eventually because of their focus on excellence and quality they end up as being status symbols and lean into aesthetics to some extent and probably could say the same with specifically the g-wagon here too right it was built for the military and now it's a luxury ride for sheiks and businessmen it's funny because i don't know if you remember it but there was actually this genius collection with montclair and one of those collaborations has been with Mercedes.

30:10So all the other ones were with like celebrities, but there was one brand was Mercedes and the car they used was this G-Wagon. If Montclair is going to partner with anyone, it probably makes a lot of sense for them to partner with G-Wagons, right? Because they're both these sort of outdoor rugged products in a way. It is a great fit. Although the collaboration, while it makes sense, I don't expect it to hit the roads at any time. I mean, a G-Wagon with Montclair jacket as wheels looks cool, but I doubt it will ever go into production. I guess we kind of drifted off of here a bit. How about we quickly go back to Mercedes EV lineup?

30:51I know you mentioned that their EQs had flopped. Can you just elaborate on that failure? Since we didn't really talk about it yet and what the future plans are for this unit? The sales numbers were pretty, I mean, they were okay at the beginning. They sold about 23 ,000 costs in the first year they they put it out which is probably 2022 because they technically started in 2021 but it was only a couple of months left then but sales immediately dropped like 40 percent the year after and the failure kind of came announced the change was to a more of an ev look which didn't resonate at all mercedes clients they call it a jelly bean and they didn't think it's a luxury look at all they didn't have fast charging which would be 800 volt as kind of like the highest end that you can have right now and if you buy a Mercedes you would want 800 volt as your charging system and overall and that's what I kind of referred to before they just tried copying Chinese cars and they lost the Mercedes DNA as a part of that and customers are very different so in in China they want entertainment systems they want a lot of technology in the car In Europe, that's not so much the demand.

32:03I think in the US it's the same. Customers want something else. And Mercedes tried to tailor these cars more to the Chinese customer and it made them fail all along. It didn't hit the demand in Europe and the US. And for China, they just had better cars at lower pricing points. The technology just wasn't as good as it should have been. The only positive I can see here is that it has been a transition to a strategy more focused on EVs, which is definitely important for every car brand, but Mercedes needed improvements on that end. So the next wave of models will now run on a dedicated EV platform rather than modified combustion ones.

32:48And that's a major point to improve on them. To pull the thread a bit more there, I am curious. because you said that the DNA kind of changed when they went to electric vehicles. So up until now, have electric vehicles been assembled alongside traditional gas-powered cars in the same process or is there a different production process that they've kind of generally gone through? Yeah, that's how you could describe it. But ICEs, so combustion engine cars, and EVs will still be manufactured in the same factories. You can think of it like a dual track where ICE and EV cars share the same factory space today, but the lines are slowly being tailored more for EVs.

33:32So they get their own architecture, their own supply chains, and the production logic is more focused on EVs than on combustion cars. That way you keep the advantages, so it's fast and it's cost effective, but you get rid of all these trade-offs. So less efficient assembling, heavier vehicles, worse battery placement. And the initial plans were even a bit further than that, which was a fully dedicated EV architecture called MBEA, which was supposed to come out in 2025. So basically today, this platform would have been designed from the ground up only for electric vehicles. And that obviously would have meant even better battery integration, higher efficiency, and also improved range.

34:19It was also supposed to be supplemented by a new operating system, which is called MBOS, which is improving all the infotainment you have in the car, which has been a major problem for Mercedes. But generally, all German automakers, driver assistance systems as well, they weren't as good. And all of that was supposed to improve with the MBOS. The fact that you say was supposed to makes it sound like we won't actually see these changes in 2025. That's absolutely right. Mercedes decided to go for the dual track solution. And that's because there's a certain dilemma that they face. EVs are the future.

34:59And Mercedes knows that. Everybody knows that. But they still sell a ton of ICEs. So they make a lot of money, especially in China, with all of their combustion engine cars. And premium consumers across the world tend to like those combustion engine cars and drive them way longer. than more price sensitive consumers, especially in China, who like to get a BYD car for$15 ,000, which is an EV car almost all the time. So now they face this dilemma of what to focus on. And their answer has been electric first, but not solely. So to drop some more confusing abbreviations here, MBEA is canceled for now and MMA has been introduced.

35:44And please don't confuse MMA with mixed martial arts. That's not what we're talking about here. With Mercedes, it stands for Mercedes Modular Architecture. The CLE, which is somewhat of a basic entry level car, at least for Mercedes, will be released this year. And it's based on this new MMA platform. And it's supposed to have a range, if we believe the numbers, of 750 kilometers, which is about 460 miles, I think. and it finally has 800 volt charging, which enables them to charge 300 kilometers in range in just 10 minutes. That's crucial. This would make it the most efficient EV car on the market currently.

36:28In my previous episode, I read that Mercedes' goal was to build the first one liter car of the electric age. And based on the numbers you said, it looks like they kind of did that. For context, the one liter car concept has been introduced by Volkswagen. And the idea, I think, was to create an extremely fuel-efficient car that could drive 100 kilometers or about 60 miles on just a single liter of fuel. That's right. Mercedes claims that the CLA is that car. And this will be a huge step forward because range is the number one selling point in the luxury segment of EVs. A key question for Mercedes is I think about this as a shareholder trying to figure out what companies are going to create the most value over the next five or ten years.

37:15And when I look at Mercedes, I see how radically competitive its landscape is and has become in recent years. And I don't think that can mean good things for the business. And with EVs, obviously that has also reshaped the market and brought in new players, especially companies from China, which are now this major force of the global stage, which I think we're a little isolated from in the US because my understanding is that Chinese cars can't be sold here. So I've never seen one. And so at least for Americans, we're kind of under this veil where we don't realize perhaps just how dominant Chinese cars, especially Chinese EVs, have become on the global stage.

37:59So maybe you could paint some more color around the industry and also Mercedes' current competitive positioning in Germany, in North America, and also just relative to these Chinese competitors? Maybe we start with the industry in general. It has always been a tough business, as you mentioned before. And, you know, we like to quote Buffett and Munger whenever we can, and this time we can, so I will use that. Both of them, Buffett and Munger, have said in the annual meetings about the automotive industry that it's a tough business and they don't really know where it will head. It's just a business where you've got a lot of worldwide competitors.

38:34They're not going to go away. and it looks like there are winners at any given time, but it doesn't get you a permanent place, although, as I mentioned, we'll see a change in the vehicles, but you won't see anybody that owns the market because they changed the vehicle. Charlie? Well, the electric vehicle is coming big time, and that's a very interesting development. At the moment, it's imposing huge capital costs and huge risks, And I don't like huge capital costs and huge risks. And despite saying that, Berkshire still invested in BYD, which is a Chinese automaker. And by now it's the biggest brand in China.

39:18And one brand that you and me haven't yet seen on the street. But I'm pretty confident in the next five to 10 years, we will see a lot of those cars on our streets as well. They invested in 2008, so pretty early. and it has been a 10 % stake, so also pretty significantly. And the main difference perhaps, and maybe that's why they invested, it was more of a Charlie Munger investment than a Buffett one. But BYD sells cars that do seem like they are more of a digital product, which I mentioned before. So Tesla and BYD, those are cars where you might say later on in the stage, maybe five or 10 years ahead, but still, or those won't have the same cyclicality as other legacy car makers just because of all the technology they can sell in subscription models and everything like that.

40:08Regarding the mode, decade-long research on engines is no longer a competitive advantage. And that is what Mercedes, BMW, and Porsche really focus on for decades. And this is obviously hurting them. The focus now is software, batteries, and user experience. and that just hasn't been their strong suit. Although it changes a bit and I think we'll get to this because I will still tell you about some models and I've been really impressed with those. So I think they're getting ahead on this. And it's important because Chinese customers, they want different cars. I've just read a statistic about how much time Chinese people spend in their cars.

40:48Actually, sometimes they go into their car just to watch a movie. They don't even drive anywhere. They just like to spend time in their cars. So that's a totally different consumer than you and me. If we look at the geographics and the border market, I guess it makes sense if I start with Mercedes's position in the market and then kind of broaden the scope. Mercedes sold 2.4 million cars and vans in 2024, which is a 4 % decline compared to last year. Except for the US, where you actually had a growth rate of 9%, the declines were global and across the board. Germany and China decreased in the high single digits and all the other countries were in the lowest single digits, something like three to four percent declines.

41:30The bad news for Mercedes is the only growing market, so the US, will now become a lot harder to compete in with all these tariffs that we're talking about. And Mercedes is producing cars in the US, but not to an extent where they're immune to tariffs. On the EV side of the business, we talked about it, EV sales declined tremendously. It was 20 % year over year and the EQ models are just not doing great. But this year they're starting over with the new MMA models, the CLA and others will follow. I'm pretty confident that product-wise Mercedes is now in a way better spot. Speaking of geographies, we keep coming back to China and it's a key market for every car company.

42:13At the same time, China has ramped up its own production so much that has also turned into a key producer, as I mentioned earlier. So maybe we could start with the Chinese market and zoom in more there on specifically how Mercedes is positioned. And I know the narrative is that American and German automakers maybe have no chance in China anymore. And I want to ask you, do you think that that is truly the case? China has become the largest auto exporter in the world. China's car production in 2014 has been 24 million cars. Germany and Japan combined had about 15 million. Two thirds of that were produced by Japan and the other third by Germany.

42:5610 years later, in 2024, China increased its production to over 30 million cars. And both Germany and Japan decreased by 20%. So while one is growing exponentially, the other one is decreasing quite significantly. It's a funny coincidence that China is technically producing the same amount of cars that they also sell in their own country. So they wouldn't need to export cars. But obviously, not all cars that drive in China or are sold in China are Chinese, which leaves you the huge amount of cars ready to export in Asia and in many emerging markets. China's EVs are the dominant force. You would see them all over the street.

43:38In Brazil, Chinese car sales have tripled in just a matter of 11 months in 2023. And Thailand, Indonesia, Mexico, all of those are countries that see rapid growth of Chinese cars, even in Singapore. I mean, Singapore is the country with the second highest GDP per capita. So they could afford Mercedes. They could afford BMW. they choose Chinese brands. In 2023, they had 6 % market share, last year 18%. It's the same trend that you see across the board. If I talk about market share data, it's always referring to newly registered cars because the existing fleet cannot be replaced that quickly. So you talked about, are brands like Mercedes or BMW even still relevant in China?

44:26The short answer is yes, they are. The reality is that Mercedes was still the second most successful brand in China if you measure it by revenue. Yes, most of those cars are ICEs, but even if that's not the future, you have$40 billion in sales that you simply cannot just ignore. And no other top 10 brand has so much pricing power as Mercedes. The average selling price of a Mercedes-Benz in 2019 has been$51 ,000. In 2024, it has been$71 ,000. In China, the average selling price is about$60 ,000. BYD, for example, is the only car company that has higher revenues in China. And they, on average, sell their cars for a price of$17 ,000.

45:11There's only one other brand that is reaching an ASP of over$50 ,000 in China. I'm trying to think about what that other brand would be that has such a high average sales price. BMW? Tesla? it's a good guess. But I've never heard of that brand name before. It's called Aitor. It's Chinese, so it's not a foreign brand. And it's a joint venture between the smartphone company Huawei and the EV maker Ceres. And honestly, I've looked at those cars and I've also seen some reviews. And they are very luxurious. And they are, of course, full of technology. So they really seem like a very strong competitor.

45:54And the cars are a huge success. They sell hundreds of thousands of models, and they just started two years ago. This kind of forces Mercedes' hand. Going back to Europe and the US, how would you describe the outlook for Mercedes in those two pretty critical geographies? Europe remains Mercedes' home market, and its sales numbers are only slightly below China, so it's incredibly important for Mercedes still. And the overall sales declined by 3%, which is modest. the German market was an outlier where it's declined by 9 % and that's mostly due to the overall bad sentiment that Germany had in the last two years and also some EV subsidies that were just cancelled pretty much out of nowhere and which brought a lot of uncertainty into the German car market.

46:42Overall I would say the trend towards EVs has really started in Europe. Registrations now go double digits year after year and currently the dominant EV company is still Tesla although its share has massively dropped in recent months which is largely due to a boycott and I've just brought a chart here which is pretty interesting to see and it shows that Tesla had an advantage of being viewed as one of these environmentally friendly brands and now that is totally gone because people just assume or connect Tesla to Elon Musk and his image has totally shifted. That's definitely a big part in why Tesla is not as successful anymore as they used to be.

47:27It's been an absolutely brutal year for Tesla. Deliveries were off 13 % last quarter and the stock is down something like 40 % year to date. So just really, really ugly numbers. And much of that is, as you kind of said, due to what has been a very dramatic narrative shift around the Tesla and owning a Tesla has become very politicized. And as a result, it doesn't surprise me that you have celebrities who are making a big point of getting rid of theirs and that on the margins people are maybe hesitant to buy new ones either just because they don't like what the brand stands for or they're worried about other people sort of retaliating against them and when I think about electric vehicles Mercedes is really not what comes to mind for me first at all it's still probably Tesla and then after that I don't know I'm always surprised by what has been turned into an EV, right?

48:17That you've got EV Hummers and EV F-150s. So it seems like nothing is off limits to be made into an electric vehicle. But I don't think these are hugely popular products either. And the bigger question is if Tesla is really losing market share, then how well positioned is Tesla to absorb some of that, especially in the luxury vehicle space? I'm surprised to see Mercedes' improvements on the EV side as well. And I don't know if they are placed second and if they could actually catch up to Tesla. I don't know how long lasting this boycott will even be. If Tesla has the best product, I'm pretty sure they will remain the number one because eventually the best product will win.

49:03So it's hard to say where Mercedes stands on the EV front, but I do know their products got a lot better. and in the US they sold about 320 ,000 cars. So there's a lot of potential there. But if we're talking about the US, I'm kind of getting tired mentioning it, but it's the elephant in the room here and we have to talk about it. It's the tariffs. Now the tariffs are off the table for most companies, but not for automakers. They initially expected Trump's tariffs to be around 10%. That's where we are for most companies now. but on car companies they are 25 and they are at least until now still in place and this will be a huge hit for margins and sales the tariff situation has been evolving so quickly that i don't really have any confidence that by the time people listen to this in just a few weeks it could be a totally different environment right yesterday we had the 90-day pause on most of the reciprocal tariffs and i think there's 10 universal tariff there's a 25 automobile tariff and something like 100 % plus tariff on China.

50:10So they could be already outdated news in a week from now. What we do know is Mercedes is probably not going to get out of this scot-free. And what everybody's trying to figure out is what are the second and third order effects of all these tariffs? And of course, no one really knows. But my question for you to put you on the spot, Daniel, is have there been any quantifiable impacts on Mercedes that we can observe yet? There have been some. And some of them come from the CEO, Ola Kalanius, personally. He has immediately reached out to politics, especially in Germany, to kind of negotiate a deal with the US.

50:47But as you mentioned, I wouldn't bet on that happening. And a tariff of at least 10 % is probably what investors have to calculate with. But you're right. The level of investment is high. The auto industry and our company, we have never invested on a higher level than we're doing now. mostly in product, of course, but also into enabling technologies like the ones that we just talked about. The CEO itself said that based on a 10 % tariff, he would expect 100 basis point impact on the gross margin. Bernstein expects 2.5 % gross margin declines, but those numbers are already tailored to the 25 % tariff.

51:27they also expect 1.7 billion euro decline in profits which sounds like a lot but later we will look at the numbers and if those are the impact of the tariffs it actually still looks quite good for Mercedes. I just wouldn't bet on that being everything we get from the tariffs. If they are 25 % I personally see higher margin declines. I see higher revenue declines and we'll get to that in my model but Mercedes CEO did a lot of talking about how American the company is he talks a lot about how American he feels that he already worked for Mercedes in America that they have factories there in Alabama and in South Carolina they employ over 10 ,000 people in the US so he tries to get this image of Mercedes as an American company at a cross but if that actually works, I would highly doubt it.

52:21I can't say it's been on my radar. I would never have thought of Mercedes in any way being an American company, but I guess you do raise a good point. I haven't seen Mercedes production plants, but I have seen pretty massive BMW production plants in South Carolina. And so, you know, the cars are being produced here and how that is going to impact the picture of tariffs is beyond my pay grade. But the simple question I want to ask you is just, Are you expecting tariffs to result in more or less production in the US? I think in the short run, you probably have a bit more production because Mercedes already said that they want to shift at least one more product line to the US factories.

53:02That's most likely going to be the GRC just because it's the most popular model in the US. And they only produce those in Germany and in China. And as you've just mentioned, China and the US are not on a good relationship right now and the tariffs, as of today, are about 125%. So it's probably a good idea to get the GLC production to America instead of having it in China. Longer term, I really don't know. Building a new factory to produce high quality cars is a multi-year project and it's about huge investments. I would guess they wouldn't decide on something like that just in panic mode after seeing a new headline after Trump had another press conference.

53:47An American president is only in place so long. Considering the production cycles and costs, I don't think we will see tremendous investment in the U.S. just because of this. The one thing I want to discuss further here so we don't linger too much on politics, and I should have brought this up more, but that is the Mercedes in-house operating system called MBOS. And I think we're all probably familiar with Cathie Wood and her famous bull case for Tesla at this point. I know she thinks the company is going to be a$9 trillion company by 2029, which may be just a tad optimistic. But her three major drivers of Tesla's business are basically software sales to Tesla owners of Tesla's passenger EVs, licensing the software to other manufacturers for a fee.

54:40And then through creating a ride hailing network that could allow Tesla to basically offer these cyber cabs that would transport passengers at all hours of the day and would compete with Uber, but be completely driverless. Those are kind of the three major catalysts she sees behind Tesla's growth over the next few years. And I happen to think it's very unlikely that these cyber cabs can compete with Uber's network effect. And maybe I'm biased because we have Uber in our intrinsic value portfolio, but I just don't think they can do it in a very capital efficient way. And as we talked about in that Uber episode, demand for ride sharing fluctuates a lot throughout the day.

55:18And if you have this fixed fleet of cyber caps in a given city, you're either always going to have too many or too few cyber caps. And that's just a very capital inefficient structure. Whereas Uber is the beneficiary of this massively flexible network where, somewhat controversially, they have part-time drivers who are contractors who can jump online at any time of day to meet demand surges and then go offline during quieter parts of the day. So with all that said, does Mercedes have similar ambitions around building a ride-hailing network with its MBOS? They're an ambitious company and they've talked about a lot of stuff that might happen in the future, but I haven't heard anything about ride-hailing.

56:00And I'm kind of glad I didn't because I don't see that as a realistic future for Mercedes to go in. What they do have with their MBOS system, that maybe sounds a lot less than ride hailing and being five to ten years out, but they enable over-the-air updates now, which is crucial because before, whenever Mercedes had an update for their cars, you actually had to drive to a car dealership and then manually update that car. What that basically means is your car is now turning into a digital product. But coming to your question, generally, I don't see Mercedes competing on self-driving cars with Tesla anytime soon.

56:39Although they make a lot of progress on that front, I got to admit, I've watched an unhealthy amount of car reviews before this episode in my free time, of course. And my major takeaways have been that all of those cars, not just Mercedes and Tesla, but all of those brands are much closer than I would have previously thought. in self-driving and in infotainment systems. For Mercedes especially, the new system works very well. They include ChatGPT 4.0, so the paid version, which is a fair deal if you buy a Mercedes for$70 ,000. They also include Gemini and Google Maps. So you have a pretty good ecosystem of capable maps and apps in general.

57:20And then one interesting thing, and it brings us back to another episode from before, which we mentioned in this episode already, which is Nintendo, you have a cloud gaming infrastructure. So if you're on the passenger seat, you can now grab your Xbox controller and you can play all sorts of games in your Mercedes. This could be Fortnite, this could be Grand Theft Auto. So you have all those big titles. They enable that by a partnership with a company called Boosteroid. Mercedes has come a long way in all of that infotainment technology within their cars. It's not a big revenue driver yet. They generated about a billion euros in 2022.

57:56nowadays that's a billion dollars in EBIT so we're getting there but it's still a couple of years ahead for making this a substantial part of their revenue and of their business and it needs to be at some point because they spend a lot of money on R &D which is the research and development costs of a company about 25 percent is estimated to be just on infotainment systems and software in general. We've already talked about some of the key numbers and trends here and there. How about we take a deeper dive to look at the financials and the key performance indicators and how that will change in 2025 for Mercedes?

58:37Right. So the more uncertain the future looks, the more we need to pay attention to financial health. And a big part of that is the balance sheet. In Mercedes' case, it's not so trivial to look at the balance sheet just because of their mobility division. The main offerings are financing, leasing, and insurance services for their cars and their vans. In Germany, it's about 67 % of Mercedes that are leased. And one of the reasons for that is that a lot of companies lease an entire fleet of cars and then basically give them to their employees as a sort of benefit. So instead of loaning it personally, you kind of get they detracted from your salary.

59:18And as you can imagine, those financing activities, they create huge positions on the balance sheet. So that's leased assets, debt, and receivables. And in Mercedes' case, that's about 40 billion euros just last year. To isolate from that, Mercedes is reporting a KPI called net industrial liquidity, which is based on the free cash flows of the business, but just those generated by the industrial business. and that's cars and vans. Net industrial liquidity is calculated as cash minus financial debt. As I said, only cars and vans segment. And it's just a more accurate assessment of Mercedes's cash position, which is huge.

59:59It stand at almost 30 billion euros just last year. And that's on a market cap of 46 billion euros. So you have a huge cash pile. And that's how and why they can pay a 10 % dividend and buyback stock. And if they just hold this level of cash flows and kind of sustain that cash balance, the stock would be a no-brainer in my books because it would re-insure that they can pay that dividend and buyback share at the same time. But that's unlikely. If you look at the chart now, you can see that Mercedes' KPIs and the outlook of the management both suggest that they decline pretty significantly. They sometimes use wordings as slightly or significantly.

1:00:42What it basically means, they say revenue is really slightly below last year. It's in a range of minus 2 to minus 7%. That just increases with EBIT and free cash flow. So significantly below for free cash flow means 25 % lower than last year or even more. That's pretty significant. I would say so. So it seems like the perfect transition here to begin talking about valuation, which is really at the core of what we're trying to accomplish in these episodes. So what did you do with all these assumptions when trying to value Mercedes? So the first thing I did is I checked the past guidance of management and whether they were spot on or if they were totally off with what they said.

1:01:25Generally, they do a pretty good job with guiding where the company will be. But one thing that stands out in recent years and quarters is that the severe impact on EBIT and EPS, so earnings per share, has been not visible in the guidance. They said they would decline meaningfully or significantly, as they say, but that just means 15 % or more. And last year, decline was more than 30%. So that's huge. in my model I base my assumptions for the total shareholder returns on the EPS plus the dividend that Mercedes is paying and that dividend is just based on the EBIT numbers which makes it a bit easier for the listener to adjust the model if you want to download it yourself because in that case I have an input called operating expense ratio and it covers all of those costs that go on between the EBIT margin and the gross margin.

1:02:20So after you subtract all the costs of goods sold, that's relatively easy for you to make that input. One thing to point out is that even if the decline in EBIT and for cash flow continue, this huge cash pile that Mercedes has would still be enough to sustain the buybacks and the dividends for the five-year period that I forecast. And even beyond that, the only thing you have to take into account is they don't want to use that cash pile because they needed for times of a recession for safety. So it's still likely the dividend could be cut despite that huge cash pile and the cash flows they still generate.

1:02:58It would be a very promising investment if you're right that we had some certainty that cash was going to be distributed to maintain dividends and buybacks. And then it'd be pretty simple to model out the expected return for the most part. But obviously it's not that straightforward. And that is the risk we take as equity investors is that we really don't have direct control over the company, right? If you make a loan to Mercedes, you know that legally they have to pay you back before they can do things like pay out dividends. So there's just a, you're kind of getting the leftovers as an equity investor.

1:03:35And sometimes that's a great thing. And then other times you're shaking your fist saying, I wish they would pay out more in dividends. And going back to your model here, out of curiosity, what growth assumptions did you use given all this uncertainty around tariffs? Did you incorporate that or did you just go with basically management's prior guidance? And if so, what was that before the recent tariff announcements? I tried incorporating that for sure. I think it was kind of conservative, but who knows if conservative is actually a word that you can use in the current environment. So as I mentioned, the brokerage house burn scene estimated 2.5 % gross margin declines.

1:04:15I doubled that. Mercedes was talking about a bit slower growth. There could be 2, 3, 4 % in revenue decline. I used 5%. So with those numbers, the 2030 revenue would still be slightly below what we've seen last year and EPS and the dividend would be significantly below that. So that's why I say conservative. Generally though, Mercedes is affected in two ways by the tariff. There are first order consequences, which is you pay 25 % tariff on everything that you sell. And the second order consequence is a possible recession. And that's a big problem because in a recession, the first thing that you delay are big purchases.

1:04:59And a Mercedes car is a big purchase. Instead you, and that's kind of where we get to the AutoZone episode that you once did. what you do is that you either buy used cars instead of new ones or you just drive your car longer and you rather take it to get a new tire one more time than saying okay it's time for a new car. Mercedes may be a bit less affected on that because they are in this premium segment and their customers tend to not be as price sensitive or as sensitive to the economy but it's still a problem. And another thing is that if you look at the multiples, Mercedes seems to be ridiculously low valued because it's trading at less than six times earnings and it's among the cheapest of all car companies.

1:05:44Ferraris, for example, is trading at over 50. Tesla is trading far above 100. But that comparison lacks a bit. Ferraris' advantages and economic downturns are huge. They have a return on invested capital of over 20%, which is something that Mercedes could only dream of. and Tesla has still a lot of future potential growth. Yes, growth slowed down last year, but we talked about Cathie Wirt's bull thesis. I'm not buying into that, but we don't need to reach$9 trillion of market cap to still have significantly more growth than Mercedes is having. At the current dividend yield, which is almost 10%, and the authorized buyback program, which is another 10 % of the company, they want to buy back the next two years.

1:06:26That looks like a pretty good investment. the only question is can they actually pull that off one thing the company has said is quote any future free cash flow from the industrial business as available post potential small scale m &a and generated beyond the 40 dividend payout ratio shall be used to fund share buybacks with the purpose of redeeming shares but the only question is can they actually deliver on that it's a big question and And just to kind of continue to think about your valuation approach here, it seems like we've talked about a few different business segments here at Mercedes.

1:07:03Did you do the classic sum of the parts valuation technique for Mercedes? Did you try to add everything up? This is actually what makes me the most bullish about the company, because the other model is very sensitive to many inputs that you can have. And you put the EBIT margin down 1%, suddenly the intrinsic value is not 60 years, it's 50. so there's not a big margin of safety. I did some of the parts variation though and if you do that, it just looks very, very attractive. There used to be a segment which is the Daimler truck segment. They've spun that off in 2021 but they still hold a 35 % stake.

1:07:39The market cap of that company is about 25 billion euros right now so that stake would be worth almost 9 billion euros. That's about 9 euros per share. The mobility business has 13 billion euros book value which would be another 13.5 euros per share. And then you just have this huge net liquidity position, which would be about 32 euros per share. And just that alone gives you 55 euros per share. I know it's a lot of numbers, but stick with me here. 55 euros per share intrinsic value without the entire car and van business. So at a share price of only 48 euros, that would basically mean you get the entire car and van business valued at zero US.

1:08:23Okay, well now comes the fun part of processing all that quantitative analysis and the qualitative factors like competition that we've discussed around Mercedes and looking at this final valuation to make a decision on, do we want to buy Mercedes at current prices and add it to our portfolio? Or is this something we should pass on? You know, I've kind of set up myself right now after giving you very attractive sum of the part valuation and also telling you across the episode that I really like Mercedes' product and what we will see in the next five to 10 years. But there are two major concerns for me.

1:09:00The one is financing. Long-term financing is something that Mercedes has done for a long time and the loans they have are all about 1%. So the interest rate is very low. They have to be refinanced soon. Most of them in like two to three years. that's far over 100 billion euros they need to refinance. Above 70 % of that is long-term, a bit less than 30 % is short-term, but the rates are generally much, much higher right now. And if we enter a recession, they will not get the same interest rates as they have now. And what that would mean is the cash position is needed as a safety cushion and it cannot pay out the dividend, which brings us to the second major concern, which is a dividend cut.

1:09:44It was already cut in 2024. And while it still looks like it's a great dividend yield of about 10%, that also looks great because the price declined significantly. And that's not a sustainable way for investors to get a good dividend yield. So my main point here is, and that's more of a general insight into investing in cyclicals, which Mercedes is, they tend to get attractive when valuations look sky high, not when they look like a bargain, because that's when they make very little profits and the PE goes up, but they are at the end of their cycle. So what you then see is over the next couple of years, the PE slowly decreases and the company is in a lot better shape, as well as the investment case.

1:10:29So currently, I would be a bit worried about Mercedes, but what's your take on that? It's kind of counterintuitive, as you said, with these cyclical companies because if you imagine the price you're paying as being constant let's say a hundred dollars per share and then the earnings are going up and down and up and down and so actually when the company's earnings are the highest at the peak of a cyclical trot or you know at a cyclical peak is actually when it's the lowest price to earnings ratio and then at the bottom of that peak when it's the highest that's actually when maybe the company's arguably the most cheapest, even though it's a high PE.

1:11:08So it isn't intuitive. So with all that said, though, I do worry. We're looking at this company, we're talking about being cyclical, as I just explained. The fact that it's cheap actually might mean it's sort of a value trap there. And I could be wrong. There could be a lot of hidden value with a company like Mercedes, just as you kind of suggested with the sum of the parts approach. But there's also just a lot of hidden risks, too that are really difficult to account for. And every company has hidden risks, but when you have a company that's really wildly profitable and clearly the industry leader, you just have a lot more room for error, which is something I come back to a lot.

1:11:48This idea of room for error, which is maybe another way to think about moats. And generally, automobile companies do not have a lot of room for error. They don't have a great track record of being shareholder-friendly places to invest your money. And this seems like a time of especially high uncertainty, which is what everybody says of every time, right? Every moment feels uncertain. But I think it's pretty fair to say this is a time of elevated uncertainty, which just structurally means that I probably don't want to be investing in companies that don't have a lot of room for error. And this isn't just some general doom and gloom that kind of occasionally grips markets and causes sell-off, but there are very legitimate barriers to Mercedes being able to grow its business, let alone sustain its current level of profitability.

1:12:38As we've talked about at length today, there's a tariffs in the US and that's going to make everything massively more complicated. And then that doesn't really say nothing about how much competition has increased in recent years for a company that already was not earning excess returns on capital. And from a financial valuation perspective, didn't really have any evidence of having a strong moat around it. So I think I've ticked off one too many red flags here today to really feel good about Mercedes. Not to say it's not cheap and we won't regret not having bought it in a year or two from now, but it's just a lot of things to consider.

1:13:16And of course, there's a price you would pay for every profitable company where it does become attractive. And maybe Mercedes is getting close to that level. You would know that better than me, but who's to say things won't just keep getting worse and worse for them either, making their seemingly cheap valuation illusory. After all, they did report less than half the net income in 2024 that they earned in 2021. And as you've sort of outlined, there's probably no reason why margins can't decline further and top line sales can't decline further. And so when you're looking at things on a trailing basis versus a forward basis, I'm just not sure that the company is as cheap as it seems on paper.

1:13:56I agree with a lot of what you said and I like how you explained the cyclicality aspect. You did a great job at that, way better than I did. I think what matters, and you pointed out to that, is that there's a price every company gets attractive at. And I see a lot of positive signs for Mercedes on the product front and I do not usually make this argument, but there are some companies that are so important politically that they might be too big to fail. We've seen that with car companies in 2008, where a lot of them were saved because they were too important. They had too many employees that would otherwise lose their jobs.

1:14:34And this is by no means me saying you should invest in terrible companies because they will get saved eventually. I think it's more so that I found this deep dive very interesting because it's a totally different industry than we usually look at because it doesn't have any of those compounded characteristics. I do think there's a price which Mercedes can be very attractive. Personally, I think that's more to the low 30s. So we still have a long way to go just because there are so many uncertainties that you would have to balance the risk and the reward of. So I think it's safe to say that for the portfolio decision, we can agree on not investing into Mercedes yet.

1:15:16And that also means we get finally to the much easier part now, which is me asking you to give us three hints about your next pitch. And as always for the listeners, I want to hear your guesses in the comments after Sean has finished. We just went so in depth on Mercedes and now it's already time to move on to the next one. It's a, it's a tough game to play. I'm sure listeners can appreciate the fact that we kind of have to have this next one up attitude to do a different company every week as we do and try to go as in-depth as we try to go. But yes, I do have my pick for next week set. And in some ways, it's kind of somewhat of Mercedes in that you have a very powerful franchise that's facing more competition than it used to.

1:16:01Personally, I think its prospects are a little better than Mercedes. That's kind of a bonus hint. But hint number one is that the company's products are the industry standard for an entire profession. The second is that despite being so widely relied upon, the stock is trading at its lowest price to free cash flow multiple in the last decade. And thirdly, one of its most famous products is a verb. So those are my those are my hints. I gave a bonus hint. If you have any guesses, you can leave them in the comments below. I think those are some good hints. And perhaps we have a company again that we might add to the portfolio, which is not in such a terrible industry.

1:16:41And with that, let's close it for today's episode with a quote from Warren Buffett. Who else? I think it's a good reminder for everyone who also looked at the news way too often. And every 20 minutes in this past week, the quote goes as follows. I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. I hope the same goes for you and have a great day and I'll see you all next time.