VW Races Ahead of German Rivals in Q3, But Daimler Could Be Safer Ride

Scandal-hit Volkswagen (VLKAY)  has overtaken rivals in Germany's quarterly earnings race after BMW (BMWYY)   rounded out the big three reports with meagre growth Friday, but Mercedes-Benz owner Daimler (DDAIF)   may have the inside track.

From the emissions-rigging scandal that has besieged Volkswagen investors, to the potential economic fallout from the U.K.'s Brexit vote in June, German automotive manufacturers have had a torrid time in 2016 - which has prompted double digit losses for the majority of the sector's constituent stocks.

Compounding short term fears is a sense of unease among investors over the longer term and the pace at which the auto heavyweights have begun piling money into R&D projects aimed at securing an edge in the development of electric cars. 

Ultimately, production of electric vehicles means tectonic change for supply chains and manufacturing operations, which will have to adjust from a focus on engine production, to battery technology.

Such a shift means significant up-front investment, while little evidence exists to date to suggest that an already-low-margin industry will be able to drive mass adoption and meet market demand in a commercially viable manner.

For the three months ending in September, Volkswagen reported 4.4% growth in volumes, with 2.4 million vehicles sold. It also delivered a 21% beat to consensus estimates of adjusted operating profit while management said that full year operating profit growth will be at the higher end of the forecast 5% - 6% range.

The result was the strongest reported by any German car maker, in headline terms, but it failed to lift the shares as investors proved skeptical of the beat and were cautious of pushing the stock higher with U.S. litigation risk still hanging over the brand.

Patrick Hummel at UBS called the report a "BEAT, but low quality," adding that VW capitalized nearly €1 billion ($1.1 billion) of R&D expenditure during the period.

On converting R&D expenses into balance sheet assets, Volkswagen wrote the same amount into its profit and loss statement - taking the shine off of the quarterly performance.

According to Factset data, out of the 25 analysts covering the stock, 13 currently rate it as a buy and 7 have it as a hold.

VW is the strongest performing German auto stock for the year-to-date, after the shares fell by just 12% in 10 months to the beginning of November, but it has the lowest margins and lags its peers for unit sales growth. 

The Wolfsburg-headquartered company is beaten hands down by smaller rival Daimler when it comes to unit sales growth and margins.

The Mercedes-Benz manufacturer left VW in the dust on both unit sales growth and margins in recent periods, unit sales up by 5% in the recent quarter and its pre-tax margin rising to 8.2% from 7.1% in the recent full year.

The stock is also the most highly-rated among analysts after falling by 21% in the first ten months of the year. Out of the 25 analysts covering the stock, Factset data shows 15 of them rating Daimler as a buy and 6 of them tipping it as a hold.

At the end of October, it reported pre-tax earnings of just over €4 billion, representing 10% growth and beating the consensus by 6%.

Bottom of the pack in terms of broker consensus, and a laggard with third quarter earnings, premium car manufacturer BMW stock has also been the worst performer after falling by 24% for the 2016-year-to-date.

The group reported solid volume growth of 7.1%, up to 583,499 units, for the third quarter Friday. But Ebitda growth of just 1% trailed the sector, coming in a fraction shy of €2.4 billion, and representing a meagre 1.3% beat against the consensus.

However, in a world where investors are concerned about the impact of capital expenditure on profitability, as well as whether it will ultimately pay off in the longer term, BMW does have something going for it.

Its pre-tax margin rose to 9.1% from 9% one year ago for the third quarter of 2016 - the highest among German auto firms. For the recent full year it was 9.8% and management have pledged to keep it at or above this level through till 2020, which might provide anxious investors with some respite during the quarters ahead.

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