Why DaimlerChrysler Isn't Up to Speed

Seven years after the giant merger, analysts warn that the combination's promised benefits remain nowhere in sight

By Gail Edmondson

DaimlerChrysler just ended another year that can only make investors wonder if the outfit's 1998 merger with Chrysler will ever pay real dividends. Operating profit fell 17% in 2003, Chief Executive Jürgen Schrempp announced on Feb. 19. While he insisted that performance "met our own goals" in a difficult economy and repeated his vow that DaimlerChrysler (DCX ) would one day be No. 1 in the global auto industry, a close look at the numbers indicates a turnaround is not yet in hand.

DaimlerChrysler's net profit fell 91%, to $564 million, and it sold 210,800 fewer cars worldwide in 2003. Indeed, excluding exceptional items -- the December sale of engine unit MTU for $1.2 billion -- DaimlerChrysler posted a $527 million loss. Market share in Western Europe edged down 2.7 percentage points and remained flat in the U.S. Revenues were down 7%, to $171 billion, hit largely by a weaker dollar.

"What concerns me is four loss-making elements: Chrysler, Mitsubishi (MHVYF ) [in which DaimlerChrysler has a large stake], Smart [European microcars], and Toll Collect [a joint venture to build a toll-collection system in Germany]" says Jürgen Pieper, auto analyst at Metzler Bank in Frankfurt, Germany. "Four problems are just too much. You can argue about the strategy, but execution has been poor."


  Rivals such as BMW, Toyota (TOYOF ), and Nissan (NSANY ) all managed to increase sales and market share worldwide in 2003 -- despite the same challenging global environment. Toyota and Nissan also boasted strong profit growth. (BMW hasn't yet announced yearend results.)

Perhaps the biggest of DaimlerChrysler's problems is the Chrysler Group, which posted a full-year operating loss of $638 million. Schrempp insists Chrysler came "very near" to its breakeven goal if one-time restructuring charges of $590 million are stripped out, and he points out that the unit had a strong second half.

The division did make up lost ground following the second-quarter loss of $1.2 billion. But the Chrysler Group received an injection of $214 million in the second half, thanks to a decision to shift some of the cost of 0% financing to DaimlerChrysler's financial-services division. Fourth-quarter results were also boosted by an 18% ($470 million) drop in research and development spending.


  So how much money did Chrysler make at its real business -- efficiently building cars and selling them? Pieper believes that just half of the $638 million in gross operating profit (before restructuring charges are subtracted) posted for the fourth quarter was due to underlying improvements at Chrysler. Even Chrysler Group CEO Dieter Zetsche admits that most of the fourth-quarter improvement came from cost cutting and that the strong numbers shouldn't be seen as a trend. Indeed, he said fourth-quarter profit levels "were not visible" in the first quarter of 2004.

Analysts say expectations at the time of the merger were that Chrysler would match or exceed the 5% operating margin over a model lifecycle that it had achieved in the 1990s. That would mean earning an average $3.2 billion a year in operating profit -- still a far cry from the results expected in the coming three years. Says Pieper: "There's no prospect of Chrysler earning [even] its cost of capital in the short term."

Chrysler's sales, market share, and earnings per vehicle are the indicators to watch for signs of improving fortunes in 2004. Worldwide, sales were down 6.5% in 2003, while in the all-important U.S. market, which accounts for more than 80% of revenues, share dipped slightly, to 12.8% from 13%.1, as incentives rose by $1,000 to an average of $3,900 per car. The incentive surge has Chrysler's marketing costs hovering at a painful 20% of revenues.


  A big factor will be whether new models can reverse declining sales volume and ease the level of incentives required to move cars out of the showroom. Many analysts expect new models to help Chrysler move into the black this year, forecasting operating profits ranging from $750 million to $1 billion -- provided the incentive wars don't get any hotter. But none views such meager and long-awaited profits as a vindication of the merger. "This is not what the goal was at the time of the merger," says one analyst.

The hope of earning premium profit margins results from the first three new models so far has not materialized. Though Zetsche insists that nine new models will help reduce incentives, the Chrysler Pacifica, Chrysler Crossfire roadster, and Dodge Durango have been unable to reverse the trend. From December, 2003, to January, 2004, Chrysler's average incentive per vehicle rose $190, according to researcher Autodata -- and a Feb. 20 Merrill Lynch report anticipates further intensification of the incentive war.

For DaimlerChrysler as a whole, Schrempp promised only a slight increase in operating profit for 2004, leaving some analysts skeptical as the company moves into the seventh year of the merger. In 2003, return on net assets plunged from 8.8% to 2.4%. "We're certainly not satisfied," admits DaimlerChrysler CFO Manfred Gentz.


  Others are even blunter: "DaimlerChrysler's results are totally unacceptable. It can't go on like this," says one German auto analyst. "Schrempp is the only one in the industry who's still arguing that the merger was a smart move."

Schrempp points to DaimlerChrysler's $4.9 billion cash flow as a sign of vigor. But many analysts note that cash cow Mercedes-Benz -- which powers 55% of operating profits -- risks being undercut by troubled divisions. They worry that Chrysler and other struggling units could continue to drain cash as profits at Mercedes-Benz are squeezed by an aging model lineup and the cost of new-model launches.

Mercedes-Benz has seen its premium-car margins diluted by diversification into smaller models, including the supermini Smart. Mercedes' Smart unit has racked up an estimated $2 billion in losses since its 1998 launch, and management recently announced breakeven will be further delayed until 2006, after a promise to be profitable by 2004.


  Struggling Mitsubishi Motors (MMTOF ), in which DaimlerChrysler has a 37% stake, sapped $354 million from 2003 operating profit and is headed for its second management shakeup and restructuring in two years. Daimler insiders say Mitsubishi CEO Rolf Eckrodt will depart and a new team headed by Smart boss Andreas Renschler will "start rebuilding Mitsubishi from scratch." A thorough overhaul may be needed: "Mitsubishi has been an absolute catastrophe," says one London-based analyst.

Another unexpected drain on cash: The failure of Daimler-Chrysler's 45%-owned joint venture Toll Collect to meet its contractual deadline to build a highway toll-collection system for trucks. DaimlerChrysler already took a charge of $252 million in 2003 for running losses, a write-down, and expected penalties for delays. Earlier this month, the German government canceled the contract. Toll Collect now has six weeks to meets it obligations or pay indemnities for its failure to deliver the system. The toll-collection debacle could cost DaimlerChrysler anywhere between $100 million and $1.3 billion in penalties in 2004.

DaimlerChrysler's $35.3 billion commercial-vehicles division was the sole bright spot in 2003. It had an operating profit of $1.1 billion, turning around several years of steady losses, including a $432 million loss in 2002.

Investors have been patient with the stock. It closed at $45.49 on Feb. 23, well above its 52-week low of $26.27 and not too far from its high of $49.85. But what really hurts is the stock is still trading at less than half its post-merger high. As the payoff from the merger seems increasingly elusive, investors might become more inclined to switch gears than put the pedal to the metal.

Edmondson is a correspondent in BusinessWeek's Frankfurt bureau

Edited by Patricia O'Connell

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