Mercedes-Benz Group AG

XETRA:MBG

Earnings Call Transcript 2022-Q3

[Steffen Hoffmann, executive]

Good morning, ladies and gentlemen. This is Steffen Hoffmann speaking. On behalf of Mercedes-Benz, I'd like to welcome you on both the telephone and the Internet to our Q3 results conference call.

We are very happy to have Harald Wilhelm, our CFO, with us today. In order to give you maximum time for your questions, Harald will begin with an introduction directly, followed by a Q&A session. As always, the respective presentation can be found on the Mercedes-Benz IR website.

And now I'd like to hand over to Harald.

[Harald Wilhelm, executive]

Thanks, Steffen, and good morning. Hello, everybody, to the Q3 call here. In the interest of time, let's jump right away into the topics.

So what is the key takeaway on the third quarter? We demonstrated that we can sustain our performance from the first half of the year that our business has become more weatherproof in a difficult environment. You could see robust demand across all the segments. We were able to increase sales while remaining constraints in the supply chain on the semi continued. And on the basis of the solid financial performance of the first 9 months, we set the pace for an increase of the full year guidance.

If we look into the numbers and the group numbers in Page 3. Well, with the higher sales, obviously, higher revenues, a significant increase in the group EBIT to EUR 5.2 billion, cash flow at the same level of EUR 3 billion. I'll come back to that a bit later, and the NIL is at a healthy EUR 23 billion.

On the highlights on the cars, Page 4. First, on the product side, on the top end, I mean, obviously, a very important addition with the EQS SUV, great feedback from the market with the sales in Europe and the U.S., which started, and very good response, I mean, on that vehicle. Also in the top end, we have the first eSUV from Affalterbach, namely the all new EQE SUV AMG.

On the core segment, the newest addition is the all-new GLC. Let's not forget that this is a very, very solid pillar in our core luxury segment and also a very important margin contributor in the future. Also in the core, we could see the world premiere of the full BEV EQE SUV 10 days ago in Paris.

On profitability, we could sustain the healthy margin, which we had, I mean, year-to-date in the half year, basically in the third quarter, thanks to healthy mix and pricing. More on that a bit later.

On the market and the performance side, we could see robust demand in all markets despite the volatility supported with a high backlog. In the U.S. and overseas, very healthy demand level. In Europe, continued good demand, mainly driven by pent-up demand, with longer order backlog carrying us into the next year. And in China, we continuously perform well on a very high level. This is true for pricing, mix and volume. Continuous situations of lockdowns obviously do not help consumer sentiment. But sure, we keep looking at this development very, very closely.

And a quick word on the semi. All the situation is easing, but we're still not happy with the overall, I mean, situation in terms of stability, reliability of the supply. And we expect that shortage to stretch into 2023.

On partnerships, we signed MOU with the government of Canada to secure electric vehicle raw materials. Next to that, we also signed an agreement with Rock Tech for delivery of average 10,000 tons annual supply agreement on lithium for our BEV acceleration.

On Page 5, I mean, if you look a bit more closely at the top end and the BEV segment, a reminder, last year, in the Q3, we have seen the trough in sales due to the semi shortage. Due to the very limited chippers availability back then and a pronounced focus on chip allocation towards higher-end portfolio, we had an exceptionally strong mix in Q3 2021. This year, we could even build up on the high top end level from last year's quarter by increasing it by another 5%.

In the top end segment, S-Class deliveries in Q3 were up in all regions, except in the U.S., where temporary model yield certification delays hindered the deliveries. Meanwhile, most of the certifications have been given by the authorities. And therefore, we are confident to put these vehicles into the market in the fourth quarter and thereafter.

The EQS continuously is ramping up. The Maybach and the G Wagon and the AMGs continue to be on a high level. At AMG, we could see an increase despite the model year changeover of the new AMG C-Class.

And in the core luxury, the growth was mainly driven by the GLC launch, the C-Class and now the EQE. And also in the entry, we had good momentum supported by the EQB.

So overall, xEV sales increased by 39%, with a BEV almost doubling in terms of the units and the plug-ins having very good market acceptance in China. PHEV and BEV sales are still impacted by chip supply constraints. And very important, obviously, the margin side of things where we see healthy margins on the whole portfolio of our BEV from the EQS to the EQE, but also on the EQA and the EQB.

Let's have a look on the Mercedes-Benz Cars financials. I'm in Page 6. Sales revenues, ASP and EBIT are up. Sales were 38%, with a higher proportion of locally produced units in China where we grew, in particular in the core segment, mainly in the new C-Class, so the GLC and the E-Class segment. Therefore, the revenues increased strongly but slightly less, i.e., 26%. ASP up to EUR 75,000 driven by strong structure and pricing, and that is EUR 5,000 higher than in Q2 this year.

And talking about ASP, as part of our strategy, we continuously work on our value proposition to the customers in all segments. Latest example is the newly released facelift of the A and the B-Class, which demonstrates a significant entry point value uplift in this segment as well.

EBIT adjusted more than doubled to more than EUR 4 billion. CFBIT at EUR 3.6 billion. How did we get there on the margin side, Page 7, to the 14.5% return in sales. Well, I mean, the bucket volume structure net price increased significantly by almost EUR 3 billion. About half of that is volume and structure, half of that is pricing.

Net pricing combining, again, further reduced the discounts and the list prices, but increased, as we said, in Q1 and Q2. The mix remains very healthy with the addition of the EQS SUV, AMG and SL sales.

FX, slightly positive, mainly from the U.S. dollar and Chinese yuan. Industrial performance is mainly on higher raw material costs and onetime commodity charges. The raw material costs were still on elevated level in Q3 on steel despite declining spot rates due to our longer-term contracts where it takes some time until they roll through.

Additionally, we see increases on the lithium. On the selling expenses, we see slightly higher marketing expenses, volume-induced higher selling expenses and agent remuneration costs from the new direct sales model in Austria, New Zealand, Australia and India.

In line with our full year guidance, we see higher R&D costs for our future platforms and technologies versus last year. The other bucket is mainly driven by the higher ad equity contribution from BBAC. So with that overall, 14.5% return on sales adjusted.

On the cash flow side, Page 8, how did we get to the EUR 3.4, respectively, 3.6 CFBIT. Well, the working capital impacted slightly negatively with EUR 0.4 billion. As we said during the Q2 call, our priority was on bringing down -- on bringing the position of semi-related unfinished products down. The teams overall managed as well. You see the unfinished goods bucket improving by EUR 700 million in the quarter.

The new vehicle stock position has increased. What does it mean? Some of the rework cars are still on the outbound logistics change on the way to the markets for handover to the customers in the fourth quarter.

In the new vehicle stock, we see an increase in heavy vehicles in the so-called long logistic chains being shipped to overseas market and customers, namely GLE, GLS, S-Class, EQS. And on the S-Class, most of them are waiting for the new model year certification, as I mentioned before. So the priority for the Q4 is now to bring the inventory to a lower level.

The Q3 working capital headwinds from the new vehicles inventory are partially compensated by better receivables and payables. The net financial investments, which were close to EUR 200 million, are mainly related to the sale of own retail outlets, I mean, in the U.K. Overall, the net investments in PPE and intangible assets, equal depreciation, amortization and impairments. Again, the other line includes the reversal of the BBAC equity result.

On the van side, a pretty good quarter actually on the performance. We look at the sales side, significant, I mean, increase year-on-year, with a strong growth, in particular, in the privately positioned vans despite semiconductor shortages. On the profitability side, a strong margin with a healthy mix enterprising, overcompensating cost inflation and raw mats. And on the market side, we see robust demand in key markets, in particular in China, with more than 50% growth versus prior quarter and also good momentum in Europe.

On partnerships, very important for the van business. We signed the MOU with Rivian for the joint production of a fully electric van in Central Eastern Europe to further accelerate our EV strategy and also to ensure competitiveness in the price-sensitive van segment. In this context, we plan to reorganize our production network for large vans in Europe.

On the financials of the van, Page 10, sales up 18%. Revenues increased 22%. So here, you can see that this is even more pronounced on the revenues. EBIT at EUR 500 million, and cash generation also very healthy at EUR 500 million.

Again, how did we get there? Page 11. The volume structure pricing bucket plus close to EUR 600 million, significant, I mean, increase in volume, but also mix and net pricing. In particular, the sales of Vito, V-Class and Sprinter increased notably. Among all markets, China contributed strongest.

And on the pricing side, discounts could further -- could be further reduced versus last quarter. FX development also favorably mainly from the dollar. And overall, I mean, on the gross profit side, which is positive on the industrial performance, as we could see on cars, we see the higher raw material prices and supply constraint-related logistics costs. Further, we have decreased research and development cost versus last year's quarter. And same on the other bucket, we see an increase on the SPAC at equity result. With this, a healthy 12.7% return on sales adjusted at van.

And also on the cash side, Page 12, that has been well, I mean, converted into cash flow. Working capital, you see a black 0. Minor increase of new vehicle stock has been offset by trade payable development. The depreciation, amortization and impairments are lower than the investments in PPE and intangible assets as we are progressing towards the then EA and the electrification of the van business as well. The bucket is a reversal of the [indiscernible].

Page 13 on the mobility. Key messages, again, in that quarter, the supply constraints continue to impact the new business volume. So we have a bit of a lower penetration ratio also due to increasing competition in financial services business as well as increasing interest rates. Solid used car prices and inflationary developments currently motivate also some customers to prefer cash buy over a lease.

Increase in interest rates currently put some pressure also on the interest margin. On the net credit losses, I mean, they remain low supported by currently strong used car prices, but weakening macro results led to an increase of the cost of credit risk.

Overall, we are protecting our margins and strive to pass on the increase in interest rates to our customers in this competitive environment. Furthermore, same as with cars and vans, we focus on profitable growth and high quality of our portfolio.

On the financials, Page 14, as I said already before, the new business, I mean, decreased by 3%, also due to the spinoff of some remaining truck business. The portfolio overall increased by 2%, but that is basically due to the FX, and the EBIT adjusted decreased versus the exceptionally high level, I mean, last year, which I would like to explain on Page 15.

So I mean let's bear in mind that, I mean, the last year's quarter and the previous quarters probably a bit unusually favorably elements in there. So now, I mean, this quarter, the return on equity has been at a lower level, but I would call that, a more normalized run rate level at a healthy 16% return on equity. Why that? Higher cost of credit risk, which we provisioned, a bit of lower volume, some pressure on the interest margin and also an adjustment, which we did on our participations in a more challenging market environment, which is included in the other bucket.

On the positive side, we could lower our G&A and saw a bit of a tailwind also from the FX side. As I mentioned before, we expect the performance in 2022 to remain strong, but more on a normalized level, call it, I mean, a run rate level for mobility as we guided already since the beginning of the year.

Looking at the group numbers, Page 16. We explained the business side, if I may say. So what's left, the recon is positive mainly due to the equity result from Daimler Trucks, which is partially offset by depreciations of assets from the PPA. EBIT adjusted is at EUR 5.3 million, adjustments on mainly diesel. And with this, I mean, the group EBIT is booked at third quarter at EUR 5.2 billion, which translates into a year-to-date EBIT of EUR 15 billion and an EPS of almost EUR 10 over the first 9 months of the year.

Also I'd like to give you a short update on Russia at this stage. The group intends to withdraw from the Russian market and to sell the shares in the Russian subsidiaries to a local investor. Final completion of the transaction is subject to the authorities' approval and the implementation of the contractually agreed conditions. From today's perspective, it is not expected to give rise to any further significant effects with regard to the group's profitability, cash flows and financial positions beyond those reported in the previous quarters, hence, no impact in the Q3 figures.

On the cash flow side, Page 17, we explained as well, I mean, the business side. So what's left, income taxes at close to EUR 900 million. As flagged earlier, cash taxes are going up significantly this year. Reasons for that, higher earnings and lower tax loss carryforwards.

The other recon, at about 180, which is some centrally processed onetime payments. With that, the free cash flow of the industrial side is at EUR 3 billion. The adjustments are mainly on the diesel side with close to 300.

Looking at the NIL, Page 18. The net industrial liquidity increased to EUR 23 billion by the end of this quarter from '19 by the end of the last quarter, Q2, obviously, with a free cash flow of EUR 3 billion, but also in the other bucket, some FX effects and dividend distributions from Mercedes-Benz Mobility and some capital decreases at MBM.

So all in all, I think, again, it's good to have such a healthy liquidity position in volatile times. And you heard me say during the Q2 call that this gives us optionality going forward.

Now probably the even more interesting part, the outlook, Page 20. On the divisional guidance, please read the assumptions charts carefully. It's the same as in Q2. Since the macro environment has not fundamentally changed within the past quarter. The assumptions are still covering our macroeconomic and geopolitical uncertainties, including situation in Russia and Ukraine, the overall inflationary pressure, increasing interest rates, the supply chain bottlenecks and also the still ongoing uncertainties related to COVID lockdowns in China.

Especially in those volatile times, one is well advised to have all sensors and early warning indicators activated. We are vigilant and ready to act quickly, if necessary. Production planning and sales planning go hand-in-hand. We have shown every quarter since the start of COVID how to do this.

Despite the macro risk, we continue to see healthy and high-quality demand for our products. This healthy demand is driven by our strong product portfolio. What does it mean for our cars' guidance? We continue to see the full year sales slightly above last year, and we continue to see demand being above supply. We expect Q4 sales above Q4 last year.

On the return on sales adjusted, so far, year-to-date, we have managed to sustain a very strong 15% return on sales adjusted. It remains our ambition to continue with the year-to-date run rate. This also means that price and mix expected to stay on a high level and that we continue to -- on improving the cost base.

We now lift our guidance for return on sales adjusted for the full year to 13% to 15%. This range would imply that for return on sales adjusted in the fourth quarter, we see an upside of around 1% ROS versus year-to-date ROS on volume revenue quality. The downside of minus 1% ROS versus year-to-date return on sales are due to onetime commodity charges and some raw mat. And thirdly, with respect to the current macro uncertainties, we remain prudent and continue for Q4 to assume a well familiar market environment protection of around 2% ROS.

The cash conversion rate for cars remains unchanged between 0.8 to 1, and PPE and R&D remain unchanged. On the van side, sales remained slightly above 21. So unchanged on this. But on the profit side, on the return on sales side, we are lifting, I mean, the guidance to a range of 9% to 11%. What's the rationale for that? Well, obviously, with the year-to-date at 11.8%, we aim to keep this year-to-date run rate also for the full year. However, comparing Q4 with year-to-date, we see a downside of minus 1% return on sales versus year-to-date on mix and revenue, a downside of up to 2 on increasing material and logistic costs and also a general market risk protection as in cars.

PPE, R&D, unchanged. On the cash conversion, based on the strong year-to-date performance, we're lifting that to 0.8 to 1. And at Mercedes-Benz Mobility, no change in the guidance at the run rate of 16% to 18% return on equity.

So on the group KPIs, Page 21, I'd like to remind you that we compare here the group KPIs versus the 2021 continued operations setup. So how do they look like for 2022? No changes in revenues on the group EBIT with a year-to-date EUR 15 billion in the 9 months. And our increased return on sales guidance at cars and vans, which has been pretty obvious that we now increased the expectation for the group EBIT by one notch to significantly above prior year.

Free cash flow on the industrial business remains at prior year level. We see it, however, at the upper end of this range. How do we look at that? As flagged at the beginning of the year, cash taxes are significantly higher. Furthermore, we work proactively with higher safety stocks for some potential gas shortages and also the semi-conductor shortage. Additionally, the restocking of the outbound supply chain influences our working capital until the year-end.

On the emission side, on the EU CO2 emissions, we now see a slightly above prior year level. I mean, why that? Some of the delays in production resulting from the constrained supply chains. And the limited availability of semis impacted, I mean, the ramp-up on the BEV. As in 2021, we impact -- we expect to meet the CO2 emission targets also in 2022.

So let us conclude on the strategic priorities, which we set out at the beginning of the year. I think quarter-over-quarter, and again, this third quarter, we're making good progress, I mean, on all of them. We're scaling the BEV year-to-date, close to 160% with EQS SUV. As I mentioned before, the EQE launch and all of the 8 portfolio positions, which we have on the BEV side.

We have strong growth expectations. I mean for the full year, we see the xEV sales to increase by more than 20% compared to 21% on a full year basis. And the increase is coming mainly from the BEV side, which means that in 2022, every second xEVs sale will be a BEV, that was every third in 2021.

On the luxury side, we continue to grow our top end vehicle sales single digit, I mean, this year, impacted by the shortage and the limitations on the supply chain, the semis. But we are very happy with the latest product additions to the family, like, I mean, the EQS SUV, but many of the others I mentioned already during the call. And we are well on track to develop, I mean, that very important segment further.

We're also accelerating on the software side. We will give a capital market update on our software strategy on February 21, I mean, next year. So we have moved this event to sunny California in the U.S., and we want to show you some real cool stuff, I mean, over there, not just slides. So I would really appreciate if you could pencil, I mean, that date down in your busy diaries so that we can have a cool session altogether over there in California.

On the supply chains, we see the constraints to continue. But at the same time, we make progress and we work hard on structural changes such as deep sourcing and direct sourcing. I mentioned lithium with the MOU with Canada and Rock Tech before, but we're also doing that, I mean, in other areas of the supply chain and the commodities to make that a more stable and resilient place in the supply chain. And needless to say that we continue the focus on the cost side. Despite the inflationary elements, which we see all over the place, we keep our targets as we communicated them before. And you see the results of that in the third quarter and in the uplift of the guidance.

And with this being said, we are now happy to take your questions.

[Steffen Hoffmann, executive]

Thank you, Harald. [Operator Instructions] Now before we start, the operator will again explain the procedure.

[Operator]

[Operator Instructions] The first question is from Patrick Hummel, UBS.

[Patrick Hummel, analyst]

I would like to talk a little bit about how you maneuver through the coming months and quarters. You said semi supply is easing. You say it's still a constraint into next year, but we hear from everywhere that the situation is improving pretty fast. So I'm wondering how you actually manage production in the coming months?

I'm trying to tie that into the order backlog situation, which probably also stretches well into next year. But you certainly need to make sure you don't overproduce so that you can sustain your pricing power and your price over volume strategy. So if you can just talk a little bit about how you navigate this very challenging environment with some visibility, thanks to the backlog, but a lot of macro uncertainty at times of improving supply?

[Harald Wilhelm, executive]

Yes. Thank you, Patrick. Well, on the fourth quarter, you heard me saying that we see, in the fourth quarter, above fourth quarter, I mean, 2021, as we are already more or less 1/3 of the fourth quarter behind us, I think we should have pretty good visibility, meaning this respect.

Then if we look into 2023, well, this is a Q3 call, we'll not give our guidance for the full year of 2023. But rest assured we permanently each and every week look at the demand side of things. As I said just before, we still see constraints on the semi side, which somehow constrains the -- unconstrained demand.

And then consciously, we adjusted compared to the free demand to make sure that we were not putting too much of a material into the market and permanently manage this matching between the sales and the production so that we are not sitting on too much material. So that is a permanent process.

So usually, at this point of the year, you do your operational plan. But I would rather say that is just a picture, a snapshot. And we work then, obviously, with scenarios, and we adopt each and every week in our operational meetings to the demand, which we see.

As we speak, however, let me be clear, we see a good level of demand in Asia and China. We see a very good level of demand in the U.S. The backbone of all of that, obviously, is a very strong product portfolio I emphasized during the intro. And in Europe, we also see a good level of demand supported by a healthy and strong backlog, which takes us well into 2023.

So this is what we see today. But for sure, we'll have plenty of opportunities to touch base for further insights into 2023.

[Patrick Hummel, analyst]

And is there any difference between the top end luxury and entry level in terms of visibility and the length of the backlog?

[Harald Wilhelm, executive]

Well, I just mentioned Europe. In Europe, we have a strong backlog across all segments. Almost obvious to state that given the prioritization we have been doing in '21, in '22, again, there's a pretty strong backlog also on the entry luxury segment. And we'll then see, given the production constraints, the semi situation for 2023, how we're going to prioritize for 2023. But globally, definitely, we give priority to the top end as we definitely want to grow that further in all of the markets. But in particular, with the additions in the top end luxury, we see a strong demand at that end.

Also in the core, with GLC and C-Class and EQE, so that's something we sometimes tend to forget a bit that there is this very healthy and important core segment with strong portfolio positions growing.

[Steffen Hoffmann, executive]

Thank you, Patrick. And we continue with Tim Rokossa from Deutsche Bank.

[Tim Rokossa, analyst]

It's Tim from Deutsche Bank. A little bit into Patrick's direction as well because I think that's obviously what people wonder about -- thinking about the environment you're heading into and giving us confidence that you can continue to do so well. You still have the 2 percentage points macro buffer in your guidance. One could argue macro is really not good right now. Yet, you didn't have to draw on it. What specifically went better than you see it? And why do you feel you still need to keep this buffer given that you're basically going to [indiscernible] into the winter holidays in 6 or 7 weeks from now?

[Harald Wilhelm, executive]

Yes. Thanks, Tim. Well, let's make a quick check on what we said in Q2. In Q2, I think we said in the third quarter and the remaining of the year, we should see a good continued run rate momentum. However, some more raw mats, a bit of higher R&D, a bit maybe of used, the latter one did not materialize, the first 2 materialized. And overall, given this unprecedented macro volatility and uncertainties and the geo on top of it, we put the 2% risk protection contingency.

Well, you can see with the Q3 results, that obviously, we did not make use of that risk protection and contingency. And that is exactly the way we take it now, forward also for the remainder of the year. As I said, we see healthy demand, mix pricing, volume was a plus 1 for the first quarter.

We see the raw mats and some commodity charges with a minus 1 in -- compared to year-to-date run rate of 15 and then a 2% -- you could argue is that 1 or 2 or 3, but we feel, I mean, 2 is appropriate at this stage. If we can do without, obviously, I think we're all happy. If some unforeseen happens, I think we are protected. That gives you, I think, comfort and our sales as well.

[Steffen Hoffmann, executive]

Thank you, Tim, and we continue with Horst Schneider from Bank of America.

[Horst Schneider, analyst]

Harald, I want to start my question basically with the quote that the Renault CFO made in the Q3 call. He said those carmakers, which generate double-digit EBIT margins, should compensate suppliers for higher costs. I'm sure you love this statement. In that context, on industrial performance, I mean, we see an ongoing high burden. You outlined a little bit why that is. But could you maybe specify this onetime commodity charges?

And could you maybe tell us, because you have got for that by now are seeing pretty good visibility also already in 2023, when this line industrial performance finally turns positive or can it at all positive or will higher raw mat costs be just replaced the higher personnel costs next year that industrial performance continues to remain a stronger burden?

[Harald Wilhelm, executive]

Yes. Thanks, Horst. Please accept that I will not comment on that quote. And what we're doing, I think, is to work in partnership with the supply chain. We have contractual arrangements, which need to be honored, I think, on both sides. But on the other side, we have -- I think we take a fair look into the situation. And if we need to do something, we are ready to do.

So what is behind the commodity charges in the bridges we explained obviously is higher cost, I mean, when it comes to semi. I think that's the vast majority of that one. Over time, I agree with you that should come down with lots of these actions we're taking, including direct supply and the deep sourcing.

We're investing into that, and it should have some return. So over time, I think we should see some easing of that, but I would caution that this is already very material in 2023. As I said, the semi constraints probably will stretch into 2023.

On the raw mat side, yes, we see the spot coming down in some of the commodities. Still, it takes some time until it rolls through our contracts. So we could see, in some commodities, some easing. On the other side, on battery materials, on lithium, we see a continued high level. So at this stage, I therefore, don't want to give any indication for 2023 whether the industrial performance bucket is going to be green or red. One thing seems to be, for sure, cost inflation coming through on top of it, which we want to fight, as I said, and we keep our targets on the fixed cost side. And energy probably will see the bill of higher energy costs also in 2023. As 2022, we were pretty well protected.

2023, by the way, we're also well protected contractually, but we'll see a step-up. So I don't want to frighten you with all of this, but I think we have our hands around all of these commodities. Rest assured that at the same time, we'll keep going on the pricing side, on the top line side to make sure that net-net pricing remains positive. That's what we demonstrated in 2021, in 2022, with a very, very material step-up in raw mats if we take the 2 years together. And definitely, we wanted that moving forward to 2023.

Maybe then beyond 2023, there is an opportunity opening up for some further easing. In particular, if we're moving more into a recessionary environment, one could expect that these commodities can normalize to lower levels.

[Horst Schneider, analyst]

Just a quick follow-up. When we look at the EUR 1 billion negative number in industrial performance in Q3, could you maybe indicate what's the split between raw material price, supplier pass-through and this onetime charge that you have taken?

[Harald Wilhelm, executive]

I would say the vast majority is on the raw mat side, which by now is definitely higher than what we expected at the beginning of the year and also a year ago. But as I just said before, we were able to offset that by net-net pricing. And again, we'll continue to do so.

[Steffen Hoffmann, executive]

Thank you, Horst. And the next gentleman line is George Galliers from Goldman Sachs.

[George Galliers-Pratt, analyst]

I had a question on pricing. I think on the call, it sounded as if the price increases you took in the -- earlier in the year actually started to flow through the P&L in this quarter. Is that correct? And as a result, do we see that continue over the coming 9 months?

And then when we think about pricing, where are you seeing the greatest improvement? Is it in the top end luxury? Or is it on the core and entry-level luxury vehicles at this point?

[Harald Wilhelm, executive]

Thanks, George. Yes. I mean we commented that in spring, there was another price increase on top of the one in fall last year. For sure, that is coming through now on a run rate in 2022. But it's only one element of all of the levers we're doing on the top line side.

Discounts continued to come down to even lower levels, which I think in the current environment, I mean, it's pretty remarkable. So I would say it's a kind of a proof or -- of us approaching markets differently, more cautiously. But in particular, I think it's a testimony of the strong product substance.

And now, all of the new models coming into the market, are positioned or have been repositioned them in terms of pricing, not just doing a price markup, but they offer a lot of substance and value to the customers. Look at the GLC, probably if you look at the exterior, you might not see even so much of a difference. If you look under the hood, under the software, under everything, you will see it's a lot more.

And that's basically what applies to each and every of the new product additions that we could step up, the pricing of the vehicles materially. And altogether, therefore, the price escalation year-on-year, the discounts and the price positioning of the vehicles are contributing to the healthy price environment. And that goes all across, I mean, definitely on the top end side with the EQS, EQS SUV, the SL, but also the GLC, the EQE. And in the intro, I also mentioned even the entry luxury, with the A and B and the facelift of these vehicles where we have a price step up.

[Steffen Hoffmann, executive]

Thanks, George. And we continue with José Asumendi from JPMorgan.

[Jose Asumendi, analyst]

It's José from JPMorgan. Can you please comment on the at-equity contribution from your Chinese business into the profit bridge? They came very, very strong in the third quarter. So how do you see that holding into the fourth quarter? Can you provide more color with regards to the improvement year-on-year? And can you remind us a little bit around the maybe localization of vehicles that you want to produce in China?

[Harald Wilhelm, executive]

Yes. Thanks, José. The at-equity result, I mean, of BBAC in the third quarter was a very healthy and strong with close to EUR 600 million improvement. Let's bear in mind that quarter 3 2021, we had to go pretty much on the brakes, I mean, in that quarter given the semi constraints at the point in time. All in all, yes, a very healthy profitability level in the JV.

I think on the full year, we provided some color in terms of the financial KPIs of BBAC, in terms of profitability, balance sheet. We're not -- we don't need to be shy. So we like the contribution, which is coming from that side. And on top of that if you look on the CBU business, obviously, this is doing very well in the market in China, great acceptance of the products, healthy margin. So all in all, I think a solid contribution coming from China.

[Steffen Hoffmann, executive]

Thanks, Jose. And we continue with Stephen Reitman from Societe General.

[Stephen Reitman, analyst]

Understand the rules in Germany are changing next year on eco-bonuses relating to supply in hybrid vehicles and they will no longer qualify for the eco-bonus, and it will be reduced on electric vehicles. Can you talk about how you're planning in terms of accelerating the switch on the [ EV ]?

[Harald Wilhelm, executive]

Thanks, Stephen. it got -- was an echo, but I hope I get it right. Your question refers, I think, to the incentives. I mean in Germany, well, I mean, our take on that one is that purchase incentives are -- on plug-ins are lowered or taken away. However, a very important one on the plug-ins is, I think, the fiscal regime or the taxation rules.

So without giving you a lecture on this one, but we understand that they are maintained, which means that basically, it's half of [ a nice ] in terms of taxable income, and that makes the plug-ins being -- continuously to be very attractive also in 2023 as lots of the plug-in fleets are also, I mean, on corporates and company fleets.

So I mean we, therefore, see continued strong demand, I mean, for plug-ins in Germany also in 2023. And on the BEV, I think, I mean, the incentives are maintained as per my understanding.

[Steffen Hoffmann, executive]

Thanks, Stephen. And the next gentleman in line is Harald Hendrikse from Morgan Stanley.

[Harald Hendrikse, analyst]

Back to sort of price/mix, really, which is, I think, the main occupation of most investors. If I look at the volume price/mix, there's another incredible quarter with nearly EUR 3 billion contribution year-over-year from volume price/mix. In the past, you've given us a little bit of a split between the volume price/mix. If I look at it in Q3 this year, you've had 150,000 units more sales. Whereas in last quarter, you had 1.5 billion contribution there, but you had lower sales.

So it looks to me like the overall volume contribution to volume price/mix is much, much bigger. And I was obviously wondering what that means for the mix/price contribution quarter-on-quarter. And considering the comps on pricing are obviously getting more difficult in the fourth quarter, can you just talk about not so much the level of pricing, which is obviously incredibly robust, but how do you see that -- do you see further upside in terms of pricing? And what sort of percentages should we look for?

And then lastly, on leasing, we've spoken to some of the U.S. dealers in the last month or so. And obviously, lease prices have gone up very, very substantially for expensive cars, $500, $600, $700 a month. How are the consumer reacting to that? Are they still as keen to buy? Or are they buying smaller cars? Or are they actually spending that extra $600 or $700? I'd love to hear your comments.

[Harald Wilhelm, executive]

Thanks, Harald. Well, I think I commented that the EUR 3 billion bucket is about half of it, volume and structure, and half of it is net pricing. Well, I also said, I think the Q3 2021 was extremely strong in terms of mix, right? As -- remember, we had the 380,000 units only. So obviously, we favored all of the top end vehicle. So therefore, to have basically a favorable volume is obvious, but I mean, a structure on top of it, so it's, I think, quite a good achievement in the Q3 2022. And the other half, being pricing, I think I gave the elements before on the discounts on the products and on the year-on-year escalation is a very good achievement. Obviously, in terms of taking that to next levels, more and more and more will be increasingly difficult. So we should not expect the trees to grow into the skies. But definitely we have the ambition to continue the favorable net-net pricing.

On the U.S., on the leasing side, yes, obviously, I mean, we are conscious. We have pricing in the market as we now debated in the questions before. We see the step-up in the interest rates. We are underway to pass them via pricing further on to customers, protecting our interest rate margin. And that means that all in all, I mean, the lease rates are going up significantly.

At this juncture, we don't see a push back in terms of 2 elevated lease rates. We see customers, as I said in the intro of the call, preferring some cash buys, but it's one of the sensors, obviously, we look at carefully, whether there is a point where maybe that level is too elevated and whether that would then impact either sales or pricing. At this stage, we don't see it.

[Steffen Hoffmann, executive]

Thanks, Harald. And we continue with Dorothee Cresswell from Exane.

[Hanna Dorothee Cresswell, analyst]

It's Dorothee Cresswell from Exane. It's actually a slightly longer-term one around IRA eligibility. So can you tell us how you're thinking around IRA eligibility in the U.S.? And perhaps more specifically, I think the lithium agreement you signed with Rock Tech will supply BEV production in Europe. Should we expect you to present a similar plan for battery raw material sourcing in the U.S. in the near future?

[Harald Wilhelm, executive]

Thanks, Dorothee. Well, should I look at the IRA, globally, I think with a strong presence, I mean, we have in the U.S. with the SUVs and Tuscaloosa, we are well positioned in this respect. I do know that, there are some ceilings in terms of price levels. Well, probably given our focus on the top end, we might be above. But then in the principle -- in principle, we are well positioned with our industrial footprint in the U.S.

Rock Tech, as you said, probably is more for the supply of lithium to the European needs. But as we announced earlier this year, we entered into agreement with AESC for local supply of battery cells to the Tuscaloosa facility to the SUVs over there. And there will be an industrial footprint on the sales supply by AESC in the United States. And therefore, I think that should be in line with the IRA regulations. This is sort of thing what we see right now, but beyond that, at this stage, we have no other intention to fundamentally change our industrial footprint.

[Steffen Hoffmann, executive]

Thanks, Dorothee. And we continue with Henning Cosman from Barclays.

[Henning Cosman, analyst]

Maybe one more question on price. I feel like we're dancing around a little bit the real question because into next year, I feel, of course, you're not lowering list prices, of course. So the question is almost what happens to a potential re-expansion in discounts. So I just wanted to ask your comments on if there's a high policy, how you're going to deal with that?

If there are certain high ceiling where you say we don't let them expand beyond a certain level anymore, is there may be other meat on the bone somewhere else in the distribution channel where you expect your partners to be also contributing to a potential incentive re-expansion? Would we be most likely to see it first in lower lease rates? And is there something that you could maneuver? If you could just comment on that or if I may be wrong, and it's not the incentives, and it's something else. But can you keep them under control? Is there a hard policy in place?

[Harald Wilhelm, executive]

Thanks, Henning. I like what you're saying. Definitely, we have not the intention to lower the list price. Definitely, we don't have the intention to step up the discounts. As I said before, in the current difficult macro context, we could further improve in the discounts. So definitely, we want to hold them into 2023.

And if I think about price escalation, probably there's some further room of maneuver in terms of further price escalation. How and when and how much, probably we're not going to debate now on this call. But all of that, suggest to me that pricing evolution overall should still be favorable in 2023 compared to 2022.

What else? Well, we have a very important changeover in the sales and distribution network as we are moving more and more countries into the direct sales model. We now did Australia, South Africa, Sweden, Austria. Next year will be a very, very important year as we will have a switchover of Germany being the largest market, I mean, in Europe. And at least on my side, I do have some expectation that it will give us on top, better control over the pricing and maybe some incremental potential or at least to stabilize the pricing on the key levers I mentioned before.

So that is the game plan and then remains a question what's happening on the cost side, whether the net-net remains positive or balanced. Definitely the ambition is to be at least balanced in terms of net-net.

[Steffen Hoffmann, executive]

Thanks, Henning. And we have time for one more question. The next one goes to Daniel Schwarz from Stifel.

[Daniel Schwarz, analyst]

Just quickly, you increased the EBIT guidance, but not free cash flow. Could you say how structural the higher level of working capital is and for how long? Is that or should we look at it as an opportunity for '23 or rather not? Maybe just in that context, could you say how many S-Classes were affected by this certification bottleneck in the U.S.?

[Harald Wilhelm, executive]

Yes. As I said, we have a model year changeover on the S-Class, and the certification are largely achieved. So these vehicles basically can come into the markets in the fourth quarter. So the bulk of that one should leave the inventory by the end of the year.

So here, we're talking a few thousand vehicles. But overall, we are sitting -- I think I can say that we're sitting on a pretty elevated level of inventory by the end of the third quarter. And definitely, we want to take that to a lower level again. It obviously requires more and more stability, reliability on the supply chain on the semi side. That is the major trigger for the reason why we are at this elevated level.

And to do that, within the remainder of the year, i.e., the remaining 3 months, is pretty tight. And therefore, we might not see the kind of normalization of working capital and inventory level by the end of the year as we would have wished for. As we could do, if you would give me another month or 2 or a quarter, so if you extend the fourth quarter by a month or 2, maybe then the cash flow looks different as well. No, joke aside. But that is the reason why we see not a full conversion of the step-up on the EBIT side into the cash flow.

I would then rather look into 2023 where we need to see that, I mean, we can make the inventory flow supply chain inbound, outbound and smoothen that compared to the bumpy road as we have it in 2022.

[Steffen Hoffmann, executive]

Thanks, Daniel. Ladies and gentlemen, thank you for your questions and for being with us today. And also thank you very much to Harald for answering the questions.

Now, as always, IR remains at your disposal to answer any further topics you may have. To all of you, have a great morning, great afternoon, great evening. And we look forward to talking to you soon. Thank you and goodbye.