In autumn 2008, as financial institutions began to crumble and thousands of bankers took their places in the dole queue, premium car brands braced themselves for the inevitable. The logic was simple. In hard times people cut back on unnecessary spending and, as luxury car-makers found out, their product is “the poster child of discretionary spending”, says Stefano Aversa of AlixPartners advisory firm. Premium car sales “fell off a cliff”, says Trevor Finn, CEO of Pendragon, a UK retailer with a specialist luxury outfit.
Yet luxury cars have enjoyed “an aggressive V-shaped recovery”. While “it was the first [sector] to go into the recession it has been the first out”. In fact, luxury car-makers are on course for one of their best-ever years. In the first six months of this year, BMW’s global sales rose 13%, while worldwide sales for Mercedes-Benz and Audi rose 15% and 20% respectively. Indeed, according to Audi CEO Rupert Stadler, the biggest challenge lies in scaling up production.
But with the US teetering on the brink of a double-dip recession and the eurozone besieged by a sovereign debt crisis, surely these sales won’t last? Well, we might be surprised. As Daniel Gross notes in Slate, “when the economy slowed dramatically in late 2008 and early 2009 [American CEOs] prepared for Armageddon: they slashed costs, restructured, made cold and swift decisions, and relentlessly pursued productivity and efficiency”. As a result, “corporate profits have largely recovered to pre-crisis levels”, while employment and wages have fallen. This has turned the US consumer story into “a tale of two cities in 2010”, says Greg Farrell in the Financial Times, with “an entire segment of consumers splurging confidently on the finer things in life, while another segment, concerned about unemployment and with little or no discretionary income, spends only on bare necessities”.
As a result, US premium car sales have picked up, even as mass-produced sales look far weaker. TrueCar.com reckons that combined new car sales for the top six exotic luxury brands are up 16% in the first seven months of 2010.
While not at pre-crisis levels, it’s a significant recovery. Another reason for the rise is growing demand from emerging markets. In China, which overtook the US as the world’s largest car market earlier this year, annual luxury car sales have risen from 98,000 to 550,000 in the last five years. That is still less than half the US figure and should grow as the Chinese economy expands.
Unlike other sectors, where local manufacturers dominate, foreign car-makers are cashing in. For example, BMW and Mercedes-Benz doubled their sales to China in the first half of 2010, while Audi sold nearly two-thirds more cars. With China yet to produce a luxury car manufacturer, the established brands look secure for the forseeable future. Chinese demand for these cars is not just about economics. By way of events such as the F1 Grand Prix, the motor industry is working hard to create a culture of motor sport enthusiasts. Porsche has even built a Chinese test track for potential customers in a bid to sell the driving experience of their cars.
There is no doubt that luxury cars will face challenges in the future. Urbanisation, rising energy prices and environmental concerns will affect demand for large, high-performance cars. The most successful firms will be those that create cars that rise to those challenges while still fulfilling the demand for prestige and quality. We look at the best bet below.
The best bet in the sector
As the only listed car manufacturer devoted entirely to premium cars, BMW (GY: BMW) offers the best pure play on the sector.
Careful inventory and labour management helped the firm survive the crisis without posting a loss, while sales are roaring in 2010. Second-quarter sales beat analysts’ expectations and the company is likely to return to pre-crisis sales volumes by the end of the year. Furthermore, JP Morgan Cazenove analyst, Bernard Donges, expects operating margins to improve as “the product cycle has yet to fully ramp up”. The company’s comprehensive offering, ranging from stately Rolls-Royces to more affordable Minis, gives it exposure to every part of the luxury market. BMW is also bringing an all-electric premium car to the market. The “Megacity Vehicle” will launch in 2013 and shows the firm’s ability to adapt to changing consumer patterns.
Last week a technical fault forced the recall of around 340,000 cars around the world. The stock slid by 6%, and while the glitch represents an embarrassment for the firm, it is also a good buying opportunity for investors. On a forward p/e of ten, the proven management team and good growth prospects mean BMW looks good value.
• This article was originally published in MoneyWeek magazine issue number 507 on 8 October 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don’t miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.