DaimlerChrysler Cuts Earnings Forecast on Back of Chrysler Group Woes

Weak New Model Programme Means Profit Warning at Chrysler 

DaimlerChrysler (DCX) has revised its full-year profit outlook on the back of larger-than-expected losses at the Chrysler Group. This decision has led several rating agencies to review their stance on the carmaker, and shares in the company fell 8.3% when the news emerged. DCX has announced that it expects Chrysler to make a 1.2 billion euro (US$1.5 billion) operating loss in the third quarter, and even though the U.S. division will strive to generate a positive operating result in the fourth quarter, the carmaker admits that it will be unable to achieve its previous profit forecast of over 6 billion euro for 2006; it now expects to make an operating profit of about 5 billion euro. DCX stressed that profit development at the Mercedes Car Group, the Truck Group, Financial Services and Van, Bus, and other segments is fully in line with planning.

In July, DCX warned that it was expecting Chrysler to suffer an operating loss of about 0.5 billion euro in 2006 as demand for its current vehicle line-up was predicted weaken, and it was therefore planning to lower production and shipments to dealers. In a statement, Chrysler explained that its losses will more than double in the third quarter because of a difficult market environment in the United States, with excess inventory, non-competitive legacy costs for employees and retirees, continuing high fuel prices and a stronger shift in demand towards smaller vehicles. At the same time, key competitors have further increased margin and volume pressures—particularly on light trucks—by making significant price concessions. In addition, increased interest rates have led to higher sales and marketing expenses. Chrysler Group said that it will make additional production cuts in the third and fourth quarters to reduce dealer inventories and make way for its current product offensive. Nevertheless, following the anticipated loss of 1.2 billion euro in the third quarter, DCX is forecasting that the Chrysler Group will end 2006 as a whole with a loss in the region of 1 billion euro.

Mixed Review from Rating Agencies

Following this announcement, DCX received mixed reviews from rating agencies. Moody's Investors Service immediately downgraded the carmaker's long-term debt rating to "Baa1", the third-lowest grade, from "A3", and warned that another downgrade could follow when it concludes its year-end review as it expects further pressure on the company's profits. Standard & Poor's announced that it was revising its outlook on DCX to stable from positive and maintaining its long-term rating at "BBB", its second-lowest investment grade. In light of Chrysler's profit warning, Morgan Stanley has said that it does not expect evident changes in Chrysler's profitability in 2007, and it has lowered its earnings-per-share estimates 24% to 2.5 euro for 2006 and 26% to 2.8 euro for 2007.

Outlook and Implications

The profit warning highlights a painful reality about DCX. Despite several rounds of restructuring at Chrysler since 2000 and a renewed focus on Mercedes lately, as a whole the group still does not function harmoniously. A weak model programme in the first half and a (predictable) change in customer demand has brought the U.S. division to its knees, shortly after having made a welcome profit in 2004 and 2005. At least the Mercedes Car Group is showing evidence that it is back on the growth path, and this should be sustainable.

Undoubtedly, Chrysler is highly reliant on the U.S. market and is not immune to the problems faced by other domestic carmakers. Given the size of the division's manufacturing operations there, it takes a little longer than most rivals for it to steer the company towards new segments when market conditions change. However, DCX's operating profit potential is also perennially plagued by the cost of ongoing restructuring measures. For 2006, DCX reiterated that it will have to book a number of special items, such as charges related to the implementation of the new management model (0.5 billion euro), the focus on the Smart ForTwo (1 billion euro), the staff reductions at the Mercedes Car Group (0.4 billion euro), as well as incurring a reduction in profit caused by the re-evaluation of its stake in EADS.

Chrysler's pessimistic view of its future operating profit development also comes after the carmaker failed to secure healthcare cost cuts similar to those granted by the United Auto Workers (UAW) union to General Motors (GM) and Ford. DCX's announcement that it expects significant production cuts in the third and fourth quarters of the year may indirectly increase pressure on the UAW, although the carmaker does not plan any job cuts for the time being. Instead, Chrysler wants to highlight the good performance of the group's other divisions and actions taken to capture growing demand for more economical vehicles with its Chrysler brand. In the second half of the year, the Chrysler Group will introduce a total of eight new vehicles, of which many are in the growing small-vehicle segment. Like the Dodge Caliber, which was launched in the second quarter of 2006, the Jeep Compass, Jeep Patriot and the new Chrysler Sebring are equipped with the fuel-efficient, 2.4-litre, four-cylinder engine. In addition, the Chrysler Group will launch the smallest Dodge sports-utility vehicle (SUV) in history, the Dodge Nitro, as well as an all-new version of the quintessential Jeep Wrangler.