Mercedes-Benz's Margin Compression: A Harbinger of Systemic Risk in Global Auto Exports

Mercedes-Benz Group AG's Q2 2025 financial results have become a focal point for investors scrutinizing the fragility of global auto sector valuations. A 68% drop in EBIT to €1.27 billion and a 56% decline in adjusted EBIT for its Cars division—despite stable cash flow—signal a systemic shift in the industry's profitability model. This collapse, driven by U.S. tariffs, China's EV dominance, and margin compression, is not an isolated incident but a harbinger of broader risks for multinational automakers.

The U.S.-EU Trade War: A Tariff-Driven Profitability Crisis

The July 2025 U.S.-EU trade deal, which imposed a 15% tariff on EU car exports to the U.S., has reshaped the competitive landscape. While this rate is a 27.5% reduction from previous threats, it still represents a significant burden for European automakers. For Mercedes-Benz, the impact was immediate: its Cars division saw a 5.1% return on sales, down from 10.2% in 2024. The Vans division fared worse, with a 10.4% return on sales versus 17.5% in the prior year.

The ripple effects extend beyond Mercedes. Volkswagen reported a 29% drop in second-quarter operating profit, with tariffs costing €1.3 billion in H1 2025. BMW, meanwhile, is investing $1 billion to retool its Greer, South Carolina plant for EV production—a costly nearshoring move to bypass tariffs. These strategies highlight a sector-wide pivot toward localized manufacturing, but the capital expenditures required (often exceeding €1 billion per plant) threaten long-term profitability.

China's EV Dominance: A Dual Threat of Scale and Cost

China's electric vehicle (EV) market now accounts for 70% of global production, with domestic OEMs capturing 80% of domestic output. BYD, Geely, and NIO have leveraged government subsidies, low-cost battery production, and aggressive export strategies to undercut Western automakers. For Mercedes-Benz, this means a 20–22% EV share in 2025—a target that pales in comparison to BYD's 27% domestic BEV market share.

The competitive pressure is evident in margins. Chinese EVs like BYD's Dolphin model sold in Europe for €32,400, undercutting the Volkswagen ID.4 at €37,400. This pricing strategy, enabled by China's €100 billion Climate and Transformation Fund and state-subsidized lithium production, has squeezed profit pools across the EU. Mercedes-Benz's withdrawal of full-year earnings guidance in April 2025 underscores the uncertainty.

Valuation Adjustments: The New Normal for European Automakers

Morningstar analysts argue that European automakers are trading at significant discounts to fair value. Volkswagen's stock, for instance, is valued at a 47% discount to its €172.00 fair value estimate, while Mercedes-Benz trades at a 45% discount to €90.00. However, these valuations come with caveats. The sector's ability to deliver on profitability hinges on resolving trade uncertainties and executing costly nearshoring strategies.

For investors, the key lies in identifying firms with the resilience to navigate these headwinds. Volkswagen's aggressive U.S. manufacturing push and its ID. lineup offer a compelling case, but its valuation reflects high uncertainty. BMW's strategic investments in North America and its strong brand positioning in the EV market also present upside potential. Mercedes-Benz, while less transparent about U.S. plans, benefits from its global brand strength but faces risks in the weak U.S. van market and China's shifting dynamics.

Strategic Risks and Policy Uncertainty

The U.S. government's authority to raise tariffs further complicates the outlook. If the EU fails to meet its $600 billion investment commitment under the trade deal, tariffs could spike to 30%, exacerbating margin compression. Additionally, the EU's Foreign Subsidies Regulation and growing scrutiny of Chinese EVs near NATO facilities signal a shift toward protectionism—a trend that could stifle global supply chain efficiency.

For Mercedes-Benz, the path to resilience involves three levers:
1. Nearshoring: Accelerating U.S. and Southeast Asian manufacturing to avoid tariffs.
2. Vertical Integration: Controlling battery and hydrogen infrastructure to reduce costs.
3. Premium Positioning: Leveraging its high-margin luxury segment to offset EV price wars.

Investment Implications: Balancing Opportunity and Risk

The automotive sector is at a crossroads. While European automakers trade at discounts, their valuations reflect the risks of trade policy volatility, high capital expenditures, and China's EV dominance. For investors seeking resilient exposure, a diversified approach is essential:
- Long-Term Plays: Volkswagen, BMW, and Mercedes-Benz offer compelling long-term upside if they execute nearshoring and EV strategies.
- Short-Term Hedging: Positioning in EV battery suppliers and hydrogen infrastructure firms (e.g., Nikola, Plug Power) to capitalize on green transition tailwinds.
- Geopolitical Diversification: Avoiding overexposure to China-centric automakers while monitoring policy shifts in the EU and U.S.

In conclusion, Mercedes-Benz's margin compression is not an anomaly but a symptom of a sector grappling with systemic risks. Investors must weigh the undervaluation of European automakers against the high-stakes challenges of trade wars and China's EV surge. Those who act with patience and a diversified lens will be best positioned to navigate the volatility ahead.