BMW, Mercedes boxed in by tariff battles

FRANKFURT — President Donald Trump's escalating trade spat threatens to disrupt German carmakers' business on three continents.

Mercedes-Benz and BMW stand to lose most from tit-for-tat import tariffs imposed first by the U.S. on China and then reciprocated, since each builds its popular SUV models in the U.S. for export to the world.

Since July 6, they have to pay a 40 percent duty on the value of each exported unit, prompting BMW to consider price hikes for its China-bound products.

Unfortunately for both, there isn't much they can do to shield themselves from the fallout.

Citing lower expected sales in China, Mercedes parent Daimler AG in June was already forced to lower this year's profit target and expects earnings at Mercedes to deteriorate, despite record first-half volumes.

Investment bank Evercore ISI, which has called the China tariff "a tax on Southern Germany," argues that there are few short-term fixes.

"The most the OEMs can do is start to work through what the options are, and probably the easiest would be examining the extent to which you reallocate distribution," said analyst George Galliers. "Economically it may make sense to keep as much of that production for the U.S. domestic market, keep supply short in other markets and look if you can take a bit of pricing [action] as a result of demand exceeding supply."

China's levy on the Alabama-built Mercedes GLE and other models comes at a time when demand worldwide may be peaking for the brand. June global sales figures show that its 63-month streak of volume gains has ended, as China could no longer offset contractions in the U.S. and Europe.

The two German companies are being targeted although they continue to invest heavily in their U.S. plants to boost their exports. Roughly a fifth of all German-brand cars built in the U.S. last year were destined for customers in China, according to industry association VDA.

Mercedes employs 24,000 workers at its assembly plant in Vance, Ala., roughly 8 percent of its overall work force, and announced in October it would spend $1 billion there to begin production of battery-powered SUVs.

In an attempt to reduce the general risks from unused fixed capacity, Mercedes is transforming its production network from churning out either front- or rear-wheel-drive vehicles to both in the future. These "full-flex" plants could theoretically build almost any kind of Mercedes model, from compact crossovers to electric sedans, on the same line.

But it's a slow transition that has only just begun, with a key groundbreaking last month in Hungary. And suppliers often have to make significant investments to keep up. One manufacturer of door trims and bumpers, Samvardhana Motherson Peguform of India, just built a production site in Tuscaloosa, Ala., to deliver parts for next-generation SUVs.

Daimler would say little, other than that it's "monitoring the situation closely" and "prepared to take corresponding measures."

Rival BMW also risks punishing import duties, precisely because it has invested heavily — nearly $9 billion to date — to localize so much production in the U.S.

According to Commerce Department statistics, BMW is the largest U.S. car exporter by dollar value, thanks to its gargantuan plant in Spartanburg, S.C.

The rising trade barriers come just as it prepares to launch its new X7 flagship SUV, a vehicle expected to be popular in China and for which BMW plunged $600 million into Spartanburg to increase annual capacity to 450,000 units — more than any other BMW plant in the world.

BMW is also looking to generally shift production where sensible to avoid tariffs, minimize currency risks and be closer to customers. BMW will soon begin building crossovers in China, which CEO Harald Krueger said would benefit U.S. dealers who had been clamoring for more SUV supply in recent months.

"That way we can provide more X3s for the U.S. market, since it won't be exported from Spartanburg to China anymore," he told reporters at the Beijing auto show in April.

But it might not be enough to avoid rising protectionist barriers. Trump has threatened to tax cars imported from Mexico, which could also affect the German duo. Exports of both the BMW 3-series and Mercedes-Benz A-class sedans from new Mexican facilities to customers in the U.S. begin in earnest next year.

Worse, the administration is now investigating whether EU automobile trade is threatening national security. If it decides to, it can enact heavy import tariffs that would severely affect exports of German-built luxury sedans, already under pressure as the market shifts away from cars to light trucks.

An additional 25 percent tariff on auto imports "would pretty much destroy the business of importing cars from Europe to the U.S.," said Galliers, estimating a burden of around €4.5 billion ($5.2 billion) for the German carmakers.

Daimler and BMW are by no means collateral damage, though. Trump has repeatedly singled out the duo and their growing presence in the U.S. market as examples of what he calls an exploitive trade relationship with the European Union.

Before his inauguration, he complained to a German newspaper about BMW and Mercedes cars parked all along New York's Fifth Avenue. His attacks have continued, most notably at a June rally in South Carolina near BMW's giant export base.

"They send the Mercedes, they send BMWs, they send everything, we tax them practically nothing," Trump told supporters in West Columbia, about an hour's drive from Spartanburg. "We can't send our cars, and if we do, they charge many, many times the tax that we stupidly don't charge. We're the piggy bank that they like to take from."

At face value, the numbers support Trump. According to the European Automobile Manufacturers Association, the EU exported 1.15 million light vehicles to the U.S. in 2017, an increase of more than 30 percent in five years. During the same period, imports from the U.S. have stagnated at around 230,000 cars a year.

Germany alone is responsible for half the value of vehicle exports from the EU and more than two-thirds of the sector's €86.6 billion ($101 billion) trade surplus last year.

But it's unclear whether the 10 percent import tariff the EU levies on U.S.-built cars truly acts as a barrier for American brands. Aside from niche favorites such as the Ford Mustang, U.S. products are often viewed as garishly large and ill-suited for Europe's cramped roads and parking garages. Their fuel consumption is also far too high for countries where gasoline is heavily taxed.

Mindful of that, German automakers have backed lowering the tariffs in recent years, including vociferous support for the now defunct Transatlantic Trade and Investment Partnership free-trade deal between the EU and U.S.

While German Chancellor Angela Merkel has recently signaled support for reducing the bloc's car tariffs, her authority in Europe has been severely compromised by political turmoil in her governing coalition.

Earlier this month, the CEOs of Daimler, BMW and Volkswagen met with Richard Grenfell, the new U.S. ambassador to Germany, to explain their concerns and push for a removal of trade barriers. The unusual face-to-face suggests a preference from one or both sides not to involve Merkel, whose inability to connect with Trump is well-documented.

"It's very unpredictable," said one source at a German carmaker, who suspects the U.S. administration is not offering constructive solutions because it has an underlying political agenda.

"Trump is trying to hit the EU and of course Germany, and the best way to do that is through its carmakers."