Welcome to the Investor and Analyst Global Conference Call of Mercedes-Benz. At the request of our customers, this conference call will be recorded. A replay of the call will be available as an on-demand audio webcast in the Investor Relations section of the Mercedes-Benz website. The short introduction will be followed directly by a Q&A session. If you are connected online and listening via the web interface, please click the telephone handset button and then the raise hand icon. This will allow you to ask your question verbally as well. If you have joined by telephone and would like to ask a question, please dial star nine, pound key on your telephone keypad.
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Good morning, ladies and gentlemen. This is Christina Schenck speaking. On behalf of Mercedes-Benz, I would like to welcome you all, both on the telephone and online, to our Q3 results conference call. I am very pleased to have with me today Ola Källenius, our CEO, and Harald Wilhelm, our CFO. To allow more time for your questions, Ola will give a brief introduction, and Harald will walk you through the financials as usual. We will then move directly into our Q&A session. The corresponding presentation is available on the Mercedes-Benz investor relations website and can also be accessed via the webcast in the web interface. With that, I will hand over to Ola.
Thank you, Christina, and welcome everybody. As Christina said, Harald will go through the Q3 results in a minute, and of course, we are happy to answer your questions. I would like to start by giving you a bit of context. What is going on in the industry, what is going on in our company, and what do we see on the horizon. The big topic that is on everybody's mind, of course, is China, and you could say that that challenge is twofold. On the one hand, there is a cyclical downturn. The Chinese car market has contracted more than 20% this year, and the premium market in China has actually been declining for more than three years in a row. The top-end segment has been hit particularly hard, and we are seeing the same trend across other luxury goods as wealthy consumers and entrepreneurs hold back on spending.
That is tough for us because this is one of our most profitable parts of our business. Maybe even more important is the structural challenge. More than 100 players are competing fiercely, and that is driving down prices and profitability across the market. This competition is not staying in China. It is spilling over into many other markets as manufacturers boost exports to get away from the fierce competition at home. How are we, at Mercedes-Benz, responding to this? First of all, we are thoughtfully managing our operating point. We are looking very carefully at the ASP, and have the highest average selling price amongst our competitors, and have been able to keep it relatively stable in this market compared to some others. The result is lower sales volume. To manage this operating point, you look at that and you look at the dealer profitabilities.
We are of course watching dealer profitability as well to protect it, and we have moved very quickly to adjust our production capacity to deal with this market condition. Needless to say, we are adapting our fixed cost structures in China also very swiftly. Even more important, the variable cost drive that we have initiated is starting to pay off, but it will take some time. We are moving away from a hybrid business model that we have used for the better part of the past 20 years. Instead, we will source almost everything in China for our Chinese production. The first vehicle that is under this new strategy is the electric E-Class that we will launch in the second half of 2027, and then continue like that beyond 2027. Even today, we are seeing early signs of stronger demand for BEVs.
The electric GLC that we launched, here in the late summer, early fall, is attracting healthy orders at our chosen price point. At the moment, we have the top model only in our offering. The upcoming six-seater and further variants will allow the GLC to position itself more favorably in the competitive set. We are looking carefully at our fan base, our customer base, and our brand positioning with focus on safety, customer-centric innovation, quality, and design continues to appeal strongly to Chinese customers. That is a good foundation. Our major push into intelligent vehicles is starting to strengthen our reputation in China, both for BEV and ICE, mind you. Customers know that Mercedes-Benz is a brand they can trust. The second topic attracting a lot of public attention is competitiveness in Germany. Why does this matter so much, and so much to us?
Germany accounts for roughly 15% of our sales, but 2/3 of our employees, our structures are based here. To reduce our fixed cost further, we have decided to restart the severance program in Germany in December. This isn't just about Mercedes-Benz, it's about Germany as a place to do business. That is why we've also launched a comprehensive productivity initiative in Germany. Discussions with the labor side are still ongoing, so I can't announce anything today. I want to reinforce the core message. Germany must make a major leap forward to safeguard its industrial footprint and jobs. Further investment in Germany depends on a significant gain in productivity. On the other hand, Eastern Europe offers opportunities to lower our average costs across Europe. We've already have a strong presence in Hungary, and we can take further steps.
The third topic to watch is our product offensive, and it's picking up pace. It's fantastic to see such a positive response to our new cars. In fact, our products have won more than 180 awards and accolades since 2025, more than ever before in such a short period. Here, I want to give kudos to the whole team that have been working hard for years making this happen. It's even more gratifying that they're also resonating with customers. If you look outside China, car sales increased every quarter in 2026, and we expect full-year sales outside China to reach their highest level since 2019. Orders for our electric cars in Europe have doubled since the beginning of the year, and that's only the beginning. More than 20 new models have made their world debut this year.
The latest example is the AMG GT SUV, the most powerful electric SUV ever, and an absolute technological marvel. Speaking of technology, together with NVIDIA, we will bring point-to-point automated driving to Germany by the end of the year. We're the first OEM to offer such a system in Germany, in addition to what we've already launched in China and the U.S. The technology gives our customers a new level of safety, intelligence, and confidence behind the wheel. You have to try this. It underscores our determination to play a leading role in automated and assisted driving. As you can see, we've been building product momentum for quite some time, and we'll keep working on our vehicles' variable cost and pull every lever at our disposal to turn that momentum into higher profitability.
If we look further ahead, there has been some external speculation about our strategic moves for 2030 and beyond. Now is not the time to discuss the details of that. We will provide a more comprehensive update next year. I can promise you this, we'll make bold and exciting decisions on technology, products, and how we organize our operations in our enterprise. We announced one major step just a few days ago. With the help of AI, we'll speed up product development at Mercedes-Benz by up to 30%. I think that gives you a sense of how ambitious we are about transforming our company. I don't want to miss the opportunity to acknowledge the performance of Mercedes-Benz Vans. Yet again, we delivered strong results in a challenging environment.
I want to thank the entire van team for what they have done, not just this year, but over the last years. Europe is our anchor in this business, and it acts a bit like a hedge to passenger cars in the current macro situation. We are just at the beginning of the biggest product and investment cycle in the last 25 years. Three weeks ago, Thomas Klein, who runs Vans, and I gave key customers the preview of our future product portfolio, very big corporate customers, and the response was overwhelmingly positive.
We feel confident that we are onto something here. In the case of Mercedes-Benz Vans, I think it holds a unique position in the van market going forward for mid-size and large vans. We will have a 100% lineup of BEV variants, but we will also have a 100% lineup of high-tech electrified ICE. Every one of these vehicles, 100%, will be software-defined. Each customer will have a perfect choice for their specific use case. In the heterogeneous use cases that you have in light commercial vehicles, this is crucial for market penetration. As I said, a unique position.
Last but not least, financial services. Of course, I will let Harald elaborate on this, but I want to highlight the strong results driven by effective margin management and cost discipline. Last year, we decided to bring all customer-facing functions together in one unit, and the goal was to create a seamless customer experience. That decision led to one of our largest restructuring efforts in decades, and now it is starting to pay off. Once again, thank you to the entire team. You did a tremendous job. With that, I will hand over to Harald, who will take you through our Q3 results in detail. Thank you.
Thanks, Ola, and hello, everybody. Let us have a look at the group numbers. Group revenue came in slightly below our prior year. EBIT and EPS are both significantly up, as last year was mainly impacted by restructuring charges and legal proceedings. While if you look on the chart, you also see that the return on sales at a group level was 5.8%. You see Mercedes is more than cars, and it demonstrates the resilience overall. Free cash flow was positive, but soft at EUR 2.2 billion, including M&A proceeds. The net industrial liquidity remains healthy at EUR 31 billion after returning more than EUR 5 billion to shareholders year-to-date. In September, we started a further share buyback program of up to EUR 1 billion.
Let's have a look at the Mercedes car sales. Total sales are down 8% to 407,000 units, mainly reflecting the challenging market environment in China. Sales, excluding China, grew by 1%, driven by continued growth in Europe, 5% up, and the U.S., 6% up. With this, our China sales exposure decreased to around 20%. Top-end sales came in lower as a function of weaker Chinese market, as well as the current model transitioning, including the new GLE AMG, GLS and S-Class, together with their Maybach and AMG variants. In the U.S., we only started supplying the new models to the dealers towards the end of Q3, while in China, the market introduction of the new S-Class is expected early 2027. Top-end share reached 13%, in line with our expectations for Q3. Our BEV sales increased by around 60% year-on-year, setting a new quarterly BEV sales record in the third quarter.
The development continues to be firmly driven by Europe, where BEV sales increased by almost 80%, while GLC BEV sales more than tripled compared to Q2. Our xEV share reached 25%, also demonstrating good progress here. In Europe, almost every second vehicle sold was electrified. Looking at cars financials, sales, I just explained before. The revenue development is slightly better than sales, as it has been supported by growth outside China. The ASP is lower than the prior year, driven by net pricing, mix and unfavorable FX. Let's go to the EBIT walk on the next page. In Q3, cars delivered an EBIT adjusted of EUR 560 million and an adjusted return on sales of 2.5%.
The volume structure net pricing bucket reflects mainly softer volume driven by lower China imports, a softer market mix and net pricing, higher cost for product life cycle measures, as well as lower contributions from parts supplies to our Chinese joint venture and after sales. The FX bucket was mainly driven by Turkish lira and Chinese yuan. Again, industrial performance was clearly positive and provided strong support to earnings. While raw mats turned negative, total material costs were positive, driven by efficiencies. Efficiencies in production cost provided further support and lower cost for product-related measures. The selling expenses reflect efficiencies, but were more than offset by the phasing of direct selling expenses, as well as effects for the rollout of our direct sales model in Korea. R&D reflects further efficiencies following our funding peak in 2025. The other bucket is negative, driven by a lower BBAC at equity result.
I will come back to the adjustments later at the group level. Turning to cash for cars, came in at EUR -200 million. As you can see on the chart, that was driven by the working capital. We did see higher inventory driven by a heavier inventory mix in the third quarter, with a higher share of top ends and BEVs, as well as the inventory buildup ahead of the Q4 product momentum. And that one more than offset the favorable trade payables phasing. Investments came down following the funding peak, while depreciation increased as a function of recent product launches. Year-to-date, investments came down by 11% versus previous year, equaling around EUR 900 million investment reduction year-to-date. The increase in other cash flow effects was mainly driven by favorable movements in tariff-related refunds and higher accrued tax liabilities.
Again, adjustments we cover on the group level. Turning to Vans. Vans performance, as pointed out by Ola already before, delivered a very solid quarter with sales stable around 84,000 units. Outside China, sales increased by 6% year-on-year, driven by growing customer demand in North America and strong growth in the rest of the world. We continue to see a softer consumer demand for midsize vans in China. The eVans remained an important growth driver, up 12% year-on-year, lifting the global xEV share to 11%. Revenue slightly up at EUR 4.2 billion. Adjusted EBIT stands at around EUR 400 million. We look at more details on the next page. On the cash flow side, it developed in line with our expectations and continues to reflect our investments into the new van architecture.
As anticipated, investments are expected to peak this year at Vans, laying the foundation for the future of our van business. With all new electric VLE now in series production, the next step will be the expansion of our lineup with the upcoming VLS and VLS Maybach. Turning to the Van EBIT bridge, EUR 400 million, high single digit at return on sales adjusted of 9.4%. What are the key drivers? Volume was up, especially ex-China, sorry. Mix was overall flattish, while net pricing was negative. In addition, a low repeat of a prior year effect. The FX bucket was positive, mainly due to the U.S. dollar. The industrial performance was supported by lower expenses for product-related measures, while ongoing ramp-up costs for the new van architecture were a headwind.
Additionally, selling expenses and R&D costs were higher due to the launch of a new van architecture and a reclass effect from selling expenses into industrial performance in Q3 last year. Turning to financial services. With the Athlon sale and the divestment of Blacklane in Q3, we further streamlined our portfolio and sharpened our focus on our core financial services business. A significant increase in the penetration rate largely offset lower car sales and the absence of the Athlon group since the end of July, resulting in broadly flat new business. Mainly driven by the Athlon sale, the portfolio declined compared to Q2 2026. On the profitability side, Financial Services delivered a strong performance in Q3, with an adjusted EBIT increasing by 42% to around EUR 450 million. How did we get there? On the EBIT walk, we have the portfolio margin, which contributed positively and then improved.
The cost of credit risk also improved, supported by better portfolio quality. Additionally, we saw further efficiencies crystallizing compared with last year. With this, the return on equity adjusted is at 13.8%. On the group EBIT, besides cars, vans, and financial services provided strong contribution to the group EBIT. In addition, the recon contributed positively. What is behind it is the Daimler Truck at equity result and the gains from further Daimler Truck disposals. This resulted in an adjusted group EBIT of EUR 1.8 billion. The adjustments offset each other. The main drivers were restructuring charges related to personnel cost measures, M&A transactions, mainly the Athlon sale, the divestment of Blacklane, and the ongoing sale of our own retail footprint in Germany, and a valuation adjustment related to our at equity participations. As a result, reported group EBIT also came in at EUR 1.8 billion.
On the cash flow side, cars and vans, I explained already. The income taxes paid were at EUR 330 million. Interest paid, also due to seasonality of bond coupon payments. The largest contribution comes this quarter from the further monetization of the Daimler Truck stake, adding EUR 620 million. Overall, this results in a positive cash generation, in terms of the industrial free cash flow of around EUR 170 million in the quarter. Looking at the net industrial liquidity, overall, we generated over EUR 3.1 billion in the first nine months of the year. As explained earlier, cash generation Q3 was soft. In September, we started a new share buyback. The program of up to EUR 1 billion will continue until our AGM next year. As we speak, we bought back shares in the amount of roughly EUR 280 million.
In total, we have returned EUR 5.2 billion of cash to shareholders in the first nine months of the year. The other bucket recorded a cash inflow from the sale of Athlon. The total group cash proceeds are approximately EUR 1 billion from that transaction, EUR 450 million of that was recognized as a cash inflow in the net industrial liquidity in Q3. The net industrial liquidity remains at a healthy level above EUR 30 billion. Now, on the guidance. First, on the divisional guidance for 2026, please refer to the disclaimer regarding forward-looking statements at the end of this presentation in relation to the outlook. I want to emphasize, in particular, the ongoing conflict in the Middle East is adding to existing uncertainties, particularly around commodity and energy prices, inflation, and unit sales, while our outlook assumes no sharp further escalation during the remainder of the year.
Now turning to the car side on the sales guidance, we retain our view for the remainder of the year and continue to target volume growth ex- China. Q4 sales are expected above Q3, driven by increased global ramp-up of our new products, but below previous year due to China. In Europe, we expect to build on recent momentum and continue the positive sales development, spearheaded by the improved GLC availability. Likewise, we expect the positive development in the U.S. to continue, driven by the increased availability of new models, such as the new S-Class, GLS, and GLE. The Chinese market became even more challenging over summer, and we expect this to continue in Q4. With the positive developments in Europe and the U.S., we're confirming our current sales guidance and continue to expect full-year 2026 sales to be slightly below 2025 levels.
Our xEV share stands at 22% for the first nine months. With increasing BEV momentum, we expect to finish the full-year well within our xEV guidance of 23%-25%. Now, on the profitability side, cars achieved an adjusted return on sales of 3.5% in the first nine months of the year. Looking into Q4, what to expect versus the first nine months. We expect a positive top-line contribution and a small pricing tailwind from our product momentum, mainly driven by higher volumes and an improved mix, also partly offset by a higher BEV share. On the cost side, we now expect the vast majority of the material one-time charges to crystallize in Q4. This reflects a shift from Q3 to Q4, not a change in absolute terms for the year. Additionally, raw mats and higher depreciation are expected to step up.
Following the inventory buildup in Q3 to prepare for Q4, we expect a material burden from capitalized fixed cost in Q4. Taking all of this together and also reflecting the phasing of cost, we expect Q4 profitability to be below Q3. With this, we lower and narrow our full-year guidance for the adjusted return on sales to 2%-3%. If you ask me what has changed since summer, where we guided H2 around 3%, I would highlight two major changes. Number one, the vast, and I really mean the vast majority of adjustment, is due to further deterioration of the Chinese market. Second, higher material costs from raw mats and product life cycle measures were the trigger for the change. In terms of the guidance on investments, R&D is unchanged, while investments in PP&E are now seen significantly below prior year.
With this, the adjusted cash conversion rate has been raised to 1.2 to 1.4. On the van side, sales, as usual, we expect Q4 to be the strongest sales quarter of the year. However, due to softer consumer demand for the V-Class in China, the ramp down of small-sized vans, and the first VLE deliveries in 2026. But with a more meaningful volume contribution expected in 2027, we now see sales at prior year level for the full-year. xEV share is unchanged. On the return on sales adjusted, the first nine months of the year, vans achieved a strong 9.9% return on sales adjusted at the upper end of the guidance range. Against the year-to-date run rate, we expect for Q4 positive effects from higher volume, headwinds from cost seasonality, higher depreciation and cost due to the ramp-up of VLE and factories.
With this, we confirm the full-year guidance range of 8%-10% for vans, and they expect the full-year to finish in the upper half of the range. No change to PP&E, R&D, and CCR. On financial services, with an adjusted return on equity of 14% for the first nine months, we continue to navigate a volatile geopolitical and macroeconomic environment in Q4, including volatility around interest rates and credit risk. Against this backdrop, we confirm our guidance and expect a full-year adjusted return on equity in the upper half of the 12%-14% range. Now to the group guidance. Obviously, that follows the same premises as the segment guidance. Revenue unchanged, slightly below previous year. Due to the lower profitability at cars, we now see the group EBIT at prior year level. That refers obviously to the EBIT reported.
Looking at the free cash flow on the industrial side, following the adjustments at cars, we now see an increased likelihood of the free cash flow industrial crossing the threshold of slightly below, which sits at EUR 4.1 billion. With this, we adjust the FCF guidance for the full-year to significantly below prior year. This includes the cash flow in the first three quarters of EUR 3.1 billion, including the EUR 1 billion monetization of Daimler Truck shares, but also EUR 1.1 billion of restructuring cash outs. This outlook includes a positive cash generation in Q4, including M&A. The guidance considers a smaller amount of disposals of Daimler Truck completed in October, but no further potential disposals going forward. I think that brings me to the wrap-up.
In terms of the way forward, well, as Ola pointed out, the road ahead is bumpy, but that requires disciplined executions and bold decisions. What are we doing? First, we will leverage the strengths of our product and technology portfolio. Our focus is on ramping up and rolling out new models, expanding ADAS functionalities, and translating our strong product substance into sales momentum. Second, we will enhance productivity and competitiveness. We will continue to address cost, structures, and capacity, including measures to improve the competitiveness of our German footprint, ramping up production in Hungary and continuing our voluntary redundancy program. We are also driving efficiencies through the broad use of agentic AI. Third, we will further enhance the resilience of the group. Mercedes-Benz is more than cars.
With strong vans and financial services business, our healthy balance sheet and Daimler Truck stake gives us means to invest into the future, including adjacent business opportunities. Early next year, we will provide an update at the capital market update alongside our annual results conference, including our outlook for 2027 and beyond. With this, let's move to the Q&A now. Thank you.
Thank you, Ola. Thank you, Harald . We will now move on to the Q&A. You know the drill. I will identify each questioner by name. Please, before asking your question, state your name and the name of the organization that you represent. As usual, please ask your question in English, and for reasons of fairness, please try and limit yourselves to a maximum of two questions. Before we begin, the operator will explain the procedure once again.
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Okay, we start and the first question goes to Tim Rokossa from Deutsche Bank. Tim, over to you.
Thank you very much, Christina, and good morning, Harald and Ola. First of all, Ola, as a German citizen and a car analyst for 18 years, thank you for making these very strong intro statements. I think you guys are spot on. Germany really needs to get their act together. Now, to my two questions. When we think about China, Ola, obviously we discussed this before, but as you say, it is on everyone's mind, right? We have seen this death by actually pretty big thousands of cuts over the last two, three years, where you just continue to moderate your expectations, sometimes during the year, not just at the beginning. So maybe more strategically, what will China ultimately be? Let's say we see a bit of a recovery.
Is this going to be one of the three major regions for you still, or is this something where you are going to sell a lot of BEV maybe going forward, but it is somewhat of a more niche-y market ultimately in your thinking? Then secondly, Harald, obviously lots of moving parts on profitability. Some seem to go away, some you might still negotiate, and some will likely also stay next year, like China, for example. Can you help us understand what you are thinking is there to stay and what is not, especially when we think about a run rate for 2027? Is this rather a Q4 number like we see it right now? Is it rather an H2 number? Shall we think about something totally different? Thank you, guys.
Good morning, Tim. Of course, in a market condition like we are experiencing in China right now, and deteriorating beyond what we had thought would happen this year, certainly what we thought at the beginning of the year. But even you can see now in the second half, the weakness of that market, the even stronger weakness on the upper end where we are the dominant brand, that is affecting us. In a situation like that, and reflecting on the last three years, you called it death by a thousand cuts or whatever. At least there have been some cuts. You do a 360-degree inventory, and you look at every single aspect of your business. Brand, brand relevance, product portfolio, go-to market strategy, production strategy, sourcing strategy, technology, the whole thing. And we have already put the whole series of measures in place to deal with this situation.
Y our question is, what does the target picture look like? I do not want to sit here in this Q3 call and give a comprehensive description of what that is going to be, because this is not the time or the forum to do it. But you can rest assured, Tim, we will do that. We will come back with a thorough assessment and the role it is going to play. But I can say this up front, we are not looking at China as something, oh, that is going away and let us focus on the other things. It will remain a very important part of our business.
T he automotive ecosystem that you have there, being the biggest market in the world still, and having an innovative sectors of tech partners that we are working with, and China not staying in China going into the world as well. If you are a global car company like Mercedes, there is not a play where you put China aside. It has to be one of the pillars of your strategy, and will remain to be for us. But bear with me for a comprehensive operating point and strategic play for the longer-term picture, and we will present that to you in the near future.
Tim, on your second question, well, I do understand lots of moving parts and a bit difficult to grab what it is. So let me help to clarify maybe and simplify. First, in terms of the run rate. How could we think about the run rate? Definitely I would say it is not the Q4, which is a run rate, as usually you have the cost phasing, which is more back-loaded. You have this fixed cost capitalization, which is in particular pronounced this year. So I would rather suggest maybe to look at the run rate right now as a function of the H2 run rate, in taking into account the guidance update we made yesterday and explained here today. So you depart from that one, how to think about 2027, and obviously this is not the point here today to give any guidance for 2027.
W hat we are driving, what we are trying to do in 2027, departing from that, call it run rate. Clearly, we want to leverage and capitalize on the product momentum, which we see in part in 2026, but should definitely have more momentum from it in 2027. Second, we will continue to drive the variable cost hard, and definitely the target, the objective is to bring variable cost further down. The same applies to fixed cost and the same applies to funding. In the nine months, you can already see quite encouraging investment down, and we continue to take that approach also for 2027. So I think these are somehow, I would say, the building blocks which are somehow under our control. Obviously, that leaves the market side.
I do not want to speculate too much about it, but as we see that favorable main customer feedback on the new products, including the BEVs, I would say clearly the target is to continue growth momentum in U.S. and Europe and all other parts of the world, ex-China. Leaves, I think, uncertainty in terms of where China is going, and I think we should not speculate about this one as of today here in this call, but rather look at it when we are coming together in February.
Very clear. Thank you both.
Thank you, Tim. I will hand over the next question to José Asumendi from JPMorgan.
G ood morning. Thank you, Christina. Two questions, please. Ola, can you speak a bit more about the topic of China? And you mentioned the new E-Class. Which changes have you done to the car to improve the overall competitiveness? Which vehicles will follow up on this new E-Class, which I think will set a new standard, a new benchmark for you in China in terms of cost competitiveness? And do you think you need to do further capacity adjustments in the region? And then question two will be for Harald. Can you speak please about the working capital and your level of confidence of turning around that working capital in the fourth quarter? Thank you.
Good morning, José. We will, of course, invite you to the world premiere of the new E-Class, which will happen next year. I do not want to give too much technical details about the vehicle, but I can tell you the approach that we took when we started the journey of developing this car about maybe three years ago or so, was really more or less a white sheet of paper. You will see a dedicated battery electric vehicle that in all its features, technology, styling, space, but also the traditional values of Mercedes that are more important than ever, I have to say, especially in China, safety, quality, the ride and drive, those things that make Mercedes-Benz a Mercedes-Benz. Every one of these things have been taken into account in designing that vehicle.
We think that in the product proposition, we are positioning that vehicle very much right for China and everywhere else for that matter. But the crucial point is, and that was the point I made in my opening speech, is that will be the first vehicle in this variable cost, material cost initiative that we started a couple of years ago to switch from what I call the hybrid business model to a new business model in China, is that we will get close, not all the way, but close to this full sourcing in China for Chinese production.
That will help us lower the variable cost significantly, vis-a-vis the past business model. And we are going to be realistic about the price point. Who knows where price point is going to be 12 months from now in this Chinese market environment. I do not think anybody can know, b ut we will then have water under the keel to adequately price point these vehicles. Although we will never take the fire sale market share at all cost approach that many other market participants are choosing to do. That will not be the play for Mercedes.
José, and on the working capital in the Q4, again, let me remind in the Q3, so build up of the inventory to support higher Q4 sales, but at the same time, a higher mix in the Q3 inventory that burdens the cash flow, as you could see in the Q3, but that will unwind in the Q4, as we ramp up in the sales, including a higher, a stronger mix, S-Class, GLS, GLE, and the like. And if you link it with the outlook on the cash flow explained, while sitting at EUR 3.1 billion of cash flow at the nine months and guiding for something which is below the EUR 4.1 threshold, as I pointed out in the intro. That leaves some cash generation, also on the organic side in the fourth quarter.
If you think about the margin, obviously, that is not that strong. So the organic cash generation is supposed to come from the working capital reduction, which means inventory down, but don't forget about the payables. They will go up at the same time. As you lower the production in the early days or in the course of December, that has an impact on the payables. But the net being a working capital contribution, that explains, I think, why we're building up in the third quarter, coming down in the fourth quarter and explains the cash flow guidance.
Thank you.
Thanks, José. Next question goes to Patrick Hummel from UBS.
Thank you, Christina. Good morning, Ola and Harald. My first question, Harald, is a follow-up regarding the puts and takes for 2027. You mentioned that you expect variable cost and fixed cost to be further down. In Q3, you even managed to overcompensate for the rising input costs. I'm wondering whether that comment you made on the cost side of the EBIT bridge would also, again, fully offset the raw mat headwinds that we see today. How big is that raw mat headwind actually, if you do a mark to market that we should have in mind for next year? The second question to Ola, this is really a bigger picture question. You keep lowering your growth expectations, basically, and China, of course, is the main driver.
I think the idea behind the wider capital allocation framework was probably to have EPS accretion to create value for shareholders. But share buybacks don't really create value if the business is shrinking. I'm just wondering in the grand scheme of things, how you think about the capital allocation framework today when it comes to growth, when it comes to M&A. Does it still make sense to sell down DTG to buy back stock? Maybe more specifically, and that might be one for Harald, how should we think actually about the dividend going forward in that context? Do you still want to keep it flat in absolute terms, which is what you did last year, or will it be more closer to the target payout ratio of 40%? Thank you.
Thanks, Patrick. On building blocks and variable costs in 2027, definitely what we'll continue to drive is efficiencies in terms of commercial and technical efficiencies. I think good progress in 2026. We'll continue to do so in 2027. The targets which we outlined as part of our efficiency program, the NLP2, I'd like to remind you, are before raw mats or ex raw mat movements and also ex- lifecycle measures. As you can see, 2026, in the nine months, definitely we can more than compensate. In the full-year, I still expect that we can compensate. Again, I don't want to speculate now on the raw mats, on the commodities. I mean, for 2027 needs to be watched, in particular, if you think about chips and semis, I would say. But what is in our hands, clearly, that is what we want to drive downwards.
Patrick, of course, it's our goal to grow. I think we have demonstrated this year that ex- China, we have grown, which means that the product offensive is working. But China has more than outweighed that, and that's the point. As was the question before, where is that sound operating point for China? I think that sound operating point for China, whereas you don't have 100% predictability, it is something that we have to seek and define and say, "What is our play?" Then go from there. We will come back with a more detailed and comprehensive view on China next year. But it is clearly our goal to grow. I think the capital allocation policy so far has worked quite well for us in turbulent times.
As Harald said, we will finish off the EUR 1 billion that we kicked off by the annual shareholders meeting next year. What then the BEVs choice of capital allocation is, that decision we will make at a given point in time. But I think this is important for the shareholders. Whatever decision we make, we will make in the interest of the shareholders. That is how we act. You can see in spite of giving back billions back to shareholders, we still have a very healthy net industrial liquidity. Balance sheet-wise, we're operating in a challenging environment, but from a position of strength. On the M&A side, shoot from the hip M&A certainly will not be our plan.
If there is meaningful addition to our portfolio that strengthens our business or an adjacency that is a logical extension of our business, yes, we have the firepower to look at that, but this is not something that you do in a hectic way as a reaction to, "Y ou have issues that you need to deal with. Now you try to escape through M&A." It is not our mindset. M&A has to be a strategic contributor to the core business or a meaningful adjacency. Should there be something there, rest assured you will know.
I would just briefly like to remind you of the capital allocation framework. We can only distribute what we generate. S hareholder returns will be framed, sized by the cash generated or expected to be generated in 2027. I would say, from that, probably dividend will be served first, and all the other we will see in February.
Thank you very much.
Thanks, Patrick. The next question goes to Harald Hendrikse from Citi.
Morning. Can you hear me?
Yes, we can.
P erfect. Thank you so much for taking my question. Ola, Harald, thank you so much. My question relates more, going away from China, if we look at where the financial results stand today, and obviously the disappointing impact in the fourth quarter that we were all hoping that maybe wasn't going to happen. It seems to me that China maybe was even more profitable to you and all of your peer group than we ever thought before. In fact, of course, the decline in Chinese profitability is a problem this year. But isn't maybe the real problem that the rest of the world profitability is actually lower than maybe we all thought it was? We understand that the BEV impact is significant. We understand the tariff impact in the U.S. is significant. Those are not the real problems.
What I really want to understand is when we go to 2027 or more importantly, 2028, 2029, your business is doing okay, right? Sales are okay, mix is okay. You've got lots of new product. How can you ensure that the profitability of the non-China business is actually much more rational, for a company of this size? I'm sure you would agree that the global business, even ex-China, should be doing, I don't know, maybe or at least margin.
Can you talk about that a little bit more? If you had had the foresight and the knowledge that China would be as difficult as it is now, what would you have done differently in the rest of the world? Or would it have changed the strategic situation in the rest of the world for you? Maybe if you could address that. Sorry, difficult question, I know, but that's what I feel.
If I start, then I will pass on to Harald. Yes, the China business is profitable and it's now less profitable. Stating the obvious. A business system is a business system as a whole, so every region contributes to the fixed cost of the overall business and also carries the funding of the overall business. If one significant piece of that breaks away, the fixed cost degression effect of it is felt. What is the measure you have to take? Also this is obvious, is you have to reduce your fixed cost, and you have to reduce your funding. We have been on a path of doing that over the last few years, quite successfully so. But the fall away of the revenue side, of the profitable revenue side of China moved faster downwards than what we had originally anticipated.
I am not a cry over spilled milk type of person and should have done this and should have done that. Going forward, we have to continue on that path so that indeed, the more healthy at the moment business around the world and the growth trajectory that we're starting to get there, in spite of wars and other things. I could complain about the fact that the very profitable Middle Eastern market, for known reasons, is not as vibrant this year, as it has been for us, and it's an upper-end market where we sell a lot of our heavy goods that also make a lot of profit.
There are many things that are working here. We will continue with determination to adjust the structures of the company to fit the revenue position of the company. There is an inertia between those two, if the dynamics on the revenue side have moved ahead in a direction that we did not foresee at that magnitude.
Q uickly, I think a part of the answer you can see already. I commented before that basically the exposure, if you want to say, to China sales is down to 20%. Clearly, that was higher than a third some time ago, on the sales side. We are expanding in the other parts of the world, rest of world. We are growing, as you can see, with the numbers in Europe and the U.S. If you look at that from a profitability point of view, well, we are not separating out the profitability by regions. But, I think you are right. The profit pools from China were very important, very material. The decline we absorbed already as we speak is definitely very material.
I can confirm that the quality of the margin in the other regions in the rest of the world, has come up, is healthy thanks to the strong product momentum, but also thanks to the cost work. What is the plan therefore? Get less dependent on the profit pools from China. Absolutely. Are we at the point where we are completely independent of the profit pools from China? Not, maybe in brackets yet, but clearly, I think given the uncertainties, that is what we have to drive for.
I think we see the building blocks with the product traction in the other markets. We will take the variable cost further down, the fixed cost of funding as elaborated before. We also work on how do we kind of ring-fence China that it is self-sustainable. Therefore, make the entire value proposition more resilient and less exposed to China. That is definitely the plan, and probably February is a good moment to talk about that in a bit more detail.
Okay. Thank you very much.
Thanks a lot, Harald. I will hand my next question over to Henning Cosman from Barclays.
G ood morning. Thank you, Christina. Morning Ola, morning Harald. Sorry, just to come back to China, actually, I am sorry to labor this. Ola, you said, your ambition is certainly to grow, regardless of what your new target picture for China will be. I appreciate you will talk more about in February, but it is a while till February, and I am just wondering about the framework, how to think about the setup between now and then. I just wanted to make clear or sure we are on the right page. When you say you want to grow regardless of what the new China picture will be, I suppose compared to 2025, we are tracking about 150,000 units down. Do I understand you correctly there? That if the current run rate remains or declines even further, growing means overcompensating that in other markets.
I just wanted to clarify that, if you can grow even if China remains or declines in your new target picture. Then the second question, much more for Harald. On the free cash flow, please, Harald, just to clarify a few things around free cash flow. Firstly, if you could just say how much the Daimler Truck stake sale was in October. You said it is small, if you could quantify it, please. But more generally, if I look at your free cash flow in the nine months, you had a pretty big outflow for these operating leases. I understand that the cost on operating leases were up a lot year-over-year, but it makes a big difference to the operating free cash flow. So if you could touch on that specifically. But just overall, a statement on the underlying free cash flow.
There is a very large contribution from payables versus receivables. I think the cash tax looks pretty low relative to the P&L tax. There is obviously the DTG stake sale of over EUR 1 billion in there now. So if you could just make a statement about the structural underlying free cash flow without help from working capital, where you say there is going to be a bit more even in Q4. How do you assess the structural health of the underlying free cash flow, excluding working capital, excluding sales on a stable cash tax run rate? Thank you.
Good morning, Henning. Perhaps I was not precise enough in my answer, but I will restate it. I will kind of quote Harald. For the remainder of this year, I repeat what Harald said. Q4 will be higher than Q3, but Q4 will be lower than previous years. We intend to grow world ex-China in Q4, but we expect China to be down in Q4. The net of all of those is what Harald said, below previous year. That does not mean that we do not have the general ambition for the business as such, and maybe that is where I was not so precise, that over time we want to grow the business. But I also appreciate, and I think that is your question, where is that landing point for China and where is the platform from which you then rebuild, so to speak?
That we are going to have to deliver to you, but we do not want to shoot from the hip doing that here today. We have started a whole host of actions that we could discuss for hours to strengthen and secure our position in China. But the market behavior has been difficult to grasp. I would say that, putting it mildly. So we are going to come back to you, as early as possible in the new year and give you a full assessment of where we think that operating point for China makes sense for us, and then we will take it from there. I hope that answers your question.
Thank you, Ola.
Adding on the cash flow side, well, maybe we can clarify the operating lease sideline, but we do not see a major tick up on the take-up on the operating lease. So the industrial free cash flow is anyhow X in any of the financing stuff. But if that requires clarification, we can take that offline. In terms of how to think about cash flow generation and levers, let me point out, number one obviously is driven by the margin of the business on the industrial side, so cars and vans. We cannot disconnect the cash flow from the margin evolution. I think I am stating a bit the very obvious. But then what we are doing in terms of working capital management, and here I think we need to look beyond the quarter and rather look on full-year.
Clearly, we want to do continuous working capital improvement, and thereby basically absorbing also impacts like the direct sales model. If you look over a couple of years now, we took quite some billions of inventory on the balance sheet from the direct sales model, but you don't see a take up in inventory as such, which means we had been doing improvements on working capital. But for this, I think you really need to take a full-year picture. Again, once we have completed 2026, we can have a look at that, which means basically working capital should be either neutral or maybe provide a bit of an upside potential. Point number two definitely is the investment side. Depreciation will go up with the new models being launched, having passed start of production. Investments is coming down.
I mentioned EUR 900 million in the nine months, year-to-date, and that number will be even bigger on the full-year. In other words, investment versus depreciation is going to be supportive, accretive to cash conversion ratio. On the pre-tax basis, therefore, I would say we should see on cars, cash conversion, at least at one moving forward. On vans, I think that will come up aggressively.
The investment peak is in 2026, not jump to one right away. But over maybe two years or so, we'll come back to one, and then has a great potential, I think, to exceed one in the midterm. On the tax side, cash taxes are running lower than P&L taxes. In some countries, we are in a tax loss situation. Guess where the tariffs, for example, end up in Germany. That makes it, that the cash taxes are significantly lower than the P&L charges you see over there. I hope that helps.
Thank you. Can you share the number for the DTG stake sale in October?
Apologies, that was a very small three-digit million number.
Thank you both.
Thank you, Henning. I will move on to the next question, and that one goes to Horst Schneider from Bank of America. Horst?
Thank you for taking my questions as well. I have got a few still, try to constrain myself to two. You made a lot of statements, Harald, on Q4, but I am not sure if you quantified now if Q4 could slip into losses or not. If I take a new guidance range, the midpoint of the range implies something like around break-even in Q4. Maybe you can say what is your ambition for the fourth quarter, stay in positive territory and achieve upper end of your new guidance range? Or should we really work with the midpoint, and maybe you can clarify again, what are then the precise drivers? I think you have not yet said what could be the magnitude of supplier compensation, for example.
Then the second question that is for Ola. Ola, when I was on the Paris Auto Show, one of the most shocking things for me were that the Chinese OEMs, they seem to try to push more into the premium space, maybe also related to the fact that their tariffs are increasing now. Don't you think that this could be into 2027 and thereafter, a bigger threat to your business also in Europe, that they finally take more share just because their vehicles are priced a lot lower than those of all the German premium brands? Thank you.
Yeah, Horst. First question on Q4 . I think if you apply it mechanically, it goes somewhere from, what, - 1 to, call it, + 1 or so. I would say, call it a break-even quarter. W e're sailing with not a lot of water under the keel, obviously. I think any movement on a particular item and an adjustment, kind of a non-recurring goes straight in one or the other direction. That's why I think why we should not exaggerate, I think, the level of granularity we're chasing here. But call it a break-even quarter. That's what I would say for cars in Q4 . Let me be clear on the supplier compensation. One of the reasons for the guidance adjustment next to China is higher raw mat cost and life cycle measures. It's not higher supplier compensation. This one is a phasing.
Which means the supplier compensation has moved to the right into the fourth quarter, but has not been stepped up. I want to make that extremely clear. There's not a single cent more for suppliers in terms of compensation. It's just a matter of fact that moved it to the quarter four, which makes the phasing a bit unfortunate. I really want to be absolutely clear about that. Moving forward, I don't want to prejudice what Jörg is doing on the purchasing side, but I think the times in terms of supplier compensation, I think in the challenges we're facing in the industry, in terms of the uncertainty and the volatility, I think the times of supplier compensation for volume are gone.
If we talk about China, also in the context of Chinese going into the world, as I said in my opening statement, this is part of our calculation, it's part of the equation, and every market is different here. But when we develop our product technology and pricing strategy, it's actually to deal with both. Yes, many Chinese manufacturers are seeking their luck in Europe as well. You can see that there's also been a regulatory response to that with the recent trip of Commissioner Šefčovič to China to actually introduce quotas now as well as one tool on top of the battery electric vehicle anti-subsidy study that was put in place a couple of years from now to maybe create a little bit more level playing field on the pricing side and on the ability to flood a market with certain vehicles.
Y ou can't rely on that. You got to rely on your own strengths, and your own strengths is ultimately your product, and your pricing play. If we look at what's going on in Europe right now, I'll take the German market as an example because it's a good bellwether, and it's by far and away the biggest market in Europe. For I think the third month in a row now, Mercedes-Benz is the clear premium leader for battery electric vehicles. The most selling vehicle, I think, in this month, is probably the electric GLC. So it's not just a matter of looking at how do you deal with new Chinese competition. It's also a matter of looking at how do you deal with the competition that was there in the first place. Here, I think our product offensive will carry momentum for us.
Not that that should be the only thing, but it's also an important thing in the play. So we will continue to roll out one car after the other with fantastic technology. It's not a coincidence that Mercedes-Benz is the first car company with Level 2++ now being launched, in Germany, and then ability to proliferate throughout other countries. We will power play on that next-gen technology and be at the forefront. Not every non-European manufacturer that comes into the market masters that digital environment as well as we do it right off the bat. As it took us a little bit of time to get our hands around that in China. But if you look at our digital play now in China, we're at the frontier. We're at the technological frontier. Our automated driving systems are as good, if not the best.
Our new smart cockpit, and we launched yet another version, significant upgrade in the fall now, is as good, if not in some aspects, the best. So, we're not going to stand still and just watch this happening to us. We're going to take the bull by the horns and play our play.
Thank you very much, Horst. Thank you very much, Ola and Harald, for answering all of the questions. I see a few more people in the line. Unfortunately, we're running out of time as well. We will reach out to you, and of course, from an investor relations standpoint, we remain at your disposal for any further questions that you may have. Now to all of you, have a great morning, have a great afternoon, and a great evening, depending on where you are in the world. Thank you very much and goodbye.