China, Europe Worries Raise Questions About BMW Profitability – Forbes

Posted: Tuesday, October 21, 2014

As investors start to worry about China, and Europe’s economy is endanger of foundering, could even mighty BMW find its fat profits coming under pressure?

Investment banker Credit Suisse thinks so, although so far this looks like a minority opinion. Morgan Stanley Morgan Stanley for instance reckons BMW is “future proof” because of its first-moves on the green technology front.

“BMW is well on track to meet future CO2 (carbon dioxide) targets. Industrialization of lightweight carbon-fiber construction should protect BMW from undergoing the same negative mix shift to small cars as peers. China is more opportunity than risk. We expect growth and margins to moderate (there), but BMW has built a strong franchise with a highly profitable JV (joint venture) in a market that remains underpenetrated with luxury cars. Fears of a downside risk look overdone,” said Morgan Stanley analyst Laura Lembke.

But Credit Suisse analyst Mike Dean is worried by China developments and Europe weakness.

“The perception of BMW as a relative safe haven is likely to change as sentiment turns on China and slower volume growth, higher incentives, falling Auto EBIT (earnings before interest and tax), and we forecast little or no third quarter free cash flow. With a rising cost burden for all (manufacturers), we are unlikely to see future costs falling away in 2016,” Dean said.

The new Active Tourer minivan is BMW's first front-wheel drive vehicle

The new Active Tourer minivan is BMW’s first front-wheel drive vehicle

BMW’s key model sales weakness will be underlined by increased competition from Mercedes, Porsche Porsche, Audi Audi, Jaguar Land Rover and Maserati next year.

“BMW faces further negative model momentum, and we calculate its average model age is 3.8 years in 2014 and rising. We are two years away from the new 5-series launch and still 14 months from 7-series,” Dean said.

China provides around 30 per cent of BMW’s operating profit. In the second quarter, BMW raised EBIT to 2.6 billion euros ($3.3 billion) from 2.1 billion euros ($2.7 billion). The auto profit margin jumped to 11.7 per cent in the second quarter compared with 9.6 per cent in the same period of 2013. BMW’s long-term profit margin target is eight to 10 per cent. BMW’s share price has been on the slide recently, along with other automotive companies. It dropped almost 16 per cent since late July’s €95 to below  €80 in mid-October. It has rallied a bit lately.

Long-time BMW bull International Strategy & Investment (ISI) remains confident though. The original share price fall was due to worries about Europe, and the Chinese monopoly authorities actions among other things. ISI remains confident though that 2015 auto profit margins can stabilize at 10 per cent.

And unlike Credit Suisse, ISI sees BMW’s product momentum as a plus, not a minus, with an added plus its regional balance.

“With a young SUV fleet, especially the new X4 and X6, a new Active Tourer and 4 Series in addition to an entirely new Mini range we can’t see how the momentum could be worse in 2015 compared with this year,” ISI analyst Arndt Ellinghorst said.

Even China shouldn’t be a problem for the likes of BMW, and Mercedes, and Volkswagen’s Porsche and Audi.

“Our most recent conversations with Chinese companies and industry contacts suggest that the momentum for German premium autos brands should continue to be solid and even improve with financing becoming more available. In addition, we are confident that BMW can manage its costs flat to down so that some positive leverage is still possible,” Ellinghorst said.




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