Yet Market, Puzzlingly, Values Them Cheaper Than Logic Suggests
What Do Investors Know That The Rest Of Us Don’t?
Premium car manufacturers are busily setting records for sales and profits, but investors are apparently aware of some negatives about their prospects that aren’t obvious to anybody else.
That’s the conclusion of J.P.Morgan auto analyst Ranjit Unnithan, who said that although profit margins are now above pre-economic crisis levels for luxury manufacturers, whose balance sheets and cash flows remain strong, share prices are about 30 per cent under levels reached before the economic crash.
“Clearly, one must assume that the investors fear that there is something unsustainable about current margins and cash flows to not value these at historic averages,” Unnithan said.
Unnithan said luxury carmakers have retraced to pre-crisis levels of profitability with BMW and Daimler margins at 11 per cent and nine per cent this year.
“Absent a deterioration of mix, which we think is unlikely, given still recovering developed markets and a still small China luxury market, we think these margins could hold,” Unnithan said.
Investors fear current margins and cash flows are unsustainable, with worries about the current level of sales, mix and the vulnerability of margins if China weakens, and future investment needs. Unnithan believes these fears are unfound because:
- Developed luxury markets are still 14-15 per cent below pre-crisis levels and have room for further recovery.
- China’s luxury penetration is “only” three per cent versus Europe at 18 per cent and U.S. at 13 per cent.
- Premium manufacturers now have a more balanced regional mix – developing markets now 25/50 per cent of mix at BMW/Daimler compared with 16/19 per cent before the crisis.
The biggest threat to the premium makers’ margins is deterioration of mix, which, according to Unnithan, is unlikely because the still nascent Chinese market will strengthen, while regulation on fuel efficiency is being met easily.
“A strengthening euro could also act as a headwind to profit margins. Both Daimler and BMW have a $15 billion currency exposure and a rapid move in euro/dollar levels could act as a drag on margins,” Unnithan said.
Neil Winton – July 1, 2011
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