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BMW Surprises With Accelerating Profits, But Doubts Remain

Most Investors Though See Tough Profit Targets Being Achieved
2010 Sales Target Of 1.4 Million In Question

BMW impressed investors with the strength of its second quarter performance, but unlike VW, there were some dissenting voices on the sidelines who cautioned that the company’s latest financial report contained some negative factors.

The performance was so good on the surface that some investors reckoned that BMW would now meet its medium term profit target – Strategy Number One – of EBIT margins between eight and 10 per cent in 2012. This target has been pushed by BMW without many outsiders believing it was possible.

BMW had prepared stock markets with its statement a couple of weeks earlier that profits and sales in 2010 would be stronger than previously thought. BMW said then that 2010 pre-tax profit would rise more sharply than its earlier forecast while sales would increase around 10 per cent to more than 1.4 million vehicles, not the previous target of “solid” single-digit figure.

In the event, BMW reported that second quarter net income rose more than six times to €831 million compared with the same period last year. Sales rose 18 per cent to €15.3 billion. Sales in 2010 would indeed hit 1.4 million in 2010, 10 per cent better than 2009, but less than the record 1.5 million in 2007. This was helped by the reception of the new 5-Series, while overall sales looked good in China and the U.S.

IHS Global Insight analyst Tim Urquhart pointed out that BMW’s performance was achieved while the company’s two best selling models, the 1-Series and 3-Series, are nearing the end of their model cycles.

BMW was keeping a sense of proportion about its near term prospects.

“BMW is still cautious over the outlook for the remainder of the year despite its bullish sales and profitability forecasts. A deterioration in the macroeconomic environment in both Europe and the United States remain a real risk moving into the second half, especially given the negative data emanating from the latter regarding the housing market. IHS Automotive believes that the BMW Group’s sales projection of a 10 per cent increase for 2010 is marginally ambitious and that it will undershoot this figure with total sales of 1.32 million,” Urquhart said.

Deutsche Bank also raised doubts about the sustainability of BMW’s performance, which bought it close to its arch-rivals Mercedes and Audi in terms of profitability.

“We believe that when taking a second look – overproduction in the second quarter boosting fixed cost absorption of about €250 million, foreign exchange hedging drop-offs, provisioning which remained way below norm in the first half – it is too early to see this as sustainable and we do see BMW giving back profitability in the second half,” Deutsche Bank analyst Gaetan Toulemonde said.

But other analysts had few reservations.

“For the first time we credit BMW with the ability to achieve its eight-10 per cent 2012 auto margin target,” said Citigroup Global Markets analyst John Lawson.

Lawson said some investors would be reluctant to assume that BMW’s performance in China was sustainable. He reckoned China accounted for about 12 per cent of sales, 15-20 per cent of revenues and 30 per cent of profits.

But there were other strong points yet to come.

“Beyond China, we also see good scope for further profit momentum. A classic auto recovery built around modularisation and product renewal still has €3-€4 billion of improvement potential, we estimate, while 1-Series, 3-Series plus X-3, 6-Series and Mini variants push down product portfolio age from four to 2.2 years,” Lawson said.

J.P.Morgan analyst Ranjit Unnithan raised his 2010 and 2011 EBIT targets by 49 per cent and 32 per cent, with 2010 now rising to €4.5 billion with a 7.5 per cent operating margin, €1.5 billion above his previous estimate. The 2011 estimate now rises €1.3 billion to €5.3 billion, with an 8.2 per cent operating margin.

The Wall Street Journal’s Heard on the Street column liked what it saw, and had no inhibitions about the future.

“Worries that these are one-offs look misplaced even if growth slows. BMW seems to have growing pricing power across its business, with a lower fixed-cost base,” the column said.

Neil Winton – August 15, 2010

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