BMW’s China Money Making Machine Under Pressure

BMW’s China Money Making Machine Under Pressure.

Threat To Profits Would Hit All In China.
Most Investors Wary, But Sanguine.
Is Nationalisation A Serious, Long-term Threat?

After five years of relentless sales improvement, BMW is warning investors that harder times may be ahead, and that China’s apparently limitless ability to provide ever-fatter profits may be coming to an end.

In 2014, BMW’s earnings before interest and taxes (EBIT) soared 14 per cent to €9.12 billion, but at the annual press conference, the company warned that 2015 sales and profit growth will slow because of an ageing model line-up and the high cost of new technology to meet tough fuel consumption regulations in Europe and the U.S.

At the press conference, outgoing CEO Norbert Reithofer had this to say, which should have rocked investors back on their heels.

“Many uncertainties remain: important markets like China are losing momentum,” Reithofer said.

BMW is believed to make about 50 per cent of its annual profits in China.

The warning had little effect on the BMW stock price, which was still close to €120 after a spectacular 50 per cent run-up since last October.

Commerzbank analyst Daniel Schwarz didn’t seem too worried. He said after an investors meeting at BMW’s U.S. factory in Spartanburg, South Carolina, that some China problems were being addressed, including parallel imports. BMW’s price discounting in China was slowing.

Bernstein Research analyst Max Warburton though said investors better take heed.

“We believe the magnitude and the consequences of China’s profit deterioration are not properly recognised,” Warburton said.

And this won’t just hurt BMW. The German premium manufacturers like Mercedes and Volkswagen’s Audi and Porsche have also become used to China being a virtual license to print money.

“At least BMW is shouting loudly about China. We have a strong suspicion that others will, in due course, find themselves having to follow suit,” Warburton said

No threat to profits
Morgan Stanley analyst Harald Hendrikse was also worried about China, although he said BMW’s general prospects have been improved by the fall of the euro against the dollar.

Other analysts thought BMW’s long-term goal of double digit EBIT profits wasn’t really threatened.

Evercore ISI said for decades BMW was a business generating 6-7 per cent EBIT margins. For coming years, this was going to rise to 10 to 11 per cent. BMW’s automotive EBIT margin was 9.6 per cent in 2014, at the upper end of its target range of eight to 10 per cent.

But Bernstein’s Warburton reminded investors that China’s sudden emergence as a generator of profits might disappear just as quickly.

Quickly given, quickly removed
“The speed and spectacular transformative effects of China from 2010 should never be forgotten. And should act as a reminder that what is quickly given can quickly be taken away again,” Warburton said.

Warburton wondered if only BMW was in trouble in China.

“The 7 Series (due to replaced later this year) is dying in the market. Mercedes hasn’t yet seen the same issue with the S-Class as it’s new, but that’s just timing. Second the (big SUV) X5 has been uniquely affected by parallel imports, requiring price cuts. The X4 has not been a hit. Chinese consumers are even more confused by the positioning of the 3 Series and 4 Series sedans than the rest of us. The 2 Series Active Tourer isn’t selling,” he said.

BMW now sells the 4 Series as the coupe version of the 3 Series.

“But ultimately, BMW is being affected by market factors that will hit everyone. Anything with a German badge used to sell at full price. Not anymore – now demand is easing, consumers are pickier, buy smaller engines and demand discounts. This is going to catch up with everyone,” Warburton said.

Warburton said he was also worried by the impact on BMW of its small car programme, which it needs to do to lower its corporate average fuel economy. The 2 Series minivan was a risk to the BMW

brand and for margins. Mini small cars were also under pressure.

Warburton’s research note was headlined “BMW: Listen! The smartest German OEM (manufacturer) is warning you about China”, but he wasn’t convinced the market was paying attention.

“China’s boom has defined Reithofer’s tenure. Will China’s deterioration define his successor’s time at the helm? It’s a clear risk in our view,” Warburton said.

The new CEO Harald Krueger takes over May 13.

Nationalisation?
Meanwhile, possibly the most eyebrow raising comment about China came from Automotive News editor-in-chief Keith Crain, who pointed to recent heavy fines levied against foreign auto makers in China, which seemed to be punitive, seeking to expand government authority on the industry.

“Many people are concerned that when the time comes – and it might be tomorrow, next year or in a decade – foreign companies will be nationalized. It might be one at a time, or it could be all at once,” Crain said in his weekly column.