BMW’s Finances Benefit From Longer, Cooler Look

BMW’s financial performance looked even better after the dust settled a bit.

When BMW announced its third quarter results, the initial reaction from investors was that the numbers, although strong, were comparatively disappointing, and put the company in third place in terms of profitability behind its great rivals Mercedes and Audi.

Audi was declared the winner with an operating profit margin of 11.2 per cent. Mercedes was second with 9.5 per cent, and BMW trailed with 8.1 per cent.

But after investors took a closer look at the numbers, the verdict became less clear.

According to Citibank Global Markets, BMW may have been happy to disguise a more powerful performance than the announced figures.  (German companies use a more opaque system of accounting than other, more transparent standards, which can hide the level of real profitability).

“In our view, it really is not in BMW management’s interest to allow too high a profit achievement during 2010,” said Citibank Global Markets analyst John Lawson in a report.

Lawson said reporting too high a profit rate confuses the message that underlying or structural profit improvements continue to be needed.

Apparently, BMW’s reported profit before interest and tax – EBIT – was lower than predicted because staff bonuses were larger than expected. If you factor that back into the numbers, BMW’s profit margin was really 9.9 per cent. Other technical factors could raise it to over 11 per cent.

Lies, damn lies, statistics
Whoever said there are lies, damn lies, and statistics, knew what they were talking about.

Deutsche Bank thinks BMW will be able to meet its long-term profit target of 8 to 10 per cent a year by 2012, but it will be very hard to beat it. Foreign currency developments could be dangerous too.

“In the current foreign exchange environment we believe that exceeding this corridor sustainably will prove to be challenging. We would stress that in our view BMW already incorporated some €400 million into EBIT in the first nine months from positive foreign exchange effects, demonstrating the large swings/dependence BMW has given its sizeable net revenue exposures,” said Deutsche analyst Gaetan Toulemonde.

Bernstein Research analyst Max Warburton agreed that there might be an argument about BMW’s exact numbers, but most everyone agreed they were pretty good.

“One can’t dispute that profitability is very strong and dramatically better than anyone could have hoped for at this stage of the cycle,” Warburton said.

But there are some worrying questions about the future of BMW, which also apply to Mercedes and Audi.

Will China last?
Can they maintain their huge profits from China? Will government regulations in Europe and the U.S., which seek to raise fuel efficiency, sabotage the premium sector’s business plan which has relied on huge profit margins from gas guzzling, hugely expensive sporty cars? Demand for BMW’s new 5-series in Europe is said to be almost entirely for two liter diesel versions with razor thin profit margins. Will the industry’s finances be crippled by the research costs for battery and hybrid cars?

Another worrying factor, according to BHF-Bank of Germany, is that BMW’s factory capacity use has now reached 100 per cent and the company is planning to raise capital spending to seven per cent from the current six per cent.

BHF-Bank analyst Aleksej Wunrau said this would offset any projected increase in BMW’s profitability.

Citibank Capital Markets Lawson believes BMW’s profitability will continue to be strong and China’s contribution will be solid.

“Chinese earnings have more longevity though we still do not project these earnings climbing much above the 2010 estimated achievement of around €1.3 billion,” Lawson said.

Bernstein Research’s Warburton is optimistic too.

“The bull case on BMW rests on Chinese profitability holding, or growing further, while mature markets recover. It is not impossible that this scenario materializes although CO2 legislation is set to raise costs and lower mix in Europe and in the U.S., some degree of caution is surely prudent. The timing of all the stars aligning is also unclear. Looking into 2011, we expect only a modest degree of profit improvement,” Warburton said.

Neil Winton – November 15, 2010