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BMW’s Positive Forecast Result of Rule, Not Character Change

“BMW reacts to new German accounting rules saying profit guidance must correlate to internal planning”

Germany’s BMW didn’t get to be the number one premium car manufacturer in the world by coming over all touchy-feely, so investors who interpreted the company’s latest upbeat profit prediction as some kind of personality change have got it wrong.

The out of character brashness at an investors meeting last month was explained, sadly, by new government regulations insisting on clarity, not a breathless urge to be nicer and more honest to the financial world. And analysts who studied BMW’s projection were also worried by more mundane thoughts about a looming hit to the bottom line from foreign exchange losses.

BMW and German companies generally are famous for their conservative profit forecasts, and are happy to admit not necessarily with a smug grin that they are now happy to report how wrong they were, and that profits last year were much fatter than they modestly anticipated.

“We expect group profit before tax to rise significantly in the current year, despite ongoing volatile business conditions,” said CEO Norbert Reithofer at BMW’s annual financial press conference.

This set off a scramble by investors to buy BMW shares. The company must be really going gangbusters for normally reticent, conservative Reithofer to make such an adventurous forecast, went the logic.

After some time for consideration, the reality became clear. BMW was reacting to new German accounting rules which said profit guidance must now show a close correlation to its own internal planning. So no more underselling and little white lies. Investment bankers also had time to examine BMW’s prospects in more depth, and some spied a looming hit from foreign exchange losses.

Macquarie Research analyst Christian Breitsprecher was one of the sceptics, in a report entitled “BMW – Dropping conservatism”.

“The company not only guided to new record sales of more than two million and an automotive EBIT (earnings before interest and tax) of eight to 10 per cent, which was expected, but also surprised with an outlook of a 10 per cent increase in PBT (profit before tax) in 2014,” Breitsprecher said.

Breitsprecher said he had a couple of reasons to question this outlook. He expected BMW pricing to come under pressure as core but ageing products like the 1, 3 and 5 series struggled in the marketplace, despite the positive impact of new but more niche vehicles like the new X5, 2 Series, upcoming 4 Series Grand Coupe and the X4. He also expressed puzzlement about BMW’s assumption that currency charges in 2014 would be close to last year’s around 214 million euros ($296 million).

“We can only explain this optimism with very favorable long-term hedges, still protecting 2014. However, that means the ‘bomb’ would go off in 2015,” Breitsprecher said. He said the real hit in 2014 would more likely be close to 700 million euros ($966 million), which could rise to 1 billion euros ($1.4 billion) if put off until 2015.

Adam Hull, analyst with Berenberg Bank, said BMW’s economic outlook, and price and mix prospects looked optimistic. BMW’s foreign exchange assumptions were too positive. For 2014, unhedged losses would be closer to 900 million euros ($1.2 billion), and that if rates stayed the same, this simply delayed the impact until 2016, Hull said.

Competition from rivals was cranking up too.

“In 2014, BMW will face greater pressure from the new Mercedes S-Class, Mercedes C-Class and Range Rover Sport, the wider availability of the Audi A3, Mercedes CLA and Tesla S, and the introduction of the (compact SUVs) Porsche Macan and Mercedes GLA,” Hull said. Despite this Hull expects BMW’s auto profit margin to slip only slightly to 9.3 per cent in 2014 from 9.4 per cent in 2013, lurch down to 9.0 per cent next year and move up to 9.2 per cent in 2016.

Not everybody shared this relatively downbeat view.

International Strategy and Investment analyst Eric Hauser expected BMW’s sales to grow this year and next, while spending on R&D falls. The BMW X7, to be made in the U.S., would expand the range of SUVs to compete with other behemoths like the Lincoln Navigator, Cadillac Escalade and rumoured Audi Q9.

“BMW is committed to deliver profitable growth despite an already high level of profitability. We believe this commitment differentiates BMW from certain peers that are facing slowing top-line momentum and increasing fixed costs. BMW is one of the very few auto stocks that has room to grow and improve margins or keep them at a high level, whilst generating more cash than is paid ordinarily in dividends,” Hauser said.

“BMW has superior product momentum than its key German peers Mercedes Benz and Audi in 2014 and 2015. Understandably high profile model lines like the Mercedes S-Class and C-Class attract the most attention when analysts and investors consider how fresh each company’s model line-up is. Yet, when we analyse the data in detail, we find it fascinating to see that BMW’s aggregate of incremental niche models is actually equally significant,” Hauser said.

Worries that BMW was too dependent on China were baseless too, he said.

Macquarie’s Breitsprecher raised his forecast for earnings per share to 8.51 euros in 2014 from last year’s 7.37 euros, but insisted that negatives would apply in following years.

“For 2015 and 2016 we continue to see a negative earnings trend driven by an overall ageing product portfolio and less favorable currency hedge rates.”

“Even if we are wrong and underestimate the positive volume and pricing effects for BMW in 2014, the lack of new volume models and the likely far bigger hit from currencies in 2015 keeps us cautious on the medium-term trend,” Breitsprecher said.

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