BYMOF - BMW Is Undervalued But Investors Will Need Patience

2023-05-19 12:15:35 ET

Summary

• BMW announced record financial results for the fiscal year 2022 and strong Q1 2023 results.
• Drivers were high car prices and accounting effects from a JV in China.
• BMW has a cautious strategy regarding the transition to electric vehicles, making the company a good pick for investors who agree with that.
• Despite the cautious approach, the transition to EVs is going well. This should further improve with the NEUE KLASSE (New Class), coming in 2025.
• Valuation is low, but there is no immediate trigger in sight to improve this.

(Note: all amounts in the article are in EUR. At the current exchange rate 1 EUR is around 1.08 USD.)

Investment thesis

BMW (BAMXF) (BYMOF) (BMWYY) achieved the best annual result in the history of the company in 2022 and reported strong Q1 numbers on May 4.

Shares are up more than 50 percent from their low in September last year, but the forward-looking P/E ratio is still only around 6, and the dividend yield above 8%.

This is certainly not expensive and also below the historical average.

As with other (legacy) car manufacturers the market is pricing in the risk of the EV transformation and the macroeconomic environment. In my view this is overblown. BMW is a quality company with record revenue and profit. The focus on the upper premium and luxury segment insulates the company to a certain degree from an economic downturn, and the EV transformation is managed well - in my view.

Where BMW stands out among its peers is the refusal to commit to a date for phasing out combustion engine vehicles. BMW continues to invest in them, which will cost billions. The money could be well spent though if full electrification takes longer than other manufacturers are planning for.

While I consider BMW a good investment, at the current valuation I prefer its peer and arch-rival Mercedes ( OTCPK:MBGAF , OTCPK:MBGYY ) due to the more ambitious EV strategy and higher profitability.

Q1 2023 results

Financial results for Q1 2023 and Q1 2022 are not directly comparable as there was a one-time effect from the full consolidation of the Chinese BBA (BMW Brilliance Alliance) joint venture in February 2022. BMW was the first foreign car manufacturer to take over the majority of its production joint venture in China, going from 50 to 75 percent ownership on February 11, 2022.

This led to a one-time accounting profit of almost 8bn and record profit of 18.6bn for the FY 2022. With the purchase, cash and cash equivalents of 8.7bn were taken over, resulting in a positive cash balance of 5bn euros in the Automobile segment. At group level, a positive cash amount of 3.5bn billion remained after the transaction. Financially, the deal was certainly worthwhile for BMW.

Given the one-time gains in 2022 profit before tax for Q1 2023 was reduced by -58% YoY from 12.227bn in Q1 2022 to 5.129bn. In Q4 2022 profit before tax had been 3.253bn.

Deliveries were more or less flat YoY

Automotive deliveries were down -1.5% YoY. BMW delivered 588,138 cars to customers in the quarter. Among the three brands, BMW, MINI and Rolls-Royce, only the ultra-luxury brand Roll-Royce managed to increase deliveries. 1,624 cars do not look like much, but with prices in the hundreds of thousands of euros, it adds up nicely.

(Note - in addition to the Automotive Segment, BMW also sold around 48,000 motorcycles in Q1 in its Motorcycle segment). The revenue and earnings contributions are comparatively small though, revenue was 933mn and EBIT 154mn. In any discussion on BMW Group financials the Motorcycle segment can be left out.)

Europe and Asia (especially China) accounted for 80 percent of deliveries.

The high dependency on China is a risk in my view. China is moving considerably faster to EVs than the rest of the world and currently BMW is selling mostly ICE vehicles there.

With the takeover of the Chinese JV BMW also made a very long-term commitment to China, as the production contract with Brilliance has been extended to 2040.

When presenting the Q1 results, the company said that order books are well filled, but did not give any specific numbers.

Revenue and profit increased due to a favorable product mix and higher prices

Group revenue increased considerably to 36.85bn from 31.14bn in Q1 2022. We have seen this from other auto manufacturers in Q1 of this year and also 2022 - through a favorable product mix and higher prices manufacturers were able to convert flat or even lower unit sales into higher revenue and profit.

BMW not only managed to increase revenue from flat sales numbers, but also profitability. The EBIT margin increased to 12.1% versus 8.9% in Q1 2022. The forward guidance is for margins to be between 8-10 percent, so we should not get too excited here, although I think the guidance is quite conservative.

As a comparison, Mercedes had an EBIT margin of 14.6% in Q1 2023 , so is significantly more profitable. This is the main reason I prefer Mercedes over BMW (I also like the Mercedes strategy to focus on the luxury segment as I have laid out in a recent article, Mercedes: The Bull Case Is Getting Stronger ). I really would like BMW management to be less content with the 8-10% margin range.

Earnings per share were 5.31 euros for the quarter. Because of the one-time gain in Q1 2022 this is a significant decrease YoY from 15.33 euros. On an annualized basis though it would still mean a P/E ratio of only around 5.

EV sales and transformation

So far BMW sales successes have been mainly due to combustion engine cars. But BMW knows that the road to success will only continue if the transformation towards electromobility succeeds. Still, the company is now one of the last car manufacturers not to give a date for completely phasing out gasoline and diesel cars.

While the company had brought the first electric car onto the market ten years ago, BMW does not believe in a fixed phase-out date for the combustion engine and is still planning to use combustion engines for a longer time than some competitors. Mercedes, the arch-rival in the premium and luxury car segment, is a prominent example. Mercedes wants to be all-electric by 2030.

Interestingly. BMW already sells more fully electric cars than Mercedes though, both in absolute numbers and in relation to total sales.

In the Automotive segment the share of electric vehicle deliveries almost doubled YoY to 11.0% from 5.9% in Q1 2022. The share was also up QoQ. In Q4 it was 10.2%. In absolute numbers BMW sold 64,690 EVs in Q1 2023. Mercedes sold 51,639 EVs in the same time period and the share was a little lower at 10.3%. Both companies also sold about the same number of plug-in EVs, but this number is stagnating and will probably go down over the next quarters.

In 2023 BMW wants to increase the EV share to 15 percent of total sales, so there is still some way to go over the next three quarters. By 2024, at least one in five new cars should have a fully electric drive, by 2025 it should be one in four and by 2026 one in three.

From 2025 onwards, the vehicles of the NEUE KLASSE (New Class) should provide a boost. Within 24 months, BMW intends to bring at least six models of this series onto the market, including high-volume vehicles in the 3-series segment. The technical platform is still under development and is fully geared towards electromobility. A major goal of is to enable a cost-effective production of electric vehicles that generates the same returns as combustion models.

At the Auto Shanghai exhibition in April this year BMW presented only EV models, for the first time. In his recent shareholder letter the CEO Oliver Zipse said that at the end of 2023 BMW will offer 11 BEV vehicles across its brands BMW, Mini and Rolls Royce, especially targeting the upper premium and luxury segments. The Rolls Royce Spectre will have a fully electric version in H2 this year.

At the same time, however, the auto manufacturer continues to rely on a flexible mixed architecture on which plug-in hybrids, diesel, petrol engines or even cars with hydrogen-based fuel cells can also be manufactured. In February, for example, the company launched its BMW iX5 Hydrogen pilot fleet .

This drive variety will cost billions but could be worth it - the more so the longer it takes for fleets to be electrified worldwide. Competitors like Mercedes are saving a lot of their development budget by focusing on pure electric architecture.

Largest connected fleet worldwide

There is a lot of talk about how much data Tesla (TSLA) is collecting, especially through its FSD (Full Self Driving) beta. But BMW can claim to have the largest connected car fleet on the road, with 20 million vehicles worldwide sending 20 billion messages daily to its own BMW Cloud which runs an Amazon Web Services. The anonymized real-life data is used to enhance development activities.

Valuation

BMW ordinary shares have a forward-looking P/E of 6.4, based on the EPS consensus of 15.6 euros. Estimates range from 12.6 to 18.6 earnings per share in 2023. This seems cheap, unless of course you think that BMW profits and cash flows will go down in the future due to either macroeconomic conditions or the EV transformation. I do not think so. While EV production is still more expensive now, the NEUE KLASSE should change this for BMW.

Thanks to the record profit of 18.6bn in 2022, shareholders received a dividend of 8.50 euros for 2022, which was 2.70 euros more than in the previous year. (Note - Like many other German and European companies, BMW has only one dividend pay-out per year.) We should expect this to decrease somewhat for 2023 given the one-time gains in 2022, but the dividend will probably not be much lower than 7 euros, so a yield of around 7% based on the current share price of around 100 euros for ordinary shares.

In addition to the dividend, a share buy-back with the total value of up to 2bn, 3% of the current market cap, is planned to be finalized in 2023, followed by another buy-back of up to 2bn until 12/2025. In total BMW Group is authorised by its board to buy back up to 10% of the market capitalisation until May 2027. So we are looking at a nice annual shareholder return of around 9-10% from dividends and buy-backs, in addition to the low valuation.

Share structure and which shares to buy

BMW has a dual share structure with ordinary (symbol: BAMXF) and preferred shares (symbol: BYMOF). Sometimes the ordinary shares are also called common shares. The difference is that ordinary shares have voting rights and preferred shares do not. As compensation the dividend for the preferred share is 2 (Euro) cents higher than the dividend for the ordinary share. At the current shares prices of around 102 for ordinary and 96 euros for preferred, the difference is immaterial.

My recommendation is to go for the ordinary shares. There are ADRs (symbol: BMWYY) too that correspond to ordinary shares ( 3 ADRs make one ordinary share ), so for U.S. investors those are usually easier to buy anyway. There are also 10x more ordinary shares than preferred shares, making them more liquid.

Conclusion

I think that BMW will come out fine through the EV transformation. Although BMW shares have a low valuation, investors need to have a long-term view to be rewarded, assuming they agree with the core thesis that BMW will continue to be successful during and after the EV transformation. A trigger for a fundamental value reset will be needed, but is not in sight yet. Shares have also gone up though over the last months - in line with the German market - and there is possibly a better entry point ahead. But the high dividend and share buy-backs will help patient investors.

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