2023-11-28 03:21:14 ET
Summary
- BMW, HQ in Germany, is a leader in the luxury motor vehicle segment, and an 'unsung hero' in the EV sector.
- The company is assessed as below fair value, and pays a competitive, but volatile dividend.
- Their long-term outlook is positive, but the next dividend is expected to be reduced, and create a better entry point than today in 2024.
Bayerische Motoren Werke AG ( BMWYY ) is a Germany-based automobile and motorcycle manufacturer. The Company divides its activities into four segments: Automotive, Motorcycles, Financial Services and Other Entities. The Automotive segment develops, manufactures, assembles and sells cars and off-road vehicles under the brands BMW, MINI and Rolls-Royce, as well as spare parts and accessories. The Motorcycles segment develops, manufactures, assembles and sells motorcycles, as well as spare parts and accessories. The Financial Services segment focuses on car leasing, multi-brand financing, fleet business, retail customer and dealer financing, customer deposit business and insurance activities.
Investment thesis
BMW is an iconic luxury motor brand with its roots in exceptional German engineering.
From a solid European base, BMW has built a significant footprint in China, and North America.
Strategically, the company is executing an ambitious electrification pivot, and is positioned as a leader in luxury electrical vehicles.
Due to Macro headwinds and one offs, growth is slow, but the company has a strong while volatile dividend yield.
I rate BMW stock a hold in the short term, accumulate in the medium term.
Regional footprint
As can be seen from the chart below, BMW has a well diversified regional footprint, weakest in the Americas, strong in Europe, but increasingly dominated by Asia. Within Asia, 75% of sales this year have been from China, which is the largest market, representing 33% of global sales, which is twice the size of the next largest market.
Business performance.
The company recently reported its 3rd Quarter results .
While sales performance has been showing double digit growth in the 3rd quarter in the rest of the world, Asia, and particularly China, has been stagnant due to macroeconomic risks, and this has been a drag on overall performance.
Deliveries, as detailed above, are showing some growth, with China lagging, but overall margins are slightly down, while EBIT margins are increasing in the Auto segment, slightly contracting in the smaller Motorcycle segment.
Group profit before tax for the year to date shows a dramatic drop of nearly 34% - what gives?
BMW choose to report the operating result and the financial results separately, and the commentary around the financial result explains the reduction in net income and the group bottom line.
Two items are explained as key drivers of reduced financial performance.
1) The previous year's result included a one off EUR 7.7bn gain from the revaluation of the company's interest in in the China J.V. -BMW Brilliance. As a result the automotive segment net income dropped from EUR 15.9 bn to EUR 9.6 bn.
2) In the 'other entities' segment, the financial impact of hedging and derivatives is reported. Here the net profit dropped from EUR 1.2bn to just EUR 112m due to yield curve changes reducing the efficiency of the interest rate hedging programme. This reflects a very active risk management and hedging strategy, which I see as a positive given the significant financing activities of the company. It's good to see that hedging still produced a net profit for the period. It does, however, introduce some volatility into the results.
However, also reported in the 'other entities' segment is the profit/loss from 'eliminations'. This refers to the activities of the leasing segment, where lower lease cancelations for the period resulted in a profit from eliminations activities rising from EUR 91m to EUR 929m, which offset a large portion of the hedging profit reduction.
Further details in the following chart show the full picture, with free cash flow from the Automotive segment growing by a healthy 24% quarter on quarter. so the picture overall is a reduction in profit year on year due to one off impacts, but a decent set of numbers and good free cash flow being thrown off by the core automotive segment.
Key Strategic initiative - Electrification
BMW is heavily invested in a long-term Electrification strategy, in which it plans to make fully electric vehicles options available for 90% of its models.
The flagship here is the Neue Klasse BMW series, which is due for release in 2025.
The Neue Klasse models will only be offered as all electric models, and promise good performance and efficiency - I reckon they don't look too bad either!
Meanwhile, electric sales of its current BMW line-up, Mini, and even Rolls Royce are growing rapidly.
The BMW sales my model shows continued progress here, with BEV, all electric models sales growth doubling year on year repeating the previous year's BEV growth rate.
Full electric and hybrid models now account for 21% of new sales, and BMW have committed to a target of 50% of sales by 2030, which looks easily achievable at these growth rates.
BMW results
Strategically, with a huge footprint in Europe and China, dominance of the luxury EV segment should provide great growth opportunities in the future. In US, and other emerging markets, the future of EV's seems a bit cloudier, but BMW will retain good optionality for ICE models as well as EV's.
Capital Management
Debt and Interest profile
BMW reports 'Financial Assets' and 'Financial Liabilities' on its Balance sheet, as it operates as a lender to clients in its Financial Services segment, and issues debt instruments to finance this, generating income from the yield, hence the extensive interest rate hedging strategy.
The balance sheet was running EUR 52bn of Financial Liabilities, but also EUR 50bn of receivables from sales financing products, so I see this as a wash.
Clearly the BMW are liable for the liabilities, and the receivables have a much higher credit risk, but the operating income shows a decent spread realised between Interest income and Interest expenses, a positive EUR 130m in the year to date, which is about 35% spread on the interest payments.
Share buybacks
In the 2022 AGM, management was authorised to buy back up to 10% of outstanding shares over a 5 year period. The first tranche with a value of EUR 2bn was completed in July 2023, with a total of 22m shares repurchased and redeemed.
A second tranche of EUR 2bn is underway, with EUR 300m completed since July 2023, and the rest due for completion by end 2025.
Outlook and targets
The management outlook for sales for growth at differing rates in different regions, with a general recovery in the global economy as per IMF's latest growth estimates of 3%. The forward outlook has been updated with a more confident outlook for the 4th quarter.
The outlook for deliveries is updated to strong growth rates, with upgrades in the outlook for EBIT margins, Return on Capital and Return on Equity.
Dividend
The dividend is paid out on a single payment in May every year, as common with European companies. The 2022 dividend rate was 9%, above the long-term average of 5%, with a 50% payout ratio. As discussed above, the 2022 profits were exceptionally boosted by the consolidation of the China J.V. As per the targets above, the profit outlook is to drop for 2023. My assumption is that the full year profit will be 30% below 2022 (i.e., a slight q4 improvement from q3). A similar payout ratio would imply an expected dividend of around 6%.
Valuation
The chart below shows BMW and peers with premium Electric Vehicle offerings. I use current PE's as YCharts doesn't provide a forward PE ratio for BMW. My rough estimate of forward PE would put BMW at 7.8 x, by comparison Volvo forward PE is 8.3 and Mercedes 4.4 as per Y Charts.
I include Tesla to show the scale of valuation differential.
As you can see, BMW seems to be at a reasonable valuation to peers, while Mercedes ( MBGAF ) looks extremely cheap. Toyota ( TM ) and Volvo ( VLVLY ) have higher valuations, while Tesla ( TSLA ) has a PE multiple over 12 times that of BMW!
Morningstar has BMW rated as a 5 star stock with a Narrow Moat rating and fair value of EUR 163, currently SP of EUR 95 at 58% of their FV estimate. This reflects an optimistic valuation perspective on the entire peer group, with Mercedes, Ford, and Renault selected as peers, all trading at similar discounts.
Seeking Alpha Quant ratings for BMW are for a Hold slightly below S.A. analysts and Wall St.
Seeking Alpha
Digging into the factor grades, the issue seems to be with the weak growth, which concurs with my own assessment. Other factors are all positive.
Seeking Alpha
For dividend investors, BMW offers a high absolute dividend, with a fair bit of volatility. SA Quant rates the dividend safety as an F, which as explained above, is a precursor to an inevitable, but foreseeable dividend cut. I expect the forward dividend yield in the 6% range as attractive and sustainable.
Seeking Alpha
My own outlook is that post the May dividend, the SP will drop by around 10% from the current EUR 95 level, but assuming the underlying business performance improves along the current outlook and trend, will recover to current levels by the end of the 2024, and improve from there.
I will be watching for whether management wait for a lower SP to continue the buybacks, or act now to save the outgoing dividend payment.
Risks
Turning to the full year 2022 report , BMW identify some key business risks.
Macroeconomic
Key risks identified here include the Ukraine War, US China trade relations and US / European recession risk. BMW assesses these risks as enhanced, but not material to the sustainability of their business in the long term. My own assessment is that the short-term risk of recession is at a material level.
Strategic
Changes in legislation and regulation & competition risks are in this bucket. BMW is quite bullish here, seeing the risk of continued emissions legislation as an upside risk to short-term earnings, given their strong momentum in EV's.
On the competition front, other prestige brands are acknowledged as presenting a material risk.
Operational & purchasing
Supply chain risks, labour risks, and natural catastrophes fall into this segment. The stable German and China labour markets are a plus here, and BMW seems to have fared comparatively well in US. Supply chain risks and dependencies, especially to Energy and Micro chips are material.
Financial
Key financial risks relate to currency, raw material pricing, liquidity, and financing pension obligations. The latter is the flip side to the stable labour relations which help mitigate operational risk.
Other material financial risks lie in volatility of residual values that impact the leasing business, interest rate movements (hedged as discussed above) and credit risk associated with their financing model.
Legal.
These risks include anti competition risk and other key compliance areas, especially in the EU, and the need to operate in multiple legal jurisdictions.
In my view, the key risks from a short-term business performance point of view are the macroeconomic risks, recession potential and a credit event.
Summary
BMW is a great technology company with a strong brand and consumer proposition, and a sophisticated financial model.
They are a bit of an 'unsung hero' in the Electric vehicle space with a compelling strategy and demonstrated progress towards ambitious targets.
The underlying business is on a good trajectory, however there is significant short-term year on year results volatility from one-off items.
The dividend yield and business outlook are positive, but a dividend cut seems inevitable in the coming year.
Valuation is at or below fair value.
I see BMW as a stock to accumulate in the medium term, but is a short-term HOLD. I expect this outlook to turn more positive after the 2023 full year results and dividend but expect to see an entry opportunity sub EUR 90 in Q1/2 2024.
For further details see:
BMW: Little Near-Term Growth But An Electrifying Future