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Funding thesis
Although BMW (OTCPK:BMWYY) is a well-renowned model that leads the premium phase of the automotive trade, there are some points of its enterprise mannequin that make me suppose it’s more likely to take a more durable hit than different automakers in the course of the troublesome months which can be looming over us. After BMW reported the 1H22 outcomes, I see some regarding knowledge about BMW’s technique, margins, and free money movement that I wish to share with the In search of Alpha group.
Abstract of earlier protection
About two months in the past, I began masking the inventory with this text: BMW Is Approaching An Attention-grabbing Valuation, However Could Undergo From Leasing Headwinds. Briefly, my analysis led me to search out out that BMW has been betting on growing its volumes by means of a robust monetary department. On this manner, it could actually declare that it’s the main premium model by way of autos offered. Nevertheless, its margins should not very excessive and the return on capital employed is round 4{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}, which isn’t very engaging. As well as, the monetary department can publish good outcomes when the used-vehicle market goes upwards, however, if a recession kicks off, then the corporate would undergo necessary losses. With a view to perceive this, I wish to report how, in my earlier article, I defined how leasing works:
To begin with, the produced automobile is offered by the automotive division to the monetary companies one. At this stage, there may be nonetheless no buy from a buyer. The sale nonetheless is registered at a traditional retail worth. The financing service division turns into the lessor and leases the automobile to a buyer who pays a month-to-month charge to make use of the automotive, having fun with the great whereas avoiding the whole value of possession. The lessor earns an curiosity on the fee. In a low price setting credit score was simple and this led many shoppers to select a leased automotive as a substitute of shopping for one. As soon as the lease is over, the shopper both has the likelihood to purchase the automotive for its residual worth or return it to the lessor and begin a brand new lease. Now, that is the place issues turn into fascinating. When the auto division offered the automobile to the monetary companies, it wrote on its revenue assertion each the earned income and the price of it. On the finish of the lease, the monetary companies division writes on its steadiness sheet the depreciation expense that comes from the distinction between the price of income and the residual worth of the automobile. Since this occurs internally at BMW, reconciliation is required to offset the income and its value between the 2 divisions, so as to stop a double account. Thus, BMW sees instantly the revenue from the automobile offered to the monetary companies, after which reconciles it because the leasing expires. Let’s get to the necessary half, the place the chance lies. BMW clearly controls the pricing between its automotive and its monetary companies divisions. If BMW is in an setting the place automotive costs are excessive, then the sale between the 2 divisions is consistent with the true retail worth for the automotive. Nevertheless, if the value of the sale is a worth that will not be accepted by clients as a result of they may ask for a reduction, then the sale between the 2 divisions takes place however it’s overpriced and there will probably be a distinction between the value of the interior sale and the actual worth that comes from the lease funds and the residual worth on the finish of the leasing interval.
BMW has made its core technique previously years to extend its volumes. Moreover, as many German automakers, it has made Chine one in every of its largest markets, exposing itself to attainable geopolitical troubles.
The scenario after 1H22 outcomes
Once I seemed on the report and skim the earnings name transcript, what I seemed for was how the corporate was dealing with a scenario the place volumes are decrease because of provide bottlenecks and rates of interest are rising, inflicting clients to be extra cautious about taking loans.
Right here is the report of the deliveries by area and market in the course of the second quarter and the primary half.
BMW 1H22 Report
As we are able to see, total volumes have been down 13.4{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} within the first half, with the second quarter being down 19.5{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} YoY. That is one thing that’s fairly widespread amongst automakers. Nevertheless, it’s a scenario the place corporations that focus extra on margins have a bonus over corporations betting on volumes.
China was notably hit in the course of the previous quarter because of the zero-Covid technique that led to new lockdowns, miserable BMW’s gross sales by 28.3{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}. As this desk exhibits, BMW offered about 43{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} of its autos in Asia, 80{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} of which in China. Which means that China makes up about 35{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} of world gross sales.
With Li Auto difficult German automakers on pricing, I do have some concern about BMW’s publicity to China. To this we might add the geopolitical uncertainties which, in the meanwhile, make me lean in the direction of corporations which can be extra centered on the West.
Revenues have been up YoY to €65.9 billion in comparison with the primary half of 2021 the place they totaled €55.3 billion. That is 19.1{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} improve YoY. Now, in the course of the early a part of this yr, BMW elevated its stake in its BBA Chinese language three way partnership from 50{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} to 75{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}. This vital progress in income primarily got here from the total consolidation of BBA in BMW’s Monetary Statements. Nevertheless, this additionally had a dampening impact on different knowledge. As defined within the report, the Q2 was negatively impacted by results from the total consolidation of BBA of €1.1 billion. The automotive EBIT margin in Q2 was 8.2{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} whereas for the primary six months of the yr it reached 8.5{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}. Excluding the consequences from the consolidation of BBA, BMW reached an EBIT margin within the automotive phase of 12.0{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} in Q2, whereas for H1 it signed 12.6{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}, which might be above the steering of EBIT margin between 8{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}-10{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}.
The EBT climbed 65.9{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} to virtually €16.2 billion. As the corporate defined, the one-time impact of round €7.7 billion from the revaluation of beforehand held fairness pursuits in BBA at honest market worth was a serious driver. Accordingly, BMW’s EBT margin was at 11.3{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} for Q2 and 24.5{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} 1H22.
Now, we now have to pay shut consideration. With out this revaluation, the EBT would have thus been €8.5 billion which is decrease in comparison with the €9.7 billion totaled within the first six months of final yr. This can be a first regarding signal that I observed and that I did not see highlighted.
Secondly, the Monetary Providers Section concluded simply over 815,000 new contracts with retail clients. This can be a consequence down 20.8{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} YoY. Clearly, because the firm was capable of promote much less autos, this was additionally mirrored within the variety of financing and leasing contracts concluded. As well as, the monetary companies sector continues to be extremely aggressive. In Q2, new contracts have been down 29.3{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} YoY, which is extra in comparison with the 19.8{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} lower in deliveries. If we take a look at the primary half, new contracts have been down 20.8{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}, in comparison with a lower in deliveries of 13.4{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}. Which means that a smaller portion of shoppers is prepared to take a mortgage to purchase a BMW, hurting a portion of BMW’s enterprise mannequin that the corporate counts on.
The truth is, as reported in its press launch, the proportion of BMW new autos leased or financed by the Monetary Providers Section stood at 44.4{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} on the finish of the second quarter, -5.8 share factors YoY when the brand new autos leased reached 50.2{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}.
Nevertheless, the preowned automotive market helped the Monetary Section encouraging the corporate to lift its goal vary for return on fairness for the phase by three share factors, within the vary between 17{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} and 20{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}.
Among the many new technological introductions, BMW introduced that its new working system has now set a brand new document for vary in an electrical SUV in a take a look at carried out by car-shopping information Edmunds. In a real-life EV vary take a look at, it drove 377 miles and exceeded its EPA vary by a powerful 62 miles. It additionally used much less vitality per hundred miles than another electrical SUV and even some smaller EV fashions. BEV gross sales are additionally going very effectively since they greater than doubled YoY reaching 75,890 autos.
Ahead outlook
What made me a bit involved was the steering BMW gave for the yr. To begin with, it said that it expects the EBIT margin within the Automotive Section to be throughout the vary of seven to 9{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e}. Because the firm stated that with out the BBA consolidation it could have reached a 12{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} EBIT margin within the first half, it signifies that it expects a really powerful second half of the yr, with EBIT margins within the low single digits. In different phrases, BMW expects inflationary strain to be heavy.
That is fairly necessary, as the corporate, having order books well-filled a number of months out, expects strong progress in deliveries for the second half of the yr that can make it capable of virtually meet up with 2021 deliveries. That is what BMW states in its report:
we anticipate a slight decline in deliveries for the total yr. This can solely partially be offset in our outcomes by constructive worth and blend results and the event of the preowned automotive markets.
Moreover, in the course of the earnings name, BMW administration introduced that it’s seeing orders coming down, stating that this was good to present some aid to the provision chain. Whereas it might be wholesome for a number of months, that is one other warning sign concerning the second half and, most significantly, about 2023. Whereas in different industries, like farming equipment producers or vans producers, order books are masking already a part of 2023, BMW and different automakers will take successful sooner than others.
One other facet that I did not like is the clear lower in free money movement. Whereas this was widespread to many capital intensive corporations that had inventories go up in the course of the previous months, BMW posted a free money movement quantity to €7.77 billion million, up 58.6{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} YoY. Nevertheless, the primary motive for the YoY improve was the money influx from investing actions, whereby larger money outflows for intangible belongings and property, plant and gear have been greater than offset by a money influx of €5 billion ensuing from yet one more consolidation, the one in every of BMW Brilliance. Thus, the actual free money movement generated by working actions was €2.77 billion, considerably much less in comparison with final yr. This, per se, is just not an actual regarding drawback, as many automakers had the identical drawback because of inventories going up. Nevertheless, since BMW’s technique focuses on volumes, its excessive inventories had a much bigger impression on its free money movement in comparison with these automakers that focus extra on margins. Mercedes-Benz, for instance, selected a number of years in the past to scale back its volumes so as to attain higher profitability, as I defined in an article. Now, this technique is ensuing extra environment friendly in at the moment’s tight setting.
Valuation
Whereas in my earlier article I said that BMW was approaching an fascinating valuation, I’ve now revised downwards my future expectations. The truth is, I feel the corporate accurately trades now round a fwd pe of 4 and a fwd EV/EBITDA of 6.7. To this, we might add the uncertainty of its future dividend, given the truth that I anticipate diminished free money movement for the subsequent yr and half.
Thus, I carry on ranking the inventory as maintain, downgrading my earlier goal worth of $28.83 by 15{430e1a8850461df0375664f3ed5a2c2297e140610805e00c8bb86520276c781e} to $24.50, which is near the present share worth.
Conclusion
Not all the time in style manufacturers are additionally the most effective shares to select. In the intervening time, I see higher alternatives within the automotive trade, as I attempted to elucidate in my protection of Stellantis’ undervaluation. Within the premium phase, I feel Mercedes-Benz is at the moment executing higher than BMW. Nevertheless, if we issue within the troublesome setting Germany and Europe are in, I might in the meanwhile counsel staying on the sidelines concerning BMW.