BMW (Bayerische Motoren Werke) AG (OTCPK:BAMXY) is a premium automobile manufacturer from Germany. The core business of the group is the conception, manufacturing and sale of automobiles. In auto, it operates under three brands: BMW, Mini and Rolls-Royce. The group also has motorcycles and financial services units.
In 2010, the last full year report available, the auto business generated around 75% of sales, financial services 23% and motorcycles 2%. It produced almost 1.5 million vehicles with around €60 billion ($80bn) in sales. The financial services unit business is based on the principle of financing as a package for selling cars, not affecting the sales price but facilitates the cross-sale of other services and boots customer brand loyalty.
Following an all-time low in 2009 the share price began a rebound, exceeding its previous peak level reached in 2007. In the last twelve months, the stock is up more than 20%, clearly outperforming its closest peer Daimler AG (DDAIF.PK), Mercedes-Benz brand owner, which is down 5% in the same time period. Compared to Volkswagen AG (OTCQX:VLKAY), owner of the Audi brand, BMW share had a similar return in the last year.
The premium market is less dependent on the credit market, or general measures to favor consumption, which distinguishes them from the mass manufacturers, such as General Motors (NYSE:GM) or Ford (NYSE:F). Although luxury manufactures are more resilient to the business cycle, they are not completely immune, because cars are durable goods and the buying decision is subject to the consumer confidence. Nevertheless, luxury brands achieve higher margins than generalist manufacturers and BMW is the most profitable one.
BMW set out in 2007 its 5-year strategic plan, ambitious targets of an 8% to 10% EBIT margin for the Auto business as of 2012. In 2010, it achieved an EBIT margin of 7.4%, clearly on track to reach those goals. Although the guidance for 2011 is for an EBIT margin higher than 10%, in Q2 achieved an impressive 13.9% margin. The company also have a strong balance sheet and high capacity to generate free cash flow, with €4.5bn ($6bn) generated in 2010 and €1.5bn ($2bn) in 2009 in the automotive business.
The U.S. is a major market for BMW, which account for around 18% of sales, being the luxury leader in 2011 beating Lexus, Toyota's (NYSE:TM) subsidiary, and Mercedes. Germany is the second most important market with 17% of sales. Although the macroeconomic outlook for Europe is negative for the automotive market, BMW's premium brand targeted for high income individuals and small dependence on peripheral countries, result in very resilient sales. In 2011, BMW achieved 7.7% sales growth in Europe, on a market that contracted 3.2%. For instance, its exposure to Spain and Italy together is 6.6% of sales, clearly manageable without a widespread recession in Europe.
China represent only around 14% of sales, but has increased significantly in the last years, given that in 2009 it accounted for only 7% of sales. It is the main source of BMW's strong earnings' growth in the last two years, and that drove the stock price to record levels. BMW operates in China through a joint-venture (50/50) with Brilliance, with local production of 30% of sales. The other 70% are imported cars, which have higher selling prices (for instance, the 3 series sedan is 20% more expensive than in Germany) increasing the group margins to new records high.
Although BMW doesn't provide its profits in individual countries, several times BMW has denied that its Chinese operations represent 40% to 50% of EBIT, as some market observers have estimated, but assume that it Chinese sales generate on average a 20% EBIT margin. The Chinese market should continue to growth in the next years, at least if China avoids an economic hard landing, and should continue to give a boost to BMW's sales growth and sustain the high margins experienced recently. According to the company, the annual growth rate in the Chinese premium segment should be 11% from 2010 to 2020. The company expects to open 30-40 dealerships per year to satisfy the increasing demand.
In the last years BMW diversified its product range, with the introduction of additional models targeting niche markets. The SUV's X models are a good example, from the less expensive X1 to the high-priced X6, which in aggregate accounted for 24% of sales in 2011. This enlarged model offering has enabled BMW group to gain market share over its main competitor Mercedes over the past years. This also lowered the dependency of sales on its two most important models (3 and 5 Series). In 2005 the 3 Series represented around half of sales, but this key model now has a weight of only 23%.
In the auto industry, one major consideration to sales growth is the average age of the products. Typically, cars reach higher sales in the years following launch and start to decline has the model matures, around 4-5 years old. The three most important products for BMW were recently launched, with the new 5 series launched in late 2010, the updated 1 series last fall and the high volume new 3 series this February.
These three models were responsible for more than 50% of sales in 2011, giving a very bright short-term outlook for sales growth. This is also supportive for margins, because there is no need to push sales using aggressive discounts, especially important in the current environment of war with Mercedes-Benz. This was especially evident last January in the U.S., when both companies delayed their 2011 sales announcement in a competitive war to be the number one luxury brand in the U.S.
The company has a strong net cash position of €10bn ($13.3bn) for the Automobile division and very positive free cash flow. Although the automotive sector is cyclical and usually the dividends are volatile and with a small yield, even for income investors the share can be interesting. BMW pays a small dividend (current yield of 1.8%), but intends to increase the payout gradually from the current 20% to a range of 30-40%. The dividend is expected to grow 17% annually for the next three years, from the 1.32€ in 2010 ($1.76) to 2.50€ in 2013 ($3.33).
BMW is very well positioned to benefit from the ongoing U.S auto recovery and the growth in China. Even in Europe, were the macro outlook is more benign, the strong brand name and its heavy exposure to home market Germany, has proven the high quality of the company reaching sales growth last year. The stock is currently cheap, trading with a past and forward P/E of, respectively, 8.79 and 9.18 below its historical average of 10-12x forward earnings. This multiples look undemanding, give that EBIT is expected to growth 10% annually from 2010 to 2013.