The market leader in in innovation and design, BMW enjoys an exceptional reputation across all continents. This reputation likely explains how the automobile constructor has come through the last two crises (U.S. in 2009, Europe in 2011) relatively unscathed.
Even better, the firm’s bottom line has marched steadily higher since 2007, reaching 95 billion euros (+60% in 10 years). Half of BMW’s results are realized in Europe, while the rest is split between the Americas (30%) and Asia (20%).
Operating margins are remarkably stable (about 10% each fiscal year since 2010). The same for return on equity (around 15%). Management has successfully preserved a balance sheet rated by Moodys among the best of its European peers.
Such a circumstance (some would say typically German) arouses both skepticism and admiration. Indeed, BMW’s financing division is at the origin of one-quarter of its revenues— which certain cautious investors will point to as a risk, since it is impossible to evaluate precisely the quality of its borrowers. And this business could serve management in smoothing the firm’s revenue in order to give the markets what they expect.
The profitability of the financing division could incite jealousy among other banks and credit institutions. However we emphasize that the level of credit risk is unknown and remains a subject of concern. Without blowing this concern out of proportion, we’ll just say that investors should remain vigilant on this point.
Equity in BMW Group has doubled between 2010 and 2016 (from 35€ to 70€ per share) and the dividend has increased in spectacular fashion in the same period (from 0.30€ to 3.20€ per share). The auto constructor posted fiscal 2016 net earnings of 7 billion euro, but this result is naturally to be taken with a grain of salt.
As with General Motors (another large auto constructor possibly undervalued), free cash-flow is a more relevant measure of earnings potential than net earnings since, in general, the capex of auto builders exceeds their depreciation and amortization (BMW is not an exception).
Therefore it is difficult (if not impossible) to evaluate precisely the real earnings potential. Not only is maintenance of fixed assets (production capacities) subject to the business cycle, but more importantly sales realized by the financing division remain a wild card.
Investor must either take the result communicated by management at face value, or — if keen on pushing the analytic effort further — recalculate the results ex-financing division. We observe that EBIT generated by BMW’s automobile activities in 2016 rose to 7.5 billion euros, while that generated by the financing division came to 2 billion euros.
In counting this second result as zero (an extreme assumption, but with recent history we have no lack of examples of lenders recording a long series of losses after record earnings), and assigning a conservative multiple of 8 to operating profits of the manufacturing business (possibly at the peak of the cycle), we value BMW roughly at 60 billion euros.
In a more mundane manner (that is, without removing the financing arm), the German constructor is currently valued at only 7 times after-tax profits expected in 2017 — a historically low multiple.
Of course risks are not lacking — uncertain profitability of growth investments, opaque finance division, potential fraud with emissions tests, high point of cycle in the American and Asian markets — this attractive valuation for a remarkable company like BMW should not fail to seduce investors seeking an undervalued large cap stock.
Article published on 07/20/2017 | 10:02