Thursday, 7 February 2008

Company Focus – BMW AG – Details Please

The once revered BMW continues to experience troublesome times within investment circles. Over-shadowed in general performance terms by its nemesis Daimler and now criticised for lack of expected detail in turning around corporate fortunes under the ‘Number ONE’ initiative launched in Q407. Even though all divisions and associated fundamental revenues are 'up' according to the November interim report of Q1-Q3 2007 figures and recent press release (Full results in March)

BMW must surely hope that the well intended investor roadshow (across London, New York and Boston) hasn’t backfired by raising investor expectations for greater transparency, only to inadvertently dash the hopes, creating greater pessimism. Add to that bad news the CEO’s inability to attend all events because of flu and the perception is that he may be trying to distance himself from the immediate criticism and reactionary 3% stock price fall.

On the surface the headlines of the ‘Number ONE’ improvement march look good. Specifically the cost-containment programme forecasting a 3% per annum saving in material costs from 2008 to 2012 (achieving €4bn), along with €500m pa in labour cost reduction from 2009. This all part of a drive to regain a ROS of 8-10% by 2012, from 5.6% today. This figure may not enthuse compared to the early 1990s heyday, but BMW is a very different beast, facing very different challenges, so a 3-4% increase will be well won.

But unsurprisingly, given the lack of detail, it has been hard for analysts to piece together the jigsaw that provides that level of cost reduction and ROS ambition. Primary cost-containment concerns are:

1. Increasing commodity prices, look set to increase with mining sector (energy & resources) costs rising, ravenous Asian demand and probable consolidation (ie the outcome of the BHP Billiton – Rio Tinto – Chinalco M&A affair)
2. Rising higher-value component costs (eg electronics) as a result of a re-structuring (& profit seeking) of the supply chain [see the Continental overview]
3. Possible ‘real-world’ social and political resistance to reduced and more flexible labour force requirement.

The issue of cost containment, and the desire to see the detailed action plan, is more critical than ever given the gloomy picture for vehicle sales in ‘advanced markets’. With a US market forecast drop of 1m units (from 15.5 to 14.5 as stated on Q307 and Q108 respectively), and perhaps if lucky an at best repeat 1% growth in Europe, the traditional revenue generating regions plainly can’t be milked as before - even if what are still considered fragile new BRIC markets are doing well- and so the onus falls on cost-cutting to maintain fundamental operational momentum.

One worry is that the size of the US (#1 market) and UK (#3 market) credit shocks have not yet been fully felt. Although the perception of BMW customers in these 2 prime markets is that of ‘well-offs’ with higher than average disposable income, the real picture may be slightly different; many more than imagined stretching their purses to afford the aspirant brand and not likely to repeat buy when trade-in time comes. For those less financially exposed, but still cautious, their conservative nature may well see them keep their vehicles longer than originally intended, or if trading-in, trade down to a smaller vehicle, or at best repeat purchase but with a far less options loaded car (NB. remember how much BMW makes on its options uptake).

If that’s the US & UK story what about Europe?

Economic indicators suggest that the German home (#2) market should fair comparatively well over 2008, supporting demand for much loved BMWs well beyond Munich. There is at present, after the rounds of labour relations negotiations that set standards for pay throughout the country, a sense that the industrial base and economic heartland is being socially and financially invested in – and this brings a sense of consumer security; along with importantly the comfort factor of relative escape from the global credit-crunch.

The remaining European countries, even previously booming Eastern Europe, appear to be more cautious. The ECB recently negatively revised growth expectation from 2.6% GDP in H207 to 1.6% GDP. More social/consumer unease relative to employment security and general inflation has been the catalyst in seeing the continuance of product and brand ‘trading-down’. An attractive crop of smaller segment cars (which have infact grown dimensionally if not semantically) from the likes of Fiat, VW, Skoda, PSA and Koreans and Japanese have scored highly with cost-conscious buyers.

It is well recognised that for 30 years the BMW 3-series has been the automakers’ profitability icon, truly ‘wunderbar’, the volume+margin revenue benchmark. 3-series was supported by a level of decades long economic growth in the west that looks to have now peaked, though counter-balanced by BRIC regions. The question is can BMW perform without such high levels of contribution from that core vehicle asset? (It’s presently 37% of entire range sales, but could it diminish if its sales plataeu in the critical emerging regions?)

Of course the company has adapted with changing times with provision of 1-series and Mini, cars pitched (respectfully) poorly and well to consumer trends for smaller cars, character cars and importantly CO2 compliant cars with green credentials. And it is here we’ve recently seen BMW really push in the PR stakes, promoting its CO2 reduction technology advances (across the vehicle range with “EfficientDynamics”) in high circulation auto-press publications; demonstrating their big-picture impact on a fleet/volume basis….the message being “stay brand loyal and be green”, knowing that buyers are indeed thinking twice before buying BMW again.

Thus, given the pressures from traditional markets, it is welcome news that BMW achieved record sales revenues in 2007, up 14.3% YoY to €56bn from €49bn, generated from record sales of over 1.5m units, up from 1.37m. Of course, much has been gained from demand in emerging markets (pretty much all VMs reliant on this off-set flat western sales).

Back to expectations of the future, and along with a lack cost reduction clarity, analysts may have been weary of the decreased level of R&D, project and plant capital expenditure (relative to revenues) over the next 4 years - even with an expected 5% output/sales increase. This may infact be a good sign, given what appear to be positive ongoing talks with Daimler regards a shared next generation small car platform - so are the figures presented reflective of BMW holding back, and reducing, necessary capital to back such a fiscally attractive venture? Possibly.
On another R&D & CapEx note, investment-auto-motives believes that the acquisition of the motorcycle and quad-bike maker Husqvana will provide major new product impetus in the 5-10 year timescale, the technical solutions of quads in particular developed and transferred to a possible new crop of urban focused Bikes, Quads & City Cars that BMW is very well placed to create. Our conjecture is that it may endeavour to break down the perceptional technical barriers between 2 wheels and 4 and bridge the ideological and technical gap between Bike and Car divisions, possibly creating a new division/function that marries the presently very seperate architecture & drivetrain technologies in the search for 'Lean Vehicles'.

Ultimately BMW looks to be taking the opportunity to put its house in order during this periodic downturn, looking forward the expected US economic 'pick-up' in 2009/10, which will re-boost Asian regions' domestic demand which (whilst de-coupled) will gain from the US upturn.

That doesn’t help immediate concerns, but investors must push harder if they want to see exactly how the fiscal savings derived from 'Number ONE' will be achieved and put to good use.
And as we've said before, BMW must open its doors (literally to the Fitz Building and BMW Technik) if it wants to maintain confidence. The market sees BMW as a leading innovator, part of its USP, so will expect to see related investment that supports and differentiates the brand as the premium tranches of all segments come under new PESTEL pressures.