Saturday, 29 May 2010

Companies Focus – The Western 8 – BMW AG: A Lean Tuned 4 Cylinder Building

After what has been within BMW history a tumultuous 2 year period between late 2007 and late 2009, the iconic “4 Cylinder” corporate building depicts a slightly leaner-tuned BMW AG. And whilst renowned for its silky-smooth powerful straight-6, the 4-cylinder is a highly apposite sign of down-sized times - the downsizing of engine capacity and engine architecture a powerful emergent trend.

But of course whilst dominant over Munich, BMW AG is far more than a single city entity, with proven production success in South Africa, USA, China, the UK and elsewhere. And whilst undoubtedly Munich-centric, it has reached-out beyond the archetype Germanic-mentality, with the sub-division BMW Group DesignWorks expanding beyond Munich & California with recent opening of a Singaporean centre to both gain consumer cultural input from Asia and broaden its own non-auto product design client base.

Yet whilst BMW has such R&D tendrils, aswell as of course the BMW-Welt centre, it is the prime Car, Motorcycle and Finance divisions to which investors must pay greatest attention to. Other organisational elements, no matter how supposedly interesting, are of a distant secondary importance. Without doubt, whichever complementary functions boost the corporate divisions performance on a quarterly basis is good for the Group en mass, but such cost centres must be constantly reviewed to critically assess cost-benefit.

In the end it is only the numbers that matter, as both investors and the Quandt family owners well know. It may well be the RHS week at Chelsea in London, where the great and the good of high finance meet, but nobody will be led up the garden path or down a dead-end road.

Thus the fact that AGM of 18th May saw 99.99% investor approval for the current BMW exec board and supervisory board spoke volumes for the way large-scale investors viewed BMW's handling of the last 2 years and its position looking forward.

Q1 2010 Performance -

BMW AG's Q1 report highlights the positive change in market circumstances versus a year ago, improved credit access for business and private customers in the west, aswell as the ongoing strength of BRIC+ economies. In all car deliveries were up 315,614 units YoY versus 277,264, so up approximately 14%, whilst motorcycle deliveries too gained with 20,840 units versus 17,232, so up approximately 21% (excluding Husqvana production). Likewise car production was boosted, 320,061 units versus 267,637 units, so up 19.6%, yet motorcycle production remained virtually flat at 30,222 versus 29,111, up 3.8%. These figures presumably demonstrate the level of cars' inventory run-down and re-stock, whilst motorcycles, typically with greater inventory levels at manufacturer and dealer levels maintained a steadier pace.

Importantly this was achieved with a workforce reduction of -3.4% YoY, illustrating restructuring efforts.

Accordantly, top-line revenue grew to E12,443m from E11,509m, and the Group EBIT grew to E449m from E-55m YoY, this made up from Cars' E291m from E251m, Financial Services' E213m from E70, Motorcycles' E32m from E28m, Other Entities E7m from E12m, whilst Eliminations reduced slightly to E-94m from E-96m. At Group level that gave a PbT of E508m from E-198m, with – as seen - the greatest turnaround contributions gained from Cars and Financial Services.
The PaT was E324m from E-152m, giving a similar E0.49 dividend per Ordinary and Preferred share, up from the E0.23 &E-0.23 of the parallel quarter a year previously.

Whilst BMW talks of its expanded vehicle portfolio including X1-series, 5-series GT, Active-Hybrid X6 & A-H 7-series, these models given their launch newness have contributed little in reality. The turnaround revenue 'pulling power' came from 7-series, new 5-series, and critically the efficient inventory and sales management of run-out 3-series. Mini helped to a lesser degree than many (except investment-auto-motives) expected, with essentially flat sales across Cooper & Cooper S, but marked upturn – even though still low figures – for the Base car. Mini reached approximately 49,500 units in Q1 over 43,600 units for Q109, which if annualised shows a 200K capacity for the platform, thus showing inefficiency versus industry norms, and illustrates the need to expand the production capacity of the base; hence Nini Countryman and evolved other BMW compact car variants (see below).

All assisted by the fact that BMW Financial Services was able to access far healthier capital markets between Q309 and Q1 2010, so able to offer improved terms and conditions to customers whilst also allowing BMW to recapture returned cars which it could price to sustain general worldwide residual values.

The Financial business itself generated 7.4% more business over the preceding comparable period, with 243,343 new contracts signed - of which approximately 29% derived from leasing and approximately 71% from credit provision. However, the newly re-opened credit markets meant greater funding options for many customers, and as a result BMW sourced financing dropped by -1.1% on BMW sold new cars. Likewise, its used cars sales saw BMW sourced financing drop by -1.8%. Both would ordinarily be areas for concern, but investment-auto-motives believes that BMW tends to require greater credit-worthiness from its clients and so should see less loan defaults and so returned vehicles compared to less stringent other premium & mass manufacturers. However, general lease & credit figures amongst new and used were lower than expected and should be addressed.

Insurance product sales improved by 14.1%, again typically indicating the tied-in nature of such products with lease and credit deals aswell as the more responsible nature of the BMW client demographic.

Strategy -

BMW has long been seen as the profitability star amongst mass manufacturers, but recent years have witnessed it lose its product conviction, with conflicting portfolio management examples of product convention versus product exploration and proliferation so as to safeguard its core lines yet also compete in new segment territories. However, the company recognises the challenge ahead and set out 'Strategy #1' previously which obviously is set to both improve operational efficiencies and expand sales numbers.

Of particular note is its lacklustre impression on the compact car market after a less than successful acquisition of Rover Cars in the early 1990s, divestment of the Rover Group business with retention/re-creation of Mini as a premium small cars, and under-achieving efforts with its own 1-series, a cramped and initially visually contorted car. A new direction has been set for the conquering of the small car premium segment. Initially eyeing the benefits of alliance ventures with other manufacturers, BMW has rightly instead chosen to exploit the technical and marketing in-roads made by Mini and 1-series, FWD & RWD platforms.

The decision to retain independence means these adapted platforms will furnish a twin-pronged attack on the compact segment, providing both 'space efficient' and 'performance proficient' solutions that can respectively match and beat the benchmark cars at either end of the practical to sporty compact requirement. Thus a new FWD-RWD modular platform is being created with nominal forecasts for 600-800k units p.a., resultant from the synergies of next generation Mini and 1&3-series platforms. Here, the new Countryman's architecture may well be used to offer FWD, RWD and AWD set-ups. Technical management at BMW's Fitz R&D centre will undoubtedly be relieved that the company's NPD culture and processes will remain untainted by external demands or limitations, which may have been the case under an alliance agreement given profitability and time to market demands.

investment-auto-motives welcomes the route chosen which exploits the leverage of proprietary technologies (including now carbon fibre structures), provides scale-efficiencies, does not undermine all important R&D vision and firmly maintains marque identity given its lineage.

Recent debate has improperly aligned BMW and Daimler compact car answers, hinting that both should seek alliances. Daimler's own dilution and move away from original A-class's unique architecture into today's conventional package for A & B class means that it should seek-out alliances to both import more cost-effective 'parallel performance' items, aswell as possibly license its own proprietary technology to the worlds old and new car-makers, as it has done in the past with the likes of Ssangyong.

In short BMW must 'Dominate' to maintain its independence and Quandt family investment-holding demands, whilst Daimler should 'Infiltrate' to further integrate itself into future global design, supply and production needs internally and externally to demonstrate its 'Engineering Excellence' and continued 'Global Grasp'. By doing so it would follow in Audi's footsteps given its adoption of the very conventional Polo platform – and basic rear suspension - for the new A1. Thus whilst Audi and Daimler have greater 'brand latitude' for 'technical generalism', BMW appreciates that it does not; especially not so given its foray into FWD propeller badged cars and probable accusations of hypocrisy for doing so. To deliver a divergent BMW car it knows it must retain its independence.

In an effort to illustrate its future-thinking in personal transport BMW has seemingly moved forward with the MegaCity car project, the important step being the acquisition of a carbon-fibre structures company named SGL Automotive, with an intent to seemingly replicate the Daimler Smart ForTwo effort in both creating a leap-forward vehicle and creating a hub-system production centre. BMW though apparently seeks not only a Leipzig EU build centre, but one in the US at Moses Lake, Washington State, undoubtedly keen to demonstrate its eco-credentials to Washington DC regards green-funding and importantly future CAFE related structures and possible tax-breaks. [NB see also FIAT-Chrysler's own reported R&D efforts in the Seattle area].

Operations -

Looking forward the highlighted new model launches whilst of high margin will be of limited volume, greatest contribution in the vehicle mix to be made from X1 (now 8 months old), 7-series, the aforementioned 5-series and face-lifted 3-series, the greater level of platform sharing between the 5 & 7, and 5 & 3, assisting per unit margins at ex-factory level.

The Touring 5-series variant will buoy income in Q3, as will Mini Countryman, yet whilst internal forecasts for 5-series is no doubt well honed given historical precedence, investment-auto-motives has concerns that Countryman forecasts, and so ultimate contribution, may be less reliable given the possible 'Mini-fatigue' of EU markets – remember perceived to be little changed since 2000 – and so directed at the US, Japan and Asia as a trendy “big little car”.

Within the EU its £17K+ price range may be too expensive for singletons and as the 2nd car, whilst families that buy Japanese soft-roaders and European MPVs etc may be turned off by its comparative impracticality and the ubiquity of the Mini badge in the smaller siblings which pepper the UK, Germany and elsewhere. Even with 4WD the model may need more consumer traction with a tide of advertising and marketing initiatives beyond the present “Life is Out There” YouTube campaign, which only adds to European regional S&M costs and corporate cash burn.

The Mini Coupe and Roadster concepts, although to be produced in far smaller quantities, may also require marketing support. The Coupe's unique cant-rail aesthetic, C-pillar treatment and integrated aerofoil should mark it out as a must-have car for a certain demographic replacing Cooper or Cooper S, but the Roadster although visually cleaner than the 4-seater convertible adds little else and reduces practicality, but importantly both cars face stiff competition from bigger transformable coupe-convertible cars from other manufacturers.

Rolls-Royce has experienced a large decline in Phantom sales over the last year or so given the after-effects of the financial crisis; less so an effect of its age given its iconic status. The £192,000 Ghost was always intended as both a new sporting dimension to the Rolls marque aswell as a cyclical off-set, and so its time in the spotlight has come, an interesting case-study given its head-to-head to Bentley's new £220,000 Mulsanne sedan. Though neither 'won-out' distinctly in press comparison write-ups, the distinct feeling on the ground probably reflects BMW vs VW expectations in that the Rolls will gain greater popularity amongst ('nouveau riche') conquest clients whilst the Bentley will retain its brand-loyal ('old-money') clients. [This an interesting about-turn of events after Phantom's capture of the Establishment and Continental GT's capture of the more recently wealthy). Of importance for BMW will be the small yet still critical level of Phantom returns trading down or 'across' to Ghost, adding little revenue contribution given the £100,000+ differential much of which swallowed in depreciation, yet maintaining customer loyalty. As stated previously in the Q3 report, Rolls Royce will be under pressure to maintain used Phantom residual values to both prop-up new car values and provide stationary asset-values to its dealers.

Regards the core BMW cars business, and the South African Rosslyn plant producing 3-series and has been disrupted by the 3 week strike action by staff at Transnet – the state owned logistics company. Inbound raw materials and parts aswell as outbound finished cars for export have been disrupted, yet thankfully for BMW its lower capacity and devaluation of the Euro versus appreciation of the Rand means any excess export demand during the period is well soaked-up by German plants.

The motorcycle market has broadly been down 12% or so YoY across the Triad, with the only real growth in small engine capacity bikes in Asia, S.America and Spain. Thus the 500cc+ segments look to stay deflated and flat for the immediate future, down -20% YoY, a blow to BMW and others such as Harley-Davidson, Triumph, Norton, Ducatti and the Japanese. A BMW recall of 122,000 motorcycles is being undertaken relative to to 'low failure instance' brake problems on the popular K1200GT. The brake hose replacement process notionally takes only 30 minutes or so, so will undoubtedly be used by BMW to have present clients peruse the new bikes in stock and recall clients will probably be questioned about their interest in bike replacement or accessories upgrade.

BMW financing saw only a 3.2% increase in volume worth of contracts at E5,914m, in what was proven to be a relatively buoyant period versus last year, and so winning new lease and credit contracts without exposing itself to lower quality risk must be a core ambition for Q2 onward; especially so in the best upward trending Americas.

With a reduction over the last 2 years seen in private retail and SME business demand, BMW has had to reach further into (multi-brand) fleet territory. Exacting details of fleet customers are of course confidential and unavailable, but the company must well know it cannot afford to muddy its premium brand image with overt allied-exposure effectively under other 'non-controllable' parties.
Dealer financing arrangements were boosted by 7.9% to E9,635m showing the strength of the factory-dealer inter-relationship, but deposit finance was down -9.2% to E9,627m, the number of custodian accounts down by -6.1% (again, partly foreseen by BMW more severe credit-standing and deposit requirements).

However, versus the likes of VW-Audi with impressive consumer deposit ratios, BMW must improve. Given the similar sums at present it seems that from the big picture perspective that client deposits may be being re-cycled to supply dealer finance. And although wholesale credit markets are contracting again due to the EU sovereign debt concern with spreads increasing, the dealer finance requirement should still be achieved at a lower cost of capital than the lost opportunity to use the client deposit sum as general working capital, added as a cash cushion or other reserve.

Financials -

Group revenues improved, E12,443m vs E11,509m, so up E934,000 set against a constrained CoGS at E10,758m vs E10,457, thus only E301,000, thus showing a basically calculated 2:1 improvement at this top-line improvement.

Headcount has been reduced which bodes well for latter-day overhead cost-savings once the effect of re-structuring costs have been absorbed, yet the pressure to re-stock inventories with newly launched cars and maintain investment rates in plant, machinery and labour-force training has undoubtedly affected cash-flow rates. Of particular note was the reduction in cash-inflow at E1,899m vs E2,426m last year. The cash-outflow rate highlighted the lesser toll of capital investment at E1,245m versus previous E1,702m.

The Balance Sheet depicts an improved high-level picture, with a 2.1% valuation increase since YE2009. Total assets sit at E104,061m vs E101,953. The component elements of the former figure being Non-Current Assets (Long-Term) at E62,846m vs E62,009 at YE, and Current Assets E41,215m vs E39,944m. Unlike the VW AG Balance Sheet which saw a marked improvement in its up & downstream supply-chain credit management to boost its figures, BMW AG has had across the board (indeed across the line-item) movement, nothing spectacular but noticeable in Current-based inventory valuation, trade receivables and cash and cash equivalents.

To balance this E104,061m figure, Equity and Liabilities show that equity interests were reduced, pension provisions were increased, short-term financial liabilities were increased, with Non-Current Liabilities up E4,653m accessing open bond & notes capital markets whilst seemingly at the time secure. As for Current Liabilities, financial liabilities decreased whilst trade payable increased so presumably showing a period of deferred payment 'turnover' from one set of suppliers to another.

As stated the Cash-Book shows a reduction in cash-inflow and reduction in cash-outflow for the period. Other areas of note was the negative Cash & Cash Equivalents differential in the comparison period, the recent E276m change over 3 months far lower than the E1,812 of last year.
Also of impact was the devaluing FX rate on the Groups liquid assets, showing a E141m hit vs last year's lower E41m toll. Obviously the Euro's recent pummeling by the US$ will have a greater impact in Q2 results.

However, the upside is that the Euro's weakness will be of major benefit in allowing BMW – like its peers Daimler & Audi – to garner foreign sales through pricing flexibility of German made cars if its so wishes, especially important for its N.A. Rebound efforts, dollar-pegged Middle Eastern sales and assisting the positive trend in S.America; much of Asian BMW sales satisfied by Chinese & ASEAN regional production.

The FT reports that the Euro is down over 8% on a trade-weighted basis over the last year, with a 10% deflation nominally providing a 0.5% GDP uplift, adding to Germany's already considerable 43% GDP support from exports].

Conclusion -

By virtue of its former 'spring clean' during the depths of the down-turn, BMW AG should be seen to benefit by leading the premium VM pack with pertinent product and converting the availability of wholesale finance into a steady and improving income stream from credit-worthy private and business clients.

The BMW marque appears strong and on the rebound as global markets once again pick the propeller badge as a brand of choice, even with Audi's rise, as the mix of sporting prowess and more conservative yet strongly handsome styling works as a good formulae in new 7, 6, 5, 3 and even 1-series including the popular X1, and the “efficient dynamics” technology lever continues to have effect. A resurgent US and still strong-pulling EM regions should have seen orders filled over the last 2 months to give a continuation of confidence with Q2 figures.

The Rolls-Royce business is seemingly well balanced given the contortions it has had to face, and its 2 car range now adds much needed market and production flexibility, the V12 Ghost taking the marque into long-forgotten yet still highly prevalent sporting-sedan territory. Its relative affordability at 2/3 its counterparts price should maintain steady volume from US, Middle Eastern and Asian clients even if the EU ultra-luxury car market stays depressed.

The real concern is the Mini division given its perceptually aging core 3-door model range, the somewhat limited volumes of higher margin cabrio models, the less than expected sales impact of Traveller - and so limited addition to Mini's overall sales volumes – and the outlined concerns that Countryman may have a harder battle to convince customers than executives believe. Recent press reports talk of the Mini division's independent identity inside the BMW Group, which given its lacklustre performance through the scrappage incentivisation period, could be construed as Munich partially divorcing itself from Oxford operations.

The now canned Rolls-Royce trimmed Mini project - and other such efforts - whilst following in the footsteps of Radford and Wood & Pickett Minis of the 1960s also convey an element of the Brand's diluted identity. As owners of Rover Group, BMW saw the commercial potential for a reborn Mini and should step back into the frey with blue-sky thinking, as opposed to possibly viewing the MegaCity as the natural successor project to a possibly decaying Mini division. Too much has been invested to see the division left aside and possibly wither if Countryman doesn't fulfill its sales remit.

BMW has proven itself operationally adept in re-aligning to the external circumstances that hit the auto-industry so hard. Now it must re-visit its visionary past to ensure the Group as built thus far remains and grows stronger. That will take fresh thought from deep in its Munich, Californian and Singaporean sites, yet the 'deep blue' thinking must be cost contained to ensure what is once again increasingly precious liquidity is being pumped into the heart of the BMW engine and not simply circulated around the ancillaries to little avail.

In short, good expectations given the positive picture, which will provide a morale boost, but no time for unproven over-confidence.