Description

Summary

After being the poster child of everything investors have shunned in recent years (value, industrial, auto, financial, Europe), we think now is the time to buy BMW.  BMW has had a tough couple of years, contending with collapsing China auto sales, tariffs, stricter diesel regulations in Europe, elevated electrification investments and now, to top it off, a complete shutdown of production due to COVID-19.   

Consequently, BMW’s stock trades at just 56% of book value (70% of tangible book) with nearly half of its market capitalization in net cash and practically no value being ascribed to BMW’s high ROIC, premium auto operations.  While investors have been worn down and seemingly given up all hope, we think there is a distinct possibility that the back half of 2020 and 2021 will mark an inflection of revenue and earnings growth as the business bounces off the bottom and perhaps even sees a benefit from a potential post-COVID structural shift in consumer behavior.  While we are not counting on it, we wouldn’t be surprised if consumers start to favor auto ownership at the expense of mass transit, which we think could markedly improve the narrative around BMW’s stock in the coming months.  We have already seen this dynamic benefit RV, boat and home improvement sectors.

The bar has been set incredibly low (it’s hard to get much worse than not operating for a couple of months) and the company will start posting solid year over year earnings momentum, particularly as we get into early 2021 (indeed, it’s quite possible BMW might even look like a growth stock for a while).  Furthermore, BMW will benefit from a sweeping cost cutting program and reduced electrification costs (that were elevated in recent years), driving increased profitability as the business begins to recover.

We think BMW’s stock can more than double in the next 18 months with strong downside protection from its significant net cash position.

Overview

BMW is a premium automotive brand that has traditionally generated best-in-class operating margins, averaging roughly 9.5% from 2010-2018 vs an expected auto operating margin of 0-3% for this year given the impacts of COVID-19.  Despite the extremely challenging short-term backdrop for auto sales and the economy, BMW will likely still earn around €4 per share this year at the trough given its solid financial services operations and strong China joint venture operations, and we think earnings will significantly improve from there.

We think BMW has several drivers to restore its auto margins to its 8% to 10% target:

(1) BMW has embarked upon a sweeping €12 billion cost cutting plan by 2022 under its new CEO that should more than offset continued fleet electrification and emissions-related costs.  

(2) The maturation of recent model introductions will result in lower launch costs and reduced inefficiencies and should provide a margin tailwind over the next few years.

(3) Pressures from increased investments in capital expenditures and research and development should subside, and we believe these investments will be more than €1 billion lower in 2020 and 2021 than the 2018 peak. 

(4)  BMW still has an opportunity to improve its product mix. For instance, their exposure to SUVs in North America is still 10 points below the overall market.

Also, we think BMW’s stock has significant downside protection and significant margin of safety as the net cash in the auto business amounts to approximately €26 per share or just over 50% of the current share price.  The financial services business, with a strong history of low credit losses and attractive returns on equity, is worth another €23 per share (or 45% of the share price) at 1x book value.  Add in BMW’s China joint venture value and the BMW auto operations are being valued at zero by the market.  Said differently, for the BMW auto and motorcycle brands, Rolls Royce and mini Cooper, which collectively produced an average annual EBIT of around €7 billion over the past 10 years, you’re effectively paying nothing.

Recent Performance / Why It’s Not a Value Trap

If you ignore the stock chart and simply look at BMW’s financial performance, you’d see a company that has consistently built cash and book value in the FinCo, resulting in a significant shift in asset value from auto operations to non-auto operations (defined as net cash plus financial services).  Just 10 years ago, BMW had €20 per share of non-auto assets, while today it has €50 per share in non-auto assets, an increase of 2.5x.  This increase has occurred while BMW paid out €26 per share of dividends to shareholders (over 50% of its current market capitalization).

What We Think It’s Worth

Looking forward, we see the potential for margins and earnings to surprise to the upside from current, depressed levels and see a credible path to approximately €13 per share of EPS over the coming years as conditions normalize and BMW uses €3.6 billion of its low-yielding cash balance to purchase an additional 25% of its lucrative China JVs (taking its ownership to 75% and allowing it to consolidate the operations).

We estimate that achieving the low-end of BMW’s 8-10% auto EBIT margin would result in over €11 of EPS compared to current levels of around €4 per share.  An additional 100bps of auto margin (to the midpoint of the company’s target) would add another €1 of EPS and the already announced acquisition of a further 25% interest in the China JV will add €0.60 of EPS (net of foregone interest income), resulting in a total potential BMW EPS target of close to €13 per share.  If it takes a couple of years before forward earnings begin to discount this earnings outlook and the stock still trades at a relatively depressed multiple of 8x EPS (with the P/E net of cash being just around 5x), the stock would be worth close to €110 including a couple years of dividends or more than 100% above the current share price.  We think this is a particularly attractive return in light of the significant downside protection from BMW’s strong balance sheet and net cash position.

Catalyst

Recovery from COVID-driven production shutdowns, increased consumer interest in personal auto ownership, cost cutting, improving reveues/earnings.