Investors aren't giving BMW AG much credit for its consistently good profits and decent cash generation. Maybe too much credit is the problem.
BMW's automotive business generated an impressive 5.8 billion euros ($6.3 billion) of free cash flow last year, lifting net liquidity (cash, marketable securities and intragroup net financial assets) to 19.6 billion euros. Yet, oddly, BMW's liquidity buffer accounts for more than a third of its market value and the shares trade on just 8 times estimated earnings, barely half the multiple investors accord to large listed European companies in the Stoxx 600.
What gives? Partly it’s the expectation that we'll all be whizzed around in driverless electric pods pretty soon, leaving carmakers like BMW without much of a business model. Then there's the fairly humdrum design of BMW's recent cars when compared to Mercedes-Benz -- read my colleague Elisabeth Behrmann here on how BMW plans to fight back.
But investors might be worried too about the risks BMW is taking in its effort to sell lots of cars. I'm talking about car finance.
The company’s captive financial services unit financed half of all BMW's new vehicle sales in 2016, some nine percentage points higher than four years ago. Leasing accounted for more than one-third of new financing business. The U.S., Germany and Britain are all big markets.
As a result, the value of leased cars on the balance sheet has climbed 8 percent to almost 38 billion euros: equivalent to about 20 per cent of BMW's total assets and 70 percent of its market value.
Of course, those leasing assets show BMW is very good at shifting cars. But they're a potential hazard. If BMW has miscalculated what vehicles will be worth when customers return them at the end of the lease, it would have to book an impairment. For now, this looks manageable but investors are right to be wary.
Low borrowing costs have stoked intense competition among carmakers to offer cheap financing. But consumer tastes are shifting. First there was the move from sedans to SUVs. Now diesel vehicles (which make up four out of five of BMW's European sales) are suffering an image crisis. The rise of electric vehicles and automated driving only adds to the problem of current models becoming outmoded more quickly, which will push down residual values.
BMW says residual value losses did increase “moderately” last year because more cars were hitting the used market in the U.S. Pre-owned vehicle prices have fallen slightly in the U.K. too, BMW's annual report noted. (I wrote about Britain's leasing dependency here.) Ally Financial Inc., a U.S. auto lender, on Tuesday warned profits might grow less than anticipated because of the used car glut.
True, BMW's risk-management is paying off in one respect: credit losses on auto loans are at a record low. And, in fairness, BMW isn't alone in running a big financial services operation. Daimler finances about half of Mercedes vehicle sales in the same way.
With money so cheap, BMW clearly feels it has to join the dance. It would be impossible to compete in the U.S. without leasing, it says. For now, shareholders are benefiting. The financial services unit accounted for more than one-fifth of yearly pretax profit and its return on equity increased to more than 21 percent.
But given the technical and regulatory upheaval in the car industry, you couldn't blame investors for wondering whether BMW's financial services business is an asset or liability.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
BMW has form here: it was forced to book a 2 billion euro impairment in 2008 for this reason.
BMW issued a four-year bond in January with a 0.125% coupon
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