BMW's Margin Squeeze

BMW third-quarter results, released Nov. 6, provoked fury among analysts and investors. Its battered shares were down nearly 5% by the end of the day.

No one can understand why BMW’s soaring sales don’t translate into higher profits. Instead, as BMW’s car sales and revenues grow, profit margins shrink. In the third quarter, sales were up 13% by volume and revenues rose a stunning 19% to 13.8 billion euros ($20 billion), powered by the new Mini and the X5. Sales at the Rolls Royce unit were up 52 percent over Q3 2006, as the swish Phantom convertible hit the market.

On the profit side of the equation, net profit rose by 78% to 803 million euros ($1.16 billion). But the group operating margin fell from 7.6% percent to 7.1%, zapped by 135 million ($195 milion) in undefined reconciliations. “BMW’s third-quarter profit should have been far, far better,” says Morgan Stanley analyst Adam Jonas, comparing BMW’s anemic result to Audi, which saw its profit up 76% on a 4% growth in volume and Mercedes up 55% with 10% growth. “Cost control and competition appear to be the culprits,” says Jonas.

Can BMW rev its bottom line back up to where it should be. My guess is that CEO Norbert Reithofer is still tuning up Bimmer Inc. He’s only one year on the job, and just presented his strategic review in October, which targets an operating margin of between 8-10 percent by 2012. I put my chips on very solid results starting in Q4 and going into 2008.

Yes — it’s hard to explain that target date of 2012 for a decent, BMW-like return on sales. Especially since Audi and Mercedes are already showing margins of 8% or better. So either Reithofer aims to surprise on the upside, or the German premium car industry is headed for some kind of major ecology-driven disjunction that throws all bets off. Reithofer in fact argues that investments in green technologies have cut seriously into earnings. R&D expenses were up 20% year on year.

BMW is a cautious company with conservative accounting practices. Its owners sit on the supervisory board and don’t like downside surprises. My guess is that Reithofer is taking a bit of a hit upfront, investing ahead of the curve to make sure he isn’t caught off balance as the industry prepares for a very different future.

After all, BMW isn’t a company that shocks the market from quarter to quarter with $1 billion black holes or quality catastrophies. (It’s amazing to me how quickly the Street forgives and forgets those blunders at other companies like ex-DaimlerChrysler.) BMW is also known for leading the industry on the technology front, not lagging. I’m betting BMW makes the profit curve sooner rather than later. In 90 days, we’ll know more.

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