Thesis
Bayerische Motoren Werke (OTCPK:BMWYY) continues to execute very well with solid performance to start the year. To give a recap on earnings, BMW reported 1Q23 Group EBIT of €5.4 billion, leading to a group EBIT margin of 14.6%, which was a very strong quarter. Notably, this robustness was observed in every segment. While the CAPEX figure of ~€2bn might seem huge and frightening at a glance – it is the highest CAPEX expenditure ever on a single quarter – However, it is crucial to consider that this substantial level of capex is underpinned by multiple projects that will contribute to BMW’s ongoing shift towards electrification. Given the strong 1Q EBIT performance and growth momentum, I believe BMW there is upside to consensus EBIT figures, which I think is pegged to management 8-10% EBIT margin guidance. In my opinion, consensus will raise their estimates for the next quarter if BMW posts another quarter of EBIT margin in the double digits. In my opinion, BMW can achieve margins greater than the 8-10% automotive margin, but its management is simply being cautious due to the uncertainty of raw material costs, inflation, and the company’s investments in electric vehicle development. I reiterate my buy rating on BMWYY.
Consensus estimates might be too low
Considering BMW’s remarkable 1Q23 EBIT margin of 14%, I think the consensus estimates for 2023 are too low. Even though the end market has gotten tougher, BMW is still doing well, and the product cadence should help them out in 2H23. Second, from an LTM perspective, BMW’s EBIT margin is lower than Mercedes’ at 10.7% vs. 12.2%, so there is still time for BMW to catch up, which I anticipate will happen by the end of FY23. I’d like to point out that BMW’s EBIT margin in 1Q23 is already competitive with Mercedes. So long as BMW keeps up the current pace and execution, there is a chance that the company will meet or beat its target EBIT margin. EBIT margin revision could come as soon as the coming quarter as consensus come to realize the momentum could continue for the rest of the year.
EV strategy
As new initiatives are introduced by management, I have a more optimistic view of BMW’s plans for the electric vehicle industry. The transformational Neue Klasse project was the most recent strategy to be unveiled. The project’s foundation is the integration of advanced battery and electric motor technology, as well as a radical rethinking of how recycled components can be used in new models and how recyclable those automobiles can be after they have served their useful purpose. In particular, I anticipate that the “pack-to-open-body” strategy will drive additional structural margin expansion. By taking this approach, BMW is able to extract maximum value from its existing manufacturing scale (in my opinion, it is simpler to change the size of the battery than to adjust all the other modules of existing models). The new generation battery used has a 20% higher energy density, a 30% higher packaging efficiency, up to 30% more range, and faster charging times than the previous generation. All of these would mean that significantly fewer batteries could be used to achieve the same top speed and range as a modern electric vehicle. If we flip that equation around, it also means that BMW EV equipped with new generation batteries can go farther with the same weight.
My positive outlook for BMW EV strategy falls back on management strong execution as it has maintained one of the most reliable product strategies, with the simultaneous introduction of ICE and BEV models. Execution is important because it bridges the innovation aspect to tangible financial results, which in this case would be to reach price parity between the ICE and BEV (release of Neue Klasse). If BMW can be the first to reach that stage, I believe it will have a huge first mover advantage that allows it to capture a chunk of share because it can price the vehicle cheaper (price is an important attribute during the purchase decision making process for the normal consumer).
Guidance / FCF
Despite a strong first quarter, BMW reiterated its EBIT margin guidance of 8 to 10%. This guidance, I believe, contains a lot of conservatism, such as raw material prices and inflationary cost headwinds. That is, management is playing it safe, and there is a good chance that results will continue to outperform guidance, resulting in a revision. Another encouraging aspect of the 1Q23 results was that BMW’s cash generation remained strong, with FCF totaling €2 billion. I expect FCF to rise from here, as the high CAPEX in this quarter should not be repeated, assuming management’s guidance is correct. CAPEX guidance is 6% of FY23 revenue, and assuming the remaining 2.4% is evenly spread across three quarters, CAPEX should be around €400 million per quarter, a €900 million step down from 1Q23’s €1.3 billion. As a result, I was not surprised to hear BMW announce a €2 billion additional share buyback program.
Risks
The main risk I see to my thesis is that BMW is not able to pass on the cost inflation to consumers fast enough, resulting in a few quarters of disappointing margins. If we couple this with the lower margin profile of BEVs, margins could look really bad on the surface, which will not screen well. That aside, BMW strategy to target the Chinese market might not work out as well, which could result in BMW burning capital and resources for no results.
Conclusion
BMW’s strong performance in the first quarter, with a notable 14% EBIT margin, sets a positive tone for the year. While the significant capital expenditures in the quarter might appear daunting, it is essential to consider that these investments support BMW’s ongoing transition towards electrification. With the potential for BMW to surpass consensus EBIT figures and achieve margins greater than the 8-10% guidance, I reiterate my buy rating on BMWYY.
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