Investors aren't giving BMW 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.
Value of leased
cars: 38 billion euros
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.
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 US, Germany and Britain are all big markets.
Read also: BMW to invest R400m in parts hub, offices
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.
Competition
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
US. Pre-owned vehicle prices have fallen slightly in the UK too, BMW's
annual report noted. Ally Financial, a US auto lender, has 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 US 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.