BMW amid evolution, revolution and tariffs

The principle that by buying into equity of a company you are becoming a partner in the ownerships of the company stands at the core of investment philosophy. Thus, investment decisions become a study of a company’s ability to generate cash in the future.

BMW has been a core holding in most of my portfolios for quite some time. I argue BMW’s innovative trend, technological edge and ever-evolving product line-up as central to their potential for consistent financial performance. However, the share is currently trading at 6.4x earnings which is undouble cheap, but at the same time worrying. Why are European automakers under pressure? And how is BMW placed in this environment?

European automakers face an uncertain future. On the one hand, optimistic economic expectations and what is perceived as a technological lead in automotive manufacturing place European manufacturers in a sweet spot. However, the European auto sector is facing headwinds from 3 sources. Doubts over diesel, electrification and US tariff action.

Diesel

Doubts over diesel remain a challenge for the industry as sales fall amid fears about pollution, penalties and bans. The pace against diesel picked up when judges decided that German cities, the heart of diesel manufacturing, have a right to ban diesels on the street. Rome’s mayor also proposed an outright ban from 2024, a year before Paris will do the same. London will double the congestion charge.

BMW remains confident the consumers will continue paying attention to the better CO2 performance and fuel economy that newer diesel technology has to offer. New cars will not fall under most of the bans being imposed and BMW has also shown that its latest tech sets impressive standards. All new BMW diesel cars tested were already well within real driving emissions limits set for 2020.

Electrification

No one in the industry denies that electrification is coming, however, few agree on a timeline. Still there were too many investors that believed that it was time-up for the legacy automakers. Reality is now kicking-in. Golden boys Tesla appears to be facing real issues as it tries to ramp up production, and a more sensible Apple appears to have abandoned the idea of manufacturing a vehicle from the ground up. Meanwhile, the olden boys are gearing up for a stream of new EVs.

BMW has arguably developed the best EV competence of any of its main competitors. BMW’s strategy allows for the full electrification of all its models without needing to alter the chassis. The current platforms were designed to be able to take a full range of power trains from conventional combustions engines, plug-in hybrids to full electric systems. The same flexible approach was adopted towards future-proofing manufacturing facilities. BMW will offer 25 electrified vehicles of which 12 will be fully battery electric vehicles by 2025.

US Trade Tariffs

BMW is a net exporter from the US having exported 272,000 X models in 2017 making it one of the largest US auto exporter. BMW has also invested €9 billion so far in its Spartanburg plant, and another €600 million is planned. Worker directly employed by BMW, supplier and dealerships exceed 70,000 in the US.

BMW’s integration with the US market is high. I do not understand the economic rationale in a tariff strategy and I am convinced that there will be more noise rather than action. The impact of a trade war would require a comprehensive investment strategy review at a macro level rather than at a single equity level.

Using a bottom-up approach BMW appears well placed to continue performing. A dividend yield of 4.5 percent adds to the attractiveness of the share at current prices. However, the fundamentals that determine the business environment are not as stable. Still, the pressure on the industry and consequent pressure on valuations of automakers may be an opportunity for the long-term investor.