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The Automobile sector has outperformed the market year-to-date with the Automobile & Parts Index returning 32 percent which is nearly twice the return achieved by the European Benchmark Stoxx 600 index which has returned over 16 percent over the period.
Still, valuations suggest that this sector remains undervalued relative to the market in general. The top four European automobile companies all have a price to earnings ratio below 14 times compared to the market index’ average of 24 times earnings.
A recovery in the European market, economic strength in the United States and demand for European products from China have underpinned the sector’s recovery in 2014 and made up for any declines from the Russian market. A weaker Euro and declining commodity prices should further support earnings growth in 2015.
BMW Group
Our top pick in this sector is Bayerische Moteren Werke AG. BMW is a German company founded in 1916 and headquartered in Munich. It also owns and produces Mini cars, and is the parent company of Rolls Royce Motor Cars. BMW is currently the best-selling luxury automaker in the world.
Our choice of BMW as a top pick in the sector is based on the long-term outlook of the company. Without going into much detail, recent full year 2014 results were largely in-line with our expectations and confirmed our confidence in the company.
In 2014 BMW delivered over 2.1 million vehicles, increased sales by 1.7 percent and earnings by 9.2 percent over the previous year. These results were achieved despite currency headwinds and massive investments in technology to reduce emissions.
Going forward, management has set in place realistic targets that appear achievable. These targets counter-intuitively include a cap on gains in margins, limits on cost cutting and increases in wages and sales bonuses. While this may appear counterproductive in terms of shareholder value, it highlights the management’s focus on the long-term.
All too often firms approach their commitment to the shareholder as their primary objective. This may lead to a drive for short-term gains that eventually eat away from the firm’s long-term brand potential. Cost cutting typically is intended to push towards a leaner and more efficient firm and is often sold as a good thing.
However, if overdone, cost-cutting may lead to a decline in quality, worker demotivation and invaluable long-term negative impact on the brand. BMW’s approach is to cap margin gains by re-investing extra efficiency gains into the company. This approach by a company is the Holy Grail for the long-term value investor.
Going forward a revamped product pipeline, especially the best-selling Series 3 expected in autumn, should boost sales. Efficiency gains will be achieved through a new modular auto construction technology where most parts are designed to be compatible in all cares. BMW is currently also a leader in the use of carbon fiber and other lightweight materials in cars leading to better performance and fuel economy.
In our opinion BMW Group is an attractive proposal for the long-term investor.
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