BMW reported third quarter results that were below market expectations with margins reported at the lower end of guidance. Margins came in at 8.3% (guidance range 8-10%). This resulted in further weakness in the price of the shares.

We see this weakness as a buying opportunity. Management said that this was more a short-term effect and, with the new products launches and additional capacity for X models, momentum should improve from November.

Also, management strengthened its 2017 profit forecast as deliveries of its luxury SUVs and sedans rise to record levels. The carmaker will post a “solid” increase in pre-tax profit this year compared with its earlier prediction of a “slight” gain.

Trading on a Price-to-earnings ratio of 7.6x compared to its 5-year historical average of 10x as well as paying out a gross dividend of 4% makes this company look attractive.

So why isn’t the price of BMW rallying in line with the rest of the market?

The main reason for the underperformance of BMW compared to the market in 2017 is mainly due to investors’ worries on residual values (RVs), leasing pressure and electrification.

In our opinion, we  believe the market is overly concerned about the financial impact on BMW’s captive finance arm of RV worries and are comfortable with CFO Peter’s insistence that sufficient provisions are in place to cover the risks.

Indeed, over the longer term we think the market is missing the upside opportunities from leasing growth in China and future mobility revenues sitting within the financial services division.

On the other hand, a concern of ours at this point in time is the more cautious commentary out of leasing peers is leaving a sentiment overhang and, until the volume growth accelerates, the shares may fail to outperform.

We think consensus estimates for 2017 are too low and the market is being too cautious on the earnings downside from electrification.

We anticipate an improvement in volume, mix and efficiency savings ensuring absolute earnings in 2017 and beyond making BMW an interest stock to hold in a well-diversified portfolio.

Valuation

We have a price target of €94 on BMW. The shares are trading on a trailing P/E ratio of 7.6x, which is at a discount to its 5-year historical average of 10x. The Euro Stoxx 50 is trading on a P/E ratio of 18.63x. The discount is a result of the sector being put under pressure, due to the allegations concerning the emission scandal on auto stocks. We think that a lot of the negativity is priced in. Looking at historical ratios, BMW traded on an average P/E of 10x, which is much higher than that of today.

We believe that at this price, auto stocks are looking more and more attractive. BMW is now trading on a forecasted earnings yield (2018) of 13% compared to the Euro Stoxx 50, which is trading on a forecasted earnings yield of 5%. We believe the gap between the two is too large and we should see further convergence in the months ahead.

Moreover, BMW is setting its sights on the future, with plans to boost spending on electric cars and self-driving features to move on from the German auto industry’s diesel woes.

Rationale for investing in BMW

• A blue chip company with management focused on innovation and driving growth
  
  
• A lot of expenditure in R&D, though will pay off in the future as the sector shifts towards electric cars. BMW is at the forefront of this technology
  
  
• Trading on a trailing P/E ratio of 7.6x, which is at a big discount to that of the market. The Euro Stoxx 50 is trading on a P/E ratio of 18.63x
  
  
• If the shares had to trade on their historic P/E average (9.2x) and assuming 2018 earnings consensus forecasts do come in as planned, the share price should move closer towards €100. Given the uncertainties surrounding the sector, we are discounting this price target to €94.
  
  However, there continues to be considerable potential upside in the stock
• The shares are trading on an attractive dividend yield of 4%, which is very attractive

Conclusion

We think a step up in volume growth in Q4 and into 2018E would help drive the shares higher but we are also aware that this appears to be the only real catalyst. We think the market will be surprised in 2018E by the earnings momentum of the group but are aware that’s a little while to wait.

About BMW

Bayerische Motoren Werke AG; German for Bavarian, usually known under its abbreviation BMW, is a German luxury vehicle, motorcycle, and engine manufacturing company founded in 1916. It is one of the best-selling luxury automakers in the world. The company is a component of the Euro Stoxx 50 stock market index.

Disclaimer: This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.