Global Insight Perspective | |
Significance | BMW has lowered its full-year profit margin outlook as the current global economic problems hit the carmaker, despite rising sales volumes. |
Implications | BMW's financial performance and profits have long been detached from its rising sales, and the combined effects of soaring raw material costs, the dollar:euro exchange rate, and lower unit sales in the United States are all hurting the company. |
Outlook | BMW's previously bullish statements that it would ride out the credit crunch are coming back to haunt it as the company will struggle to attain anywhere near its targeted margins in 2008 or 2009. In terms of products, BMW has cancelled its full-size SUV, the X7, and there are likely to be further developments regarding co-operation agreements, such as the Fiat announcement and a deal with Daimler over technology sharing. |
BMW has reported that its second-quarter net profit fell 33% year-on-year (y/y) to 507 million euro (US$789.1 million), from 753 million euro in the second quarter of 2007. Sales revenues slipped just 0.9% y/y to 14.6 billion euro from 14.7 billion euro as pre-tax profit plunged 44% y/y to 602 million euro, from 1.07 billion euro last year. Earnings before interest and tax (EBIT) plummeted 58% y/y to 425 million euro from 1.02 billion in the second quarter of 2007. BMW issued the following statement along with its early earnings release: "Business conditions for the automobile industry have deteriorated sharply over the past weeks. Rising oil and raw-material prices, the weakness of the U.S. dollar, the impact of the international financial crisis and a weaker U.S. economy have made business conditions significantly more difficult." It added: "As a result of the ongoing global financial crisis, the price level of pre-owned cars has dropped and consequently the revenues that can be generated on vehicles returned at the end of leases have not recovered." The company also now expects sales in the United States, its largest single market, to come in lower this year compared to 2007, and it may redirect some vehicles originally intended for sale in the U.S. market to "countries with higher margins". BMW CEO Norbert Reithofer said: "We now expect that the pretax return on sales for the year to be at least 4%." BMW had previously said that its margin on earnings would rise from 6.4% in 2007 to between 8% and 10% in 2008. BMW was originally scheduled to release its second-quarter earnings on 5 August.
Results for the half-year period were hurt accordingly and profit before tax for the January-June period fell 35.2% y/y to 1.243 billion euro, from 1.917 billion euro. Group net profit fell by 25.8% y/y to 994 million euro, compared with 1.34 billion euro in the first half of 2007. BMW booked a one-off charge of 695 million euro in the period as a result of higher risk provisions and allowances for residual value risks and bad debts relating to its financial services business; this included the 236 million euro booked in the first-quarter period. BMW said that it will continue to "monitor the situation on the pre-owned car markets carefully and, if necessary, adjust the risk provision for residual value risks and bad debts during the second half of the year". BMW also booked a charge of 107 million euro related to the ongoing reduction of its workforce in Germany (see Germany: 28 February 2008: BMW Executive Details Planned Job Cuts).
As for sales volumes, BMW is "still aiming for a new high level for the year", according to the release. However, despite reiterating its intention to remain the biggest premium car manufacturer in the world, and although it is maintaining its long-term target of 1.8 million sales across all brands by 2012, the company said that it will not pursue volumes at any cost: "This is only possible through growth. Sales volume growth, however, will not be pursued at the expense of profitability", it said.
Separately, BMW also announced that it has sold 72.9% of its shares in IT consulting firm Cirquent GmbH to Japan's NTT Data as part of an effort to focus on its core business. As part of the sale agreement, neither company has disclosed the purchase price, noting that the finalisation of the transaction is subject to approval by the competition authorities. BMW will keep a stake of 25.1% in the IT consultancy. It said that 2% of the shares will remain within Cirquent.
Outlook and Implications
BMW has followed Daimler in issuing a grim forecast for the rest of the year as the economic situation in its key markets of the United States and Western Europe worsens. The statement contrasts sharply with comments by BMW’s chief financial officer (CFO) in March, prior to the first-quarter results (see Germany: 20 March 2008: BMW CFO Confident of Riding Out Credit Crunch). At the time Michael Ganal said that the current difficulties in the international credit market would not have a significant effect on the company's 2008 earnings, although he admitted that it had seen a rise in credit defaults. Today's early earnings release points to the severity and deepening nature of the economic crisis, something clearly not predicted by BMW. Ganal had intimated that BMW's customers tend to be in higher-income brackets and would thus be cushioned to a degree from the economic downturn. This is clearly not the case and the appetite for luxury goods is waning fast as consumers across all demographics tighten their budgets.
BMW is also suffering from the current dollar:euro exchange rate as its heavy exposure to the U.S. market, something that has fuelled much of its growth in recent years, starts to have a negative effect. To counter the drop in profits BMW announced earlier in the year that it would increase prices across the board for its range of vehicles sold in the U.S. market. The 1% price increase took effect from 1 June, and came as the U.S. dollar lost nearly 8% of its value versus the euro since the beginning of the year. The reality of this is calculable as an average 5-Series sedan has lost US$3,150 in profitability since January.
BMW's sales performance has long been detached from its profitability, reflected in the fact that its first-half sales suggested that it was seemingly on course to meet its 2008 sales target of 1.5 million units. Indeed, despite a fall of 4% y/y to 157,913 sales in the U.S. market in the first half of the year, BMW recorded strong overall gains in Europe, Asia, and South America, with Western European sales up 6.6% y/y in the first-half period. However, with BMW so heavily reliant on the U.S. and Western European markets, the company's management is now conceding that the gloom surrounding the fundamentals governing the global economy will hurt the company badly. The sharp shift in segment trends, particularly in its key markets, has also led BMW to cancel its X7 sport utility vehicle (SUV) programme, designed to compete with the Mercedes GL-Class and Land Rover Discovery. The programme had been in doubt for some time, and BMW has now confirmed that it will kill the model in light of recent developments.
BMW has a fight on its hands to hit its key financial targets over the next few years. The U.S. and Western European economies are highly susceptible to the ongoing rises in energy costs, while the rising cost of borrowing as a result of the credit market freeze means that buyers will find it more expensive to finance vehicle purchases. These factors could all have a sizeable effect on BMW's second-half sales and in the worst-case scenario could threaten the company's record full-year sales target. Even if BMW does manage to maintain the kind of sales growth it generated in the first half of 2008, it continues to face a huge challenge to meet the goals of CEO Norbert Reithofer's "Number ONE" strategy. A major component of this plan is for BMW to increase its return on sales to 8-10% by 2012, up from the current level of between 5% and 6%. With the prices of global commodities such as oil, steel, and rubber experiencing record rises, BMW has given up this cause for 2008 and may indeed struggle to meet the target in 2009, despite its sales success. It is likely that the recent co-operation agreement with Fiat will be expanded and that a deal with Daimler on technology sharing will be signed going forward as BMW realigns its model range and seeks to reduce research and development (R&D) costs in the smaller segments.