BMW Is Remarkably Undervalued

Summary

• BMW is benefiting from strong demand for electric vehicles, leading to all-time high operating margins.
• The company has more than doubled its sales of electric vehicles in each of the past two years and expects further growth in the future.
• BMWYY is trading at a cheap valuation and offers an attractive dividend yield, making it an attractive investment for patient investors.

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I have always followed the advice of Warren Buffett to avoid the stocks of vehicle manufacturers due to the cut-throat competition in the automotive industry and the excessive amounts the manufacturers need to spend year after year just to come up with new models and remain competitive. However, thanks to technological progress, the business landscape has greatly improved in recent years. Numerous consumers are willing to pay a hefty premium to purchase electric vehicles while manufacturers have an excessive backlog of orders due to the supply chain disruptions caused by the pandemic. As a result, BMW (OTCPK:BMWYY) currently enjoys all-time high operating margins. The German manufacturer is the global leader in the sales of premium vehicles and one of the leaders in electric vehicles and is now trading at a forward price-to-earnings ratio of only 5.6x, offering a dividend yield of 9.0%. Given the secular growth of electric vehicles, the dominant position of BMW in this market and its exceptionally cheap valuation, the stock is highly attractive for patient investors.

Business overview

Based in Germany, BMW is the largest manufacturer of premium vehicles in the world. The company generates 85% of its earnings from its automobiles, only 1% of its earnings from motorcycles and 14% of its earnings from its financial services business. Therefore, the automotive segment is by far the most important division of the company.

The auto industry is infamous for its cut-throat competition. Auto manufacturers need to spend excessive amounts on capital expenses year after year in order to come up with new models and remain relevant in consumer preferences. Due to the competitive nature of their business, many auto manufacturers carry excessive amounts of debt and hence they are highly vulnerable to recessions. The bankruptcy of General Motors during the Great Recession is a stern reminder of the vulnerability of most car manufacturers to recessions.

Fortunately, for BMW, the business landscape has greatly improved in the last two years. Due to the supply chain disruptions caused by the pandemic, BMW enjoys extremely strong pent-up demand for its vehicles, which currently exceeds the production capacity of the company. As a result, BMW enjoys markedly strong pricing power right now. In addition, as a leader in premium vehicles, BMW has been able to pass its increased production costs to its customers without any problem. It raised its prices significantly in 2021 and 2022 due to the surge of cost inflation and has kept its prices essentially flat this year, as inflation has subsided.

More importantly, BMW greatly benefits from a secular trend, namely the exponential growth of the sales of electric vehicles.

BMW Sales of Electric Vehicles (Investor Presentation)

As shown in the above chart, BMW has more than doubled its sales of electric vehicles in each of the last two years and has grown them by 93% in the first nine months of this year.

Moreover, the auto manufacturer seems to have ample room to grow its electric vehicle sales for several more years. According to the projections of S&P Global, the sales of electric vehicles are likely to accelerate from 2026. As a result, by 2030, the sales of electric vehicles will comprise 25% of total new vehicle sales. Even better for BMW, economies of scale will be paramount, as they will help large manufacturers sell their models at more competitive prices than their small competitors. As a result, the top automakers are expected to generate more than 70% of electric vehicle sales by 2030. As the top automakers generated just 10% of total electric vehicle sales last year, it is evident that the boom in this industry will greatly benefit the top automakers.

BMW does not report the share of electric vehicles in its total earnings but it reports the share of electric vehicles in its total sales. The share of electric vehicles in the product mix of BMW has climbed from 9% in the third quarter of 2022 to 15% now and is expected to climb further, to 20% in 2024, 25% in 2025, and 33% in 2026. As consumers are willing to pay a hefty premium for electric vehicles, the breathtaking growth of the sales of electric vehicles is a major growth driver for BMW. It is also safe to assume that the share of electric vehicles in the total earnings of BMW is larger than their share in the total sales, given the superior profit margins of these vehicles.

The positive effect of the boom of electric vehicles is clearly reflected in the operating [EBIT] margin of BMW.

BMW EBIT Margin (Investor Presentation)

The company experienced an almost flat operating margin of 8-9% from 2015 to 2019. It then incurred a temporary decline in its operating margin in 2020, but its operating margin has bounced to an all-time high of 12.0% this year thanks to the wide profit margins in the market of electric vehicles.

It is also important to note that BMW is ideally positioned to benefit from the boom in the electric vehicle market. The company has been spending more than €6 billion per year on research & development (R&D) expenses over the last five years in order to remain the global leader in its business. Given the nearly 30 new models of electric vehicles BMW has delivered in the last four years and the record sales and earnings of the company this year, it is evident that the R&D investments of the company have borne fruit.

Analysts expect BMW to post blowout earnings per share of $7.06 this year. These earnings are 5% lower than the record earnings per share of $7.45 last year but the results of last year included a one-time valuation gain of €7.7 billion as part of the consolidation of a joint venture in China. Excluding that non-recurring gain, BMW is on track to post record earnings this year.

BMW is expected by analysts to incur a 13% decrease in its earnings per share next year, from $7.06 to $6.12, due to the fading tailwind of pent-up demand after the end of the pandemic. Nevertheless, the stock is remarkably cheaply valued even if it is evaluated based on its expected earnings in 2024.

Valuation

BMW is currently trading at only 4.85 times its expected earnings this year. However, as the earnings of the company are expected to moderate next year, it is important to focus on the forward price-to-earnings ratio of the stock. As mentioned in the introduction, BMW is currently trading at a forward price-to-earnings ratio of 5.6x. This price-to-earnings ratio is much lower than the 10-year average of 8.3x of the stock. Therefore, BMW is extremely cheap when compared to its historical valuation.

Moreover, BMW has a strong balance sheet. Its interest income exceeds its interest expense and hence the company essentially has no interest expense. Furthermore, its total liabilities are essentially equal to the current assets of the company plus the long-term receivables from the loans the company has offered to its customers to enable them to purchase vehicles. Therefore, BMW has a negligible amount of debt and hence it is hard to justify its exceptionally low price-to-earnings ratio.

Given the sustained growth of the sales of electric vehicles and the wide profit margins of this category of vehicles, BMW is not likely to incur a material decline in its earnings beyond next year. It is also highly informative to focus on the historical performance record of BMW in order to evaluate a worst-case scenario for the stock.

BMW Historical Earnings (Investor Presentation)

In a worst-case scenario, the annual earnings of BMW would plunge approximately 50%, from about €16 billion (or $7.06 per share) this year to about €8 billion (or $3.53 per share), which the company reported in 2012-2013. This is highly unlikely, as the vehicle manufacturer did not enjoy the strong tailwind from the boom of electric vehicles back then. Nevertheless, even in such an adverse scenario, the current stock price corresponds to a price-to-earnings ratio of 9.7x, which is reasonable for a vehicle manufacturer. Overall, BMW is remarkably cheaply valued both in absolute terms and in comparison to the historical valuation of the stock. Even in a highly unlikely worst-case scenario, in which the tailwind from electric vehicles disappears, the stock is reasonably valued.

Dividend

BMW offered an annual dividend of $3.08 in May. This dividend corresponds to a dividend yield of 9.0% but some investors may claim that this yield is somewhat misleading, given that the dividend has already been distributed and the dividend of next year is unknown right now.

Nevertheless, BMW has an explicit long-term goal of maintaining a 30-40% dividend payout ratio. The company has proved loyal to this policy for more than a decade, with the exception of just a few years, such as 2020-2021 due to the pandemic and 2022 due to the aforementioned one-time gain. As the company is expected to earn $7.06 per share this year, it is likely to offer an annual dividend of $2.12-2.82 in less than six months from now. Based on its current stock price, BMW is likely to offer a dividend yield between 6.2% and 8.2% next year. This is undoubtedly an attractive dividend yield.

Risk

The primary risk for all vehicle manufacturers, including BMW, is the adverse scenario of a global recession. In such a case, many consumers are likely to postpone the purchase of a vehicle and hence BMW will experience a material decrease in its revenues and earnings. BMW is somewhat more vulnerable to recessions than mass-market manufacturers due to the luxurious nature of its vehicles. Nevertheless, the company has always recovered strongly from past recessions. Moreover, there are no signs of a recession on the horizon. Instead, the central banks around the globe are doing their best to cool the economy in order to restore inflation to normal levels.

Final thoughts

Manufacturers of vehicles are infamous for their cyclicality and hence investors should be particularly careful before investing in this industry. However, BMW appears highly attractive right now. It is one of the global leaders in the electric vehicle market, which is characterized by secular growth, while the stock is remarkably cheaply valued and is offering an attractive dividend. Therefore, the stock is likely to highly reward investors in the upcoming years.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.