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TEMPUS

BMW remains stuck in neutral

The Times

Car manufacturers face no shortage of challenges. Interest rates and inflation remain stubbornly high, internal combustion engines (ICEs) are on their way out and nimble tech disruptors want a piece of the action.

Poor sentiment has left BMW, a company synonymous with premium prices, trading at a fat discount. The German giant’s ordinary shares are currently valued at 73 per cent of book value, a sharp fall-off from the ten-year average of 112 per cent. To many investors, this might scream “value trap”. A closer look under the bonnet suggests otherwise.

For starters, the tricky economic backdrop has not resulted in demand falling off. Orders are flooding in and margins are expected to widen. BMW is not ignoring the electric vehicle (EV) revolution either. Unlike some rivals, the company, which also owns the Rolls-Royce and Mini brands, has not been shouting from the rooftops about being super-committed to battery-powered autos. It was an early adopter, only to backtrack and focus more on hybrid solutions, probably because it realised how hard it was to make EVs financially viable.

Investors confused being frugal and wanting to exploit a winning strategy of catering to the whole market for as long as possible as BMW burying its head in the sand. They were wrong. ICEs are not dead and will probably be around longer than governments hope. And BMW actually has a decent foothold on the burgeoning EV market.

The company is steadily ramping up production as demand grows, and is selling more than traditional rivals. In the second quarter of 2023, fully battery-powered vehicles accounted for 14 per cent of deliveries — a number expected to keep rising. Encouragingly, management also believes its Neue Klasse EVs, due to start launching in 2025, will be at least as profitable as ICE models.

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Another common misconception is that Chinese brands, with their technical knowhow and cornering of supply chains, will be too tough to compete against in the EV space. Onlookers have noticed VW’s struggles in China, a key market where EV sales are much more advanced, and worry a similar fate awaits other traditional carmakers.

BMW is less exposed to these risks as it targets the premium market, where consumers are happy to pay extra for brand names. BMW is highly regarded, not just in the West but also by Chinese consumers.

Tesla poses a greater challenge. It has had a bigger head start, holds some brand appeal and is cutting prices to appeal to the mass market. That last move could prove disastrous or give BMW an edge, assuming it is able to maintain the same level of quality with its EVs.

Should investors recognise some of these points, the discount on the shares will likely narrow. The problem is, it may take a while for BMW’s competitive edge to become readily apparent. In the meantime, there continues to be plenty of uncertainty and general scepticism.

A spat between the EU and China over the latter’s exports of cheap EVs is threatening to boil over into tariffs. Both sides would lose a lot from a trade war, but you never know.

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Elevated costs will also weigh on the shares. Carmaking is expensive, even more so now that the tech is completely changing. High capital expenditure and research and development outlays will not pay off immediately and could squeeze dividends and endanger the share buyback programme.

Investors do not love incumbent carmakers at the moment, even if they trade for cents on the dollar, and it is going to take something big to change that. Without an obvious rerating on the horizon, it is probably best to stay on the sidelines.

ADVICE: Hold
WHY: The shares have been excessively punished but it may take investors a while to recognise this

Mobico

Mobico, the transport operator previously known as National Express, does not inspire much confidence. Margins are thin, the balance sheet is strained and faith in a sufficient turnaround, after a series of disappointments, is lacking.

Travel disruption in the pandemic and subsequent inflationary pressures have been tough. And investors haven’t been forgiving, wiping about 80 per cent off the share price since the start of 2020. Results covering the first half of the year were disappointing.

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Profits got battered as rising revenues and passenger numbers weren’t enough to offset higher operating costs, mainly linked to wage inflation and an end to Covid-related government handouts. Fortunately, the second half should be more prosperous. The driver shortage issue is apparently now resolved, additional costs have been cut and prices are climbing.

Demand is also expected to continue rising. Management is pinning a lot of its hopes on people ditching cars for mass transit. Governments are becoming stricter about which type of vehicles can be used, and where, and offer subsidies to encourage public transport. The strategy is to capitalise on this trend, focus on more defensive revenue streams and step up the asset-light side of the business. Contract work and leasing carry less pricing and cost risk. However, this security could come at the expense of lower profitability and make the goal of widening margins to more respectable levels harder to achieve.

Another big concern is debt. Management has been chipping away at it but leverage remains uncomfortably high. Interest costs will increase, too, following the negotiation of a bigger revolving credit facility with a later expiry date and refinancing of a soon-to-expire £400 million bond. Wariness about Mobico is reflected in a paltry enterprise value of 3.97 times forecast earnings before interest, taxes, depreciation and amortisation, which is considerably below the ten-year average.

A lot of bad news is now priced into the shares and talk of potential corporate bidders might be forthcoming. But that’s not enough to warrant a buy recommendation.

ADVICE: Hold
WHY: Not in great shape, but shares are priced accordingly

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