Main Risks Factors Impacting the Business - BMW Group - Case Study Example

Main Risks Factors Impacting the Business BMW group is leading automobile industry with capital market share. The BMW group declared their limited profits figures in the third quarter of 2008, the results were "perceptibly influenced by the economic downswing in the wake of the financial crisis" (Citigroup, 2008). Several reasons have attributed towards the limited financial earnings of the group, "ongoing consumer reticence in the main sales markets, the weak state of the used car markets as well as increasing refinancing costs" have significant influence on the earnings of the BMW Group. The limited profits earned by the company were due to the "model life-cycle factors" which significantly enhanced the car sales volumes. During this period, the BMW group sold less than 350,000 automobile units, which includes BMW, Mini and Rolls-Royce. The figure of the units sold was less than 5percent against the units sold in the previous year. During the contemporary year, more than 1,200,000 units were sold in the market which is approximately 2percent greater than previous year's figure. The financial performance of the group is severely restricted by the "market conditions for the motorcycle business"; the conditions are regarded as severe and crucial for the market. The sales of the motorcycles produced by BMW have shown similar trend, during the third quarter of the running year the sales volume is almost equivalent to the sales of the previous year. The units of motorcycles sold in the market were less than 3percent of the figures sold in the previous year. The financial crisis has been responsible for the negative impact of the BMW group. In the wake of international economic crisis, the customers have practiced reluctance in procurement of the automobiles unit, "the third-quarter revenues reported by the company, decreased by 8.6 % to euro 12,588 million". During the running economic recession, the company was able to collect revenues of euro 40,425 million, which was highest than the figures of than the figures of the previous year. The variation in the foreign exchange rates was also responsible for the improvement in the revenue generation, "the BMW Group revenues for the nine-month period were up by 5.1percent". The BMW group was controlled its expenses, and residual expenses have been eliminated, "the company increased the cumulative amount of expense recognised for additional risk provision for residual value and bad debt risks to a total of euro 1,037 million". The brief financial outlook for the BMW group for the third quarter of the running year is reduction in the earnings by euro 258 million, profit dropped by 60percent to euro 387 million. The pre-tax earnings of the BMW group were truncated by the external factors, "pre-tax profit stood at euro 279 million for the third quarter, the amount is 63percent lower than one year earlier, while that for the nine-month period fell to euro 1,522 million" (Citigroup, 2008). The net profit earned by the company stood at euro 298 million for the third quarter. The running economic recession has severely dampened the financial outlook of the company for the years to come (Bilgen, 2004). The business conditions are not encouraging, the market is volatile, and this has "deteriorated further for the BMW Group over the past months". The financial crisis has escalated, and there is strong possibility of this recession will cause "noticeable reduction in consumer spending in numerous markets" (Citigroup, 2008). The BMW group is yet to experience the environmental challenges; the growing understanding of the consumers about green house gases emission has developed reluctance among the customer to acquire goods which shall be detrimental for the environment. The BMW group is trapped by "significant level of volatility on the financial and commodity markets, this poses the risk of even greater uncertainty". The purchasing power of the consumer has depleted, "private consumption and consumer confidence have dipped perceptibly, particularly in the USA and Europe". The BMW group shall face numerous challenges, "the dynamic growth rates registered on these markets in recent years will be trimmed back as a result of the financial crisis" (Bilgen, 2004). The number of new registrations is expected to drop; this will "ease pressure on raw material markets, which is near sufficient to offset the extremely high level of expenses that have had to be borne" (Citigroup, 2008). It is believed that the looming financial crisis and drop in the purchasing power of the customer has developed uncertainties, "making reliable forecasting difficult and impossible to make reliable assertions for the near future". As per the official comments by the BMW group, all such factors have been considered for the formulation of the strategy to combat the wave of recession. Financial and Operational Reforms The company however understands that it might not be possible to "surpass the previous year's record sales volume figure in its automobile business". The company is aware that it might not be possible to achieve the profitability targets set for 2008. The company realises that "it cannot rule out the risk provision for bad debts and lease financing, which have to be increased again before the end of 2008". The company has failed to give its financial and sales outlook for the next year, "based upon difficult business conditions, the likely progress of business over the coming months cannot be forecast with any exactitude; it is therefore impossible to estimate the level of BMW group earnings for the year, other that they will continue to remain clearly positive". The BMW group is renowned and popular worldwide, and is regarded as "sine qua non of automotive achievement" (Citigroup, 2008). The company has outshined "in both respects as the creators of the archetype aspirant volume car and, as a consequence and more importantly for investors, the archetype ROCE & ROE value driven automotive company". The investors have always been confident about the financial outcome of the company, and many investors were sure that the group "provided the returns that seem to mix the best of Porsche and Toyota" (Leonard, 2000). The BMW group has been immensely popular among its customers for several design aspects relevant to the product unit, "the produced unit is relatively lean and lightweight in structure and reporting, with controlled centre of inertia at board level, and balanced masses between R&D and production, having low un-sprung weight enabling quick action and above all the ability to transmit, feel and read the external environment reacting to its stimuli" (Jan, 2002). The BMW group is regarded as the integration of the "likes of Piechestreider and Reitzle, a culture that merged old school Munich pragmatism with broad-scope NYSE acumen to develop a focused product development capability set within a worldly, future-forward business strategy". The combination was successful, and was "worth of economic expansion in traditional markets, which boosted by ever expanding global liquidity and credit, allowed many an aspirant consumer to fulfil their BMW dreams" (Citigroup, 2008). The combination was successful, and was "worth of economic expansion in traditional markets, which boosted by ever expanding global liquidity and credit, allowed many an aspirant consumer to fulfil their BMW dreams". The running economic slowdown has caused "slower revenue growth rates and external macro headwinds" (Edward, 2006). The production and sales record of the BMW group reveals that "global deliveries are up +4.7percent at 764,874 units and group revenues are up +4.5percent at 27.837bn Euros but group EBIT profitability is down -35percent at 1.243bn Euros; of which only approximately two-thirds is automobile sales contribution". Last year, the financial outlook of the company was healthy, the company was able to demonstrate highline performance, and the leading indicators were EBIT, revenues, profit before taxes. The Citigroup has issued a report in which the financial position of BMW group was discussed along with the financial challenges for the company in the coming years. The report termed that "the outlook of BMW is so full of caveats of leasing that it seems to be preparing us for a miss on guidance, courtesy of the financial crisis" (Harald, 2000). As per the report issued, "in third quarter of 2000, euro 500million charge, DCX pumped 6x as much into FS equity over the next three quarters to stabilise its business". The economists are of the strong opinion that "the company has been over-using its captive finance, at least for current credit conditions" (Vidal, 2002). It was identified that the achieved success in US "was bought at price-levels implicit in lease rates which have been artificially low; this will be a painful unwind" (Hamel, 2000). A comparison between the BMW group and its competitors projects "evidence of superior-refinancing capacity, while general cost of risks seems well controlled". The conclusion drawn from the performance of the first quarter suggested that "volume was the biggest contributor so far, as expected, so any slow-up required in the US, which is equivalent to 21percent, may jeopardise this" (Citigroup, 2008). The economists have observed "insufficient volume or restructuring offset to higher FX and product cost headwinds when the product cycle is relatively weak and financing tighter, reflected in our sub0market estimates". The economists have strongly advised BMW to "look for attractive asset when credit conditions improve, but even a 9.2x 08E PE does not convince to step up now with earnings momentum so weak" (Citigroup, 2008). The financial outlook for the BMW group has been envisaged based upon "balance of 08E as in 1Q08 equivalent to 236m, and lower returns on the FS book in 09E". The financial concerns have "necessitated smaller adjustments at the EPS level than at the PBT level, as tax seems to be running below our expectations in the current year" (Dejan, 2003). It is important for BMW to understand that any variation in the second hand vehicle prices will emerge as "economic event for all companies with captive finance" (Shah, 2002), therefore the captive finance write downs matter significantly. Several tactics have evolved to counter such situations i.e. "group might end up taking charges to right-price their portfolios, so that the accounts show an immediate cost, or make more conservative provisions and pricing assumptions on off-lease vehicles, but on a lower disposal price lower profits on disposal will be recognised" (Citigroup, 2008). Evaluation The financial impact is suspected to be "re-timed in the accounts to the time of disposal of the vehicle". There is strong perception in the market that the BMW group has sold its vehicles at lower prices, this suspected to curtail "top-line development" (Fandel, 2004), which is regarded as the crucial contributor of the BMW turnaround potential. The evaluation of the sales revenue performance revealed gloomy outlook for the BMW group in 1Q08. A relationship between the FS and the sales revenue performance was negative in the first quarter of 2008. The average automobile was able to recover "marginally higher implied revenue of 1percent (Fig A). The sales values shrunk by 3percent due to the " 14% US$/ change on annual basis, combined with BMW's 22% NAFTA sales weight" (Citigroup, 2008). The revenue of the BMW group was restricted to increment of mere 7percent, onside the rising FS revenue was responsible for the revenue growth of BMW. Such rise was responsible for the increase in sales by 7pecent, "the reason for the 25percent rise in FS revenues seems to have been related to portfolio growth, and rise in the number of vehicles coming off lease and whose disposal proceeds are a major element of FS revenue" (Citigroup, 2008). The volume growth supported the earning performance of the company, "the high BMW revenue conversion from unit sales is otherwise largely a symptom of the leasing operation" (Citigroup, 2008). The economists have urged that the company should have "most profitable captive, with a low cost of borrowing emanating from its top-end A+ credit rating, strong profile amongst retail debt investors and relatively low cost of risk". On the other hand, the company has to aggressively pursue its FS business till the time stability is achieved in the current market conditions. The company has been rigorously focused upon the expansion of its business, relative to any other corporate industry. The BMW group has "ended up more reliant on FS as a marketing support than any of our other companies; this is particularly evident in the FS intensity index", the index is the comparison of the "the assets held within FS with the sales of the groups" (Citigroup, 2008). The automobile giant has emerged as the "least profitable based upon its ROA or ROE analysis, especially bearing in mind the higher returns achieved by Peugeot, RNO and even Fiat recently". The output has been justified by the BMW group, and the decline has been linked with the "forthcoming divisional split of business will give a more accurate view on ROE as some other financing operations are dropped out of the FS equity" (Citigroup, 2008). The acquisition of Dekra SS by the BMW group has severely affected the ROE. The business risks as discussed before need to be handled in sophisticated manner, as to ensure that such risks do not dampen the business activities of the group. The BMW group has to primarily focus upon "refinancing cost on the liability side of its BS, in credit quality, and in residual exposure on the asset side" (Ronald, 2003). The group has not yet reported of any "unusual issues with credit quality except those linked to residuals in the US" (Citigroup, 2008), therefore the main operational issues are likely to "remain the residual exposure". The group appears to have strong stand against refinancing side. The BMW group is greatly involved in the leasing deals, "euro 17bn in group accounts and euro 20bn in the FS segmented accounts at BMW, with the consolidation adjustment being essentially a valuation allowance". The data gathered from the Historical Mannheim Auction revealed 10percent rise in the second hand car prices, therefore it is warned that severe risk is associated, which "may even be worse, as credit concerns and gas prices combine negatively in some segments". The risk factor exists; therefore the company has to readjust its market values. Based upon the variation in the maturity factor of the vehicles on leasing, a defined limit of 5percent shall be applicable. Through analysis it is evident that "low values in the portfolio might even lead to higher off-lease gains once more" (Citigroup, 2008). The BMW group is financially stable; therefore the company has been able to "enjoy reasonable stability in its cost of risk". The economists have agreed that the BMW group does not have "higher default rates than other captives" (Bilgen, 2004). It is important for the company to evolve investment strategy; the increase in the earnings shall influence the BMW share price. The company has limited "hedged exchange rate exposure and the higher variable costs associated with its major efficient dynamics initiative to improve the fuel economy/emission performance of its cars create risks for achieving even modest profit growth short term" (Citigroup, 2008). The BMW strategy shall be based upon "steady building of the franchise, brand values and volumes; however rising spending trend has curtailed the cash generation of the company". It is important for the company to prove that "it can return emphatically to value creation, superior growth and positive earnings deltas before it can expect investors to grow materially more enthusiastic" (Citigroup, 2008). The performance of the BMW is suspected to get influenced by the "revival of adverse tax proposals by the German government" (Christine, 2003). As per economists, the risk rating of the BMW group is medium, "this rating is based on a broad range of factors and includes our assessment of historical share price volatility, indicators of future stock-specific risk" (Citigroup, 2008). Payments of Dividends The dividend policy is considered to be the 'controversial subjects' of finance, the scholars of the subject have been involved in extensive theorizing to analyze and explore the possibility for the declaration of the dividends (Maurice, 2003). Several empirical models have been proposed and recommended for the explanation of the dividend behaviour, and the BMW group has been engaged in the implementation of such models for the exploration and assessment of the dividends. However the driving policy towards the assessment of the dividend has remained unclear and complex, primarily due to the diligence of the process followed by the de-capitalization of the revenue, and owing to the clash of interest and reluctance in the public declaration of the achieved profits. The BMW group has adopted cautious stand towards the dividend policy, and has ensured that the declaration of the dividends does not affect the firm value. The economists are of the opinion that dividend and its frequency shall not to be considered on neutral on short term basis; the BMW group has declared and manifested its dividend policy based upon the implementation of the policy of tight money. However, the management understands that negative relation between wage inflation and unemployment, and considers these factors into account prior to the declaration of the dividends, however the management further realized that 'money growth raises output in the short run which ought to be shared and delivered to the shareholders (Steve, 2004). A conclusion that can be reached that 'exogenous part' of the money influence the dividend rates and its frequency, on the basis of the assumption that the money responds to real variable, therefore the money supply has further overshadowed the liquidity effect on the dividend rates (Maurice, 2003). However it is incorrect to regard the money as the appropriate measure of the policy towards the increase in the dividend rates, the dividend rates are based on the supply of bonds, and rate of dividend is regarded as the return on investment and bonds, through bonds the evaluation of the liquidity effect can be exercised. The measurement of the money can be exercised through the non-borrowed reserves; the purpose of injecting the money cannot be achieved through the withdrawals. The injection of money can also be exercised through the purchase of long-term bonds, and this is expected to develop an impact on the short-term rates, which is expected to influence the dividend declaration process. The stock market risk are associated with the occurrences when the allocation of the funds is granted towards any investment project, without any evaluation and analysis of the purchasing and selling price of the product afterwards. Such concerns are imminent because stock markets are considered to be incomplete and segmented. The risk within the stock market based on the declaration of the dividends is experienced when the company and the shareholders are willing to invest their resources in towards the investment plan. The BMW group has practiced a policy related to the estimation of the dividends based upon the long-term shares of the company, to facilitate the old and potent partners. The buyers are the expected beneficiaries when the dividend percentile is positive, the positive effect is based on the lower prices of the stocks as compare to the expected prices, and when the expected rate of return has been crossed. Therefore within the stock market business, the dealers are expected to make good fortune, and 'any real consequences are distributional because the shock has favoured some agents at the expense of others'. The expansion and growth of the stock market is expected to determine the time period associated with the downgrade within the stock market, the time is considered to be major dimension, and the declaration of the dividends is based on the 'relationship between the indicators and the downgrade' (Maurice, 2003). Appendix -A Hold /Medium 2M Price (2nd May, 2008) Euro 36.84 Target Price Euro 38.00 Expected Share Price Return (A) 3.10% Expected Divident Yield (B) 2.90% Expected Total Return (Sume of A and B) 6% Market Cap Euro 23,800 M Source: (Citigroup Company Focus) 2006A 2007A 2008E 2009E 2010E Sales (Euro 000,000s) 48,999 56,018 58,300 60,300 63,600 Net Income (Euro 000,000s) 2,498 3,126 2,613 2,682 3,138 Diluted EPS (Euro) 3.82 4.78 4 4.1 4.8 Dilued EPS (Old) (Euro) 3.82 4.78 4 4.1 4.8 PE 9.6 7.7 9.2 9 7.7 EV / EBITDA 3.6 3.5 2.7 2.5 2.1 DPS 0.7 1.06 1.25 1.44 1.68 Net Div Yield 1.9 2.9 3.4 3.9 4.6 Source: (Citigroup Company Focus) References 1. Company Focus: BMW AG. Citigroup Global Markets: Equity Research. Citigroup Publication. May, 2008. 2. Bilgen, B., Ozkarahan, I., 2004. Strategic tactical and operational production-distribution. International Journal of Technology Management 28, 151-171. 3. Fandel, G., Stammen, M., 2004. 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