A Work Project, presented as part of the requirements for the Award of a Master Degree in Finance from the NOVA – School of Business and Economics. EQUITY RESEARCH IN THE AUTOMOTIVE INDUSTRY: VALUATION OF BMW BRUNO ALEXANDRE MOTA AZEVEDO, 24245 MARCEL PHILIPP OLSCHEWSKI, 29855 A Project carried out on the Master in Finance Program, under the supervision of: Nuno Quartin Bastos de Vasconcelos e Sá January 3, 2020 Abstract This work project “Equity Research – Valuation of BMW” analyzes BMW’s business within the automotive industry. Given a strong demand for BMW’s luxury cars, e.g. SUVs, we estimate further modest sales growth of 1.2%-1.6% in a challenging environment. However, this imposes potential fines for missing EU CO2 fleet emission target but also finance the necessary R&D and CAPEX needs to master the current sector trends. This results in a lower operating profitability in the future. Our valuation for BMW yields a price target of €75.52 for FY20, which results in a 7.4% total shareholder return and hence, a HOLD recommendation. Keywords Equity Research, Automotive Industry, BMW, Valuation This work used infrastructure and resources funded by Fundação para a Ciência e a Tecnologia (UID/ECO/00124/2013, UID/ECO/00124/2019 and Social Sciences DataLab, Project 22209), POR Lisboa (LISBOA-01-0145-FEDER-007722 and Social Sciences DataLab, Project 22209) and POR Norte (Social Sciences DataLab, Project 22209) MASTER’S IN FINANCE BAYERISCHE MOTOREN WERKE AG COMPANY REPORT AUTOMOTIVE INDUSTRY 3 JANUARY 2020 STUDENTS: BRUNO AZEVEDO, MARCEL OLSCHEWSKI [email protected], [email protected] BMW’s success at crossroads Recommendation: HOLD Vs Previous Recommendation HOLD Technology and electrification challenge profitability Price Target FY20: 75.52 € § Despite a global market sales downturn of about -5.8% in Vs Previous Price Target 74.41 € 2019, with China’s weakening momentum, ongoing trade tariffs Price (as of 31-Dec-19) 73.14 € conflict and Brexit uncertainty, BMW unit sales are expected to Reuters: BMWG.DE, Bloomberg: BMW.GR increase by 1.4% to 2.525m. § Changeover from ICE to lower-margin EV drivetrains 52-week range (€) 57.99-78.30 Market Cap (€m) 47,120 challenges BMW and its profitability. Our forecasts estimate a lower Outstanding Common Shares 601,995,196 profitability (6.1-6.4% EBIT-margin) than historically (7.2-9.6%) Outstanding Preferred Shares 56,126,904 Price Preferred Shares (as of 31-Dec-19) 55.05 € for the automotive segment in the future due to negative impact from Source: Company data, Bloomberg higher R&D investments. § Increasing SUV sales finance BMW’s CAPEX and R&D BMW vs STOXX Europe 600 (indexed) 130 needs and are likely to result in fines for missing EU CO2 fleet 120 emission target of 101 g/km in 2021 (currently at 128 g/km). 110 100 § Consumers are projected to continue to withhold EV 90 purchases due to concerns on pricing, charging infrastructure and 80 range capacity. Ceased or expiry of governmental financial stimulus 1/19 4/19 7/19 10/19 STOXX Europe 600 BMW will further decelerate adoption rates. Source: Bloomberg, Analysts estimates § Based on a sum of the parts valuation of Automotive & (in € millions) 2018 2019E 2020F Motorcycles, Financial Services and the Chinese JV, BMW’s price Revenues 97,480 100,009 102,304 target is €75.52 for FY20, meaning a shareholder return of 7.4%, Automotive sales (‘000) 2,490 2,525 2,560 Gross margin 19.0% 18.1% 17.8% considering a €3.00 dividend. Hence, this results in a HOLD EBIT 9,121 7,229 8,763 recommendation. EBIT margin 9.4% 6.9% 8.1% Net income 7,117 5,079 6,097 Company description Earnings/Share (in €) 10.82 7.72 9.26 Dividend/Share (in €) 3.50 3.00 3.10 Munich-based BMW Group is a German manufacturer of automotives P/E 6.50x 9.28x 7.54x and motorcycles. The company operates globally with plants and Source: Company data, Analysts estimates offices in more than 150 countries on 6 continents. With a focus on the premium segment, the group markets cars under its brands BMW, MINI and Rolls-Royce. Additionally, it also distributes BMW motorcycles and complements its product offerings with financial services, such as financing, leasing, insurance brokerage, and fleet management for private and business customers. THIS REPORT WAS PREPARED EXCLUSIVELY FOR ACADEMIC PURPOSES BY BRUNO ALEXANDRE MOTA AZEVEDO AND MARCEL PHILIPP OLSCHEWSKI, MASTER’S IN FINANCE STUDENTS OF THE NOVA SCHOOL OF BUSINESS AND ECONOMICS. THE REPORT WAS SUPERVISED BY A NOVA SBE FACULTY MEMBER, ACTING IN A MERE ACADEMIC CAPACITY, WHO REVIEWED THE VALUATION METHODOLOGY AND THE FINANCIAL MODEL. (PLEASE REFER TO THE DISCLOSURES AND DISCLAIMERS AT END OF THE DOCUMENT) PAGE 1/32 BAYERISCHE MOTOREN WERKE AG COMPANY REPORT Table of Contents EXECUTIVE SUMMARY ........................................................................................ 3 COMPANY OVERVIEW ......................................................................................... 4 COMPANY HISTORY ......................................................................................... 4 MANAGEMENT BOARD AND SUPERVISORY BOARD .............................................. 4 SHAREHOLDER STRUCTURE ............................................................................. 5 BUSINESS MODEL ............................................................................................ 5 MARKET OVERVIEW AND SECTOR OUTLOOK ................................................ 7 MACROECONOMIC OUTLOOK AND SECTOR EVOLUTION ....................................... 7 EUROPEAN MARKETS ............................................................................ 7 UNITED STATES MARKET ....................................................................... 9 CHINESE MARKET ................................................................................. 9 BUSINESS CHALLENGES AND TRENDS ............................................................. 10 BUSINESS CHALLENGES AND OPPORTUNITIES ....................................... 10 SECTOR TRENDS (CASE) ................................................................... 12 COMPETITIVE PERFORMANCE ........................................................................ 14 INTRINSIC VALUATION ...................................................................................... 15 AUTOMOTIVE SEGMENT ................................................................................. 15 REVENUE EVOLUTION .......................................................................... 15 R&D EXPENSES .................................................................................. 16 OPERATING PROFITABILITY .................................................................. 16 CAPITAL EXPENDITURE ........................................................................ 17 CHINESE JOINT VENTURES: BMW BRILLIANCE AND SPOTLIGHT ............. 18 MOTORCYCLES SEGMENT .............................................................................. 19 INDUSTRIAL ROIC AND FCFF EVOLUTION ...................................................... 19 FINANCIAL SERVICES SEGMENT ..................................................................... 20 OTHER ENTITIES AND ELIMINATIONS SEGMENTS ............................................. 21 COST OF CAPITAL .......................................................................................... 21 SCENARIO ANALYSIS ..................................................................................... 22 SENSITIVITY ANALYSIS ..................................................................................... 23 MULTIPLES VALUATION ................................................................................... 23 FINAL RECOMMENDATION ............................................................................... 23 REFERENCES ..................................................................................................... 24 APPENDIX 1 ........................................................................................................ 28 INCOME STATEMENT ..................................................................................... 28 BALANCE SHEET ........................................................................................... 28 CASHFLOW STATEMENT AND JV BMW BRILLIANCE AUTOMOTIVE .................... 29 APPENDIX 2: DISCLOSURES AND DISCLAIMERS .......................................... 30 PAGE 2/32 BAYERISCHE MOTOREN WERKE AG COMPANY REPORT Executive summary Changing consumer habits and expectations due to the digitalization as well as the BMW Group unit sales technological progress paired with environmental concerns within the society lead 2,368 2,464 2,491 2,525 automotive industry to undergo a major transformation. The sector trends, which 2,118 2,247 BMW faces, are summarized under the term CASE (Connectivity, Autonomous Driving, Sharing Mobility and Electrification/Environment). By unit sales in 2018, BMW is the second largest premium car manufacturer globally. The group has '14 '15 '16 '17 '18 '19E BMW MINI Rolls-Royce Total increased its sales by more than one million units (CAGR of 6.8%) since the 2008 FiGure 1: BMW Group unit sales by brand (in ‘000 units) financial crisis. Despite challenging market conditions with decreasing global car Source: Company data, Analyst estimation sales caused by tariff conflicts and Brexit uncertainty, in 2018 BMW’s unit sales increased for ten consecutive years, primarily attributable to increasing demand from China. While the domestic market, Germany, is expected to grow only slightly at a CAGR of 1.0% from 2020 onwards,