BMW Deals with Strong Euro, Weak US Demand

Folks, let me assure you that I use the BMW for transportation. But, it’s not what you’re thinking. Rather, I use the bus, metro rail, and walk to get where I need to [rimshot! Take my wife pleeze, etc.] Seriously, though, the famed German automaker whose luxury sedans are technologically advanced enough to make Toyota’s Prius seem like a gas guzzler by comparison is dealing with two ominous and interrelated headwinds. First is the infamous declining dollar and, conversely, the excessively mighty Euro denting profits. While BMW does hedge its transactions as most of its sales are outside the Eurozone–think forward purchases of euro–hedging is not exactly a costless endeavor. Moreover, the fallout from the subprime contagion is having effects on key markets like the US, home of the infamous Beemer-loving upwardly aspirational yuppies. Unsurprisingly, the company is looking to make more cars Stateside to lower production costs. From the BBC:

BMW’s glitzy new showroom, BMW World, dominates the Munich skyline. Walking into the futuristic building, with its steel roof, everything is geared towards promoting the BMW brand. There are restaurants, a café and a shop selling BMW merchandise. Since the luxury showroom opened its doors last autumn, more than a million visitors have flocked here. BMW chose the showroom as the venue for the company’s annual press conference.

The world’s biggest premium carmaker sold a record 1.5 million vehicles in 2007, and says its on course to meet its target of selling 1.8 million cars in 2012, confident that sales of its BMW, Mini and Rolls-Royce brands will continue growing. The company’s profit before tax was 3.9bn euros ($6.1bn; £3.0bn) in 2007, 6.1% down on the previous year, but still high.

Managers told reporters that despite the weak dollar and high commodity prices, the carmaker is hoping to increase its earnings this year. But there is one big cloud on the horizon. The BMW group is battling to limit the fall-out from the weakening dollar. In an interview with the BBC, BMW’s chief executive, Norbert Reithofer, confirmed that the carmaker would be increasing production at its plant in the US.

“If I look into the future, we will increase our production capacities in the US from 150,000 units to 240,000 units, the car plant in the US helps us on the natural hedging side, it can reduce your total exposure,” Norbert Reithofer said. The United States is BMW’s biggest single market and the group has a big plant in Spartanburg, South Carolina. Four out of five BMW Group cars are exported, so the company is exposed to exchange rate fluctuations.

The carmaker knows that it is operating in a tough economic climate. “During the first two months of this year, in January and February, we had a challenge in the US,” said the company’s chief executive. “We were able to compensate for the losses in car volume in the US elsewhere in the world. We have a very good market situation in China, Germany is going up, and we had good results in the UK. We are a global player and we are not just dependent on one market,” he said. “From a financial hedging point of view, we are in a good position this year,” Mr Reithofer said, smiling broadly. “It’s not just one currency. We have three important markets, Japan, the UK and the United States,” Mr Reithofer explained.

BMW said that it has hedged itself completely this year with “all of the main currencies”. However, currency fluctuations are taking their toll. They cost BMW 517m euros last year, while raw material price increases cost the group 288m euros. But that was offset by higher sales and improvements in efficiency.

Faced with tough competition from rivals, the German group is bent on cost-cutting. “Our major production cost is materials, which amounts to 26bn euros,” Mr Reithofer said. We have to have discussions with our supplier networks about prices and we have to start an initiative to find out if we can we reduce the costs of our supplier companies and cut logistics costs. We have to buy more goods, that means more components for our cars, in the US. For our car plants in the US and Europe.”

The premium carmaker has announced that it is planning to axe more than 8,000 jobs, a decision that provoked outrage in Germany. And it is worried that a slowdown in the US market could affect its sales. “A slowdown of the car market in the US in 2008 could affect the whole car market. Look at our customers, we are a premium car manufacturer and that helps,” Mr Reithofer said. “Over the last 10 years, during a recession, first volume car manufacturers are affected, then later it’s premium carmakers. Will it affect us? We don’t know, it depends on how deep the crisis will be,” he added, sounding an ominous tone.

Di Plane Pt. 3: 787 in Trouble + EADS v. Boeing

This post is a follow-up to two I made earlier regarding the troubles brewing at Boeing over its now thrice-delayed 787 and the continuing row over EADS winning a $35B contract to supply the US Air Force with air tankers at the expense of Boeing. These do not seem to be the best of times for the famous Chicago-based firm. Let us begin with the 787 being officially delayed for a third time and the customers who are now harrying Boeing over late delivery. Worse, the whole program may require a major overhaul in light of ongoing difficulties:

Boeing admitted on Wednesday that it would have to redesign parts of its troubled 787 Dreamliner, raising the prospect of a third delay in recent months to delivery of the new aircraft. The company’s comments came in response to a warning from Steven Udvar-Hazy, chairman of International Lease Finance Corporation (ILFC), the 787’s biggest customer. Mr Hazy told a JPMorgan Chase conference that the state of the Dreamliner programme was “not pretty”. He said first deliveries would be delayed for at least another six months because its centre wing box – which holds the wings in place – needed to be redesigned.

Boeing refused to comment on the specifics of the redesign work but said Mr Hazy was not painting an accurate picture of the overall programme. “We are doing some redesign work but things are more complex than what he said,” said Yvonne Leach, for Boeing. “There’s a whole load of things going on.” Mr Hazy said he expected delivery of the long-range, 250-300 seat jet to be delayed until the end of the third quarter of next year. Boeing’s most recent guidance was that the Dreamliner would be ready “early” in 2009.

Boeing said it was sticking to its most recent guidelines, but added that it was undertaking a review of the 787 and would report its findings publicly at the end of March or early in April. There is now widespread expectation in the industry that the company will at that point announce a further delay.

Mr Hazy’s warning echoes a report from Goldman Sachs this month, which also said delivery of the 787 would not begin until the third quarter of 2009. A further delay would be hugely embarrassing for the company, which replaced Mike Bair, the former head of the 787 programme, after the first delay was announced in October last year. His replacement, Pat Shanahan, who was drafted in from Boeing’s missile defence unit.

Mr Shanahan has found it difficult to stick to the aggressive timetable laid out for the aircraft and in January the programme was delayed again. The two earlier delays were both attributed to assembly problems rather than issues with the aircraft’s design.

Boeing now faces having to make penalty payments to customers of the sort that have plunged Airbus, its European rival, into heavy losses. Last month ILFC said it would seek compensation “on a large scale” from Boeing for the 787 delays. Qantas, the Australian flag carrier, has also said it will ask for damages.

The 787 is Boeing’s most successful new aircraft, with 857 orders in place, worth about $140bn. But analysts are asking difficult questions about how profitable the whole programme could be if penalty payments are added to other cost concerns. “The large number of 787s sold at low prices, combined with rising recurring costs, are steadily eating away at programme margins and long-term programme profitability,” wrote Joseph Nadoll of JPMorgan in a research note on Wednesday.

ILFC, the world’s leading aircraft leasing firm, has ordered 74 Dreamliners, making it the biggest buyer for Chicago-based Boeing’s fastest-selling aircraft. The company has already struck leasing contracts with a string of international carriers such as Air Berlin, Lan Chile, Royal Jordanian, AeroMexico and Air Seychelles.

Meanwhile, Boeing is now battling EADS in a race to gather the biggest guns in the DC lobbying clique. As the Government Accountability Office (GAO) decides whether Boeing’s complaints have merit, there will be no lack of political bickering in the meantime. The international political economy angle is interesting in that (a) improved US relations with France and Germany in the aftermath of the Iraq invasion may be damaged and (b) Boeing and Airbus–the commercial airline making subsidiary of EADS–have lodged complaints against each other at the World Trade Organization. Whoever said IPE was staid? When big money is at stake, the calculus of political consent often ratches up, too:

Northrop last week hired a lobbying firm run by Trent Lott, the former Mississippi Republican senator, and John Breaux, a former Democratic senator from Louisiana. Northrop and EADS are relying on a group of Washington firms – including Hill & Knowlton, Quinn & Gillespie, and Public Strategies – to counter Boeing’s powerful lobby on Capitol Hill.

Boeing supporters have challenged the unexpected decision on several fronts, including that it would cost American jobs and damage the US defence industrial base. They have also lambasted the air force for choosing EADS while Airbus and Boeing are involved in a World Trade Organisation dispute.

Boeing last week lodged a protest with the Government Accountability Office, the oversight arm of Congress. Boeing allies allege that the air force changed the requirements of the competition at a late stage in a manner that favoured EADS. The company has also suggested that the air force misled Boeing by encouraging it to offer the 767, a smaller aircraft than the Airbus A330 which won.

The GAO has 100 days to respond to the protest. While the air force is not legally required to follow the agency’s recommendation, it almost always does. One congressional aide familiar with the process said government departments were inclined to treat GAO recommendations as mandatory because they are given great deference in the courts.

Major David Small, an air force spokesman, on Sunday said the air force “will follow the recommendations of the GAO.” If the GAO ruled in Boeing’s favour, it would also provide ammunition to politicians on Capitol Hill who want to reverse the deal.

Last week, Sue Payton, head of air force acquisitions, says the air force was legally required to ignore the impact on US jobs and the industrial base. With Robert Gates, US defence secretary, and Admiral Mike Mullen, chairman of the joint chiefs, Ms Payton has strongly defended the competition as fair.

While the GAO considers Boeing’s protest, lawmakers from states with a strong Boeing presence – particularly Washington and Kansas – are trying to engineer broader opposition to the deal on Capitol Hill. EADS and Northrop are hoping to counter that by urging politicians without a direct stake in the fight to stay on the sidelines.

Another element of the Northrop-EADS strategy is to downplay the role of the European company in public statements. While EADS will supply the Airbus tanker, Northrop, which is the prime contractor, generally comments publicly instead of its European partner.

EADS and Northrop must decide whether to start the tanker programme soon or wait until the GAO has issued its recommendation. A source familiar with the planning said the companies had already decided to proceed with a groundbreaking ceremony in Mobile, Alabama, where the tankers would be assembled. Randy Belote, a Northrop spokesman, said only that the companies “hadn’t announced plans”.

The companies have had some success pushing back against Boeing. Last week, John Warner – the Republican on the Senate armed services committee who backed Senator John McCain’s investigation of the original Boeing deal – reminded lawmakers the defence industry was increasingly globalised.

”Until the GAO acts and reports to Congress their findings, we should lower the emotional rhetoric, be accurate with the facts, and withhold judgment of the work done by a large dedicated group of uniformed and civilian acquisition specialists,” said Mr Warner.

Mr Warner also defended John McCain, the Arizona senator and presumptive Republican presidential nominee, who aggressively investigated a previous Boeing contract to provide the air force with tankers. Congress cancelled that deal in 2003 after investigations revealed that a senior air force officer had held illegal job negotiations with Boeing.

Some Boeing supporters have blamed Mr McCain’s investigation for ending the original deal. Others have accused Mr McCain of pressuring the air force to change the requirements of the competition to suit EADS. Mr McCain responds that he only forced the air force to remove language that would have tilted the competition unfairly towards Boeing.

Richard Aboulafia, an aerospace analyst at the Teal Group, said that while Boeing faced a “long fight” to try to regain part of the tanker contract, the outcome might depend on whether the Democrats won the presidency and retained control of Congress in November, which he said would produce a 60 per cent chance of a split-buy.

Loren Thompson, an analyst at the Lexington Institute, said he doubted whether there would be enough evidence “within the narrow confines of a GAO inquiry”, but added that “a combination of GAO findings and legislative action could stall or reverse the decision”.

Paul Nisbet, an aerospace expert at JSA Research, said the GAO decision was also likely to be “engulfed in politics”. He added that there was also the possibility that the recent improvement in US relations with Germany and France could work against Boeing.

“It would be a blow to these improved relations with these Airbus countries if the US air force decision were to be reversed. The GAO, looking out for its own well being, will likely be ‘politically correct’ regarding its ruling.”

Mr Nisbet says he believes Boeing’s chances are a “long shot”, and said he doubts that “there is sufficient resolve in the Congress to pass legislation that would unfund the tanker or reverse the US Air Force’s decision.”

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