Those who buy luxury cars aren’t counting their pennies or looking for deals that will make the cars affordable. Sure, they’d like a bargain, but they’ve already made the decision about which car they want — and they don’t care how much it costs.

As a result, companies such as Germany-based Dr. Ing. hcF Porsche AG and Bayerische Motoren Werke AG (BMW) can both keep their prices up and usually raise them when costs increase. That translates into good operating margins for BMW and very good ones for higher-end Porsche.

Prospects are excellent in the sector. As well as continued good sales growth in the developed world, sales are surging in emerging markets such as China, India and Russia, where expensive cars are a way for the newly rich to display their wealth.

The sector doesn’t escape the volatility that other automakers, like most manufacturers of durable goods, have to deal with. Porsche and BMW sales in Germany have reflected the weak local economy, but for luxury automakers this volatility tends to translate into lower profits in some years rather than losses.

Global analysts and money managers consider Porsche and BMW to be well-run companies with excellent prospects. Some, such as New York-based independent investment research firm Bernstein Investment Research and Man–agement, currently prefer the bigger BMW — which sold 1.3 million automobiles and 97,500 motorcycles in calendar 2005, also its fiscal year — rather than Porsche, which sold about 88,400 vehicles in its fiscal 2005, which ended on July 31 of that year.

In a report this past June, Bernstein said that BMW has clear valuation upside, while Porsche is fundamentally attractive but the stock isn’t cheap enough to be interesting. Porsche shares have recently been trading at around 11.5 times 2007 earnings, compared with 9.5 times for BMW. Both companies’ shares trade on the Berlin-Bremen Stock Exchange.

Other analysts — including Charles Burbeck, head of global equities at HSBC Halbis Partners in London — prefer Porsche. The company outsources most of its production, which keeps costs and capital requirements low. However, Burbeck also likes BMW, saying he would own one of its cars if he didn’t already have a Porsche.

Porsche had an operating margin of 18.5% and return on equity of 25% in fiscal 2005, compared with 8% and 13%, respectively, for BMW. Burbeck expects both companies to improve their operating margins by about two percentage points by fiscal 2008, but believes Porsche’s ROE will increase to more than 30%, while BMW will move up to only about 15%.

Porsche’s much better margins reflect the fact that its products are higher-end. Average revenue per vehicle sold was 74,000 euros for Porsche in fiscal 2005, compared with 35,100 euros for BMW (including motorcycles, for the latter). Burbeck notes that the gap is widening as BMW moves more downmarket to increase sales. He believes this is diluting the BMW brand.

The move downmarket to smaller, lower-margin vehicles is also of concern to U.S. rating agency Standard & Poor’s Corp. An S&P report published in May said BMW “will need to continue to develop and integrate the new products into the existing program successfully while avoiding margin erosion, loss of brand prestige and cannibalization among models.”

Bernstein’s faith in BMW’s operational excellence and fundamental strengths remains undimmed, however. Bernstein said in a May report that it expects BMW’s sales growth to be in the high single digits throughout the next five years, and cost reductions from vehicle and engine re-engineering should lead to margin gains for the Mini.

Still, Porsche also has issues. Burbeck is not enthusiastic about the company’s 25% equity stake in Germany-based Volkswagen AG that it has purchased over the past year for three billion euros. The company’s rationale for the acquisition was to prevent VW from falling into other hands.

VW is involved in the production of some Porsche models, including the very successful Cayenne sport utility vehicle. The two companies are also working on the next version of the Cayenne, as well as a hybrid version that is scheduled to be launched by the end of the decade.

Burbeck doesn’t buy Porsche’s rationale because he thinks the negatives from the VW purchase — some dilution of the value of Porsche as a company — outweigh the benefit of preventing a hostile takeover of VW. Although he would have preferred Porsche to return excess cash to shareholders through stock repurchases or dividends, Burbeck does admit that the investment has worked out well for Porsche so far, given the more than 20% increase in VW’s share price over the past year.

@page_break@Porsche’s share price has done much better. As of July 31, it was 769 euros — up 114% from 360 euros three years earlier. This contrasts with the 18% gain for BMW — to 40 euros from 34 euros over the same period.

However, Bernstein has a 12-month target price for BMW of 48 euros, up 20% from the recent share price of 40 euros; Bernstein sees Porsche’s shares increasing only 4%, to 800 euros.

Bernstein warns, however, that if the U.S. dollar drops vs the euro, that could stall the increase in the sector’s profitability that began in the second half of 2005. With sales remaining strong, Bernstein blames the falling US$ for BMW’s disappointing earnings performance in the past few years. Further drops in the US$ would also affect Porsche.

Here’s a look at the two companies in greater detail:

> Porsche. The company was launched in 1931 as the Porsche Engineering Office by Ferdinand Porsche, who as technical director at Daimler AG developed the Mercedes SS and SSK supercharged sports cars. Porsche initially did work for other companies, including VW. The first Porsche sports car was produced in 1948.

Porsche currently makes three kinds of sports cars: the 911 models, the Boxster and the newly launched Cayman S. It also has the Cayenne SUV. The company only got into SUVs in fiscal 2003, and the line accounted for 47% of sales volume in fiscal 2005. Cayenne sales were down 12% in the six months ended Jan. 31, pushing the model’s share of revenue down to 40%. The company attributes this drop to the decision not to offer price concessions as its competitors have done. However, the drop in sales may also reflect consumers’ desire for more fuel-efficient vehicles.

The Cayenne has been central to Porsche’s Chinese and Russian sales programs; it has also been a huge hit in industrialized countries, including the U.S. The model’s success proves Porsche can compete in different markets. As a result, the company plans to build on this success by entering the higher-priced sedan and coupe market in 2009 with the launch of the Panamera.

The company is also innovating in its core sports-car arena with models such as the Cayman S. Porsche believes the brand will appeal to a younger age group, which would extend its customer base.

The decision to widen the product lineup also reflects the increasing competition that Porsche is facing as mainstream firms target high-end customers. Porsche cited this when it sold its wholly owned subsidiary, CTS Fahrzeug-Dachsysteme GmbH, which makes vehicle roofs, to Aurora, Ont.-based Magna International Inc. in February. The press release said Porsche was focusing on its core business and a strategic realignment was necessary, given the increased competition it faces.

Porsche’s total sales volume was up 18.2% to 42,230 units in the six months ended Jan. 31. Net income rose 14.5% to 169.8 million euros for the same period in 2005. (Revenue and balance sheet data are available only for fiscal 2005.) Porsche has a finance arm, but the firm does not provide the division’s contribution to net income.

Sales in Japan and emerging markets were 540 million euros in fiscal 2005, up 10% from the year before and accounting for 8% of total sales. Germany and the U.S. came in at 2.2 billion euros each (34% of sales each); the rest of Europe accounted for 1.6 billion euros (24%).

Japan and emerging markets account for almost twice as much of BMW’s sales percentages, which may reflect Porsche’s higher price.

As of July 31, 2005, Porsche had 3.1 billion euros of debt and pension liabilities of almost 600 million euros.

Porsche has 8.8 million common shares, held by the Porsche and Piech families, and 8.8 million preference shares that are widely held and publicly traded.

Motor racing is an important marketing tool, and building the racing cars develops knowledge that is used in retail consumers’ cars. Porsche won its first race in 1951. Now, it sponsors seven Porsche Carrera Cups and the Porsche Michelin Supercup.

> BMW. Founded in 1916, the company currently makes BMW, Mini and Rolls-Royce autos and BMW motorcycles. The dominating BMW auto brand — which constitutes 1.1 million units, or 79%, of total sales volume — has eight models. The smaller, less expensive Series 1 cars accounted for 13% of sales in 2005, while the bread-and-butter Series 3 and 5 accounted for 38% and 20% of sales, respectively.

The company’s version of the Mini was introduced in 2001; its first Rolls-Royce, in 2003. BMW acquired the Mini with its 1994 purchase of Britain-based Rover Group and kept the brand when it sold off the rest of Rover in 2000. BMW bought the rights to the Rolls-Royce name from VW in 1998, although BMW wasn’t allowed to produce Rolls-Royce vehicles until 2003. The Mini accounted for 200,000 units (or 14% of total sales) in 2005, while production of the very expensive Rolls-Royce brand remains small at just 692 units. Motorcycle sales were 97,500 units.

BMW realigned itself in 2000 after its sale of most of Rover — focusing again on premium brands, although it also added the less expensive Series 1 BMW. The result was increased sales after drops of 10% in 2000 and 14% in 1999. There was a drop in net income in 2003, but it has increased thereafter.

Revenue was 24.8 billion euros during the first six months of fiscal 2006, up 10.2% over the previous year, with car sales rising 10.5% to 24.2 billion euros, and motorcycle sales falling 1.2% to 732 million euros.

The company reported net income of 1.5 billion euros, excluding unusual or non-recurring items in the first six months of 2005, up about 19% from a year earlier. The non-recurring items relate to a gain of 375 million euros in 2006 arising out of partial settlement of the exchangeable bond on Rolls-Royce PLC, plus a “fair value” gain of nine million euros on the remaining Rolls-Royce obligation. In 2005, there was a loss of 56 million euros on the bond.

Net income from financial operations — auto financing services, including banking products and insurance — was 299 million euros in the first six months of 2006 before consolidation of transactions between subgroups, compared with 244 million euros in the same period a year earlier.

Operating cash flow after net change in non-cash working balances was 16 billion euros, compared with 5.5 billion euros a year earlier. Debt was 14.4 billion euros as of June 30.

BMW says the traditional car markets of the U.S., Japan and western Europe got off to a slow start, but growth rates in Asia and Latin America are still strong if somewhat less dynamic than in previous years.

Japan and emerging markets accounted for 15.5% of vehicles sold in the first six months of this year. The Americas accounted for 25.4% of sales, with the U.S. alone constituting 22.5%. Germany was 21.4% and other European countries accounted for 37.8% of total sales. This suggests that BMW may have room to increase market share in the U.S., given the better penetration Porsche has in that market (at 34% share of its total sales value).

In June, BMW introduced two new models, the BMW Z4 coupe and the BMW Z4 M coupe. A new BMW Series 3 coupe and an updated BMW X3 will be available in September. There also will be a new Mini, with greater functionality and a more spacious interior, within three years. The company is also working on a Rolls-Royce convertible.

BMW’s in-house production is concentrated in Germany, where costs are high, but the company has a strong history of cost control and efficiency gains.

On the marketing side, BMW is competing in motor racing with its own team for the first time this year, although it has been involved in the sport since 1952.

BMW had 622 million common shares as of Dec. 31, 2005. There were also 52 million non-voting preferred shares, which receive an ad-ditional dividend.

The common shares were trading at around 39 euros in mid-August. They have fallen from their spring high more than Porsche’s did, which supports Bernstein’s contention that there is more upside potential for BMW. IE