Volkswagen’s Rally Is on Wobbly Wheels
Volkswagen has mapped out its route to a better future, but the road conditions look treacherous.
The company’s preference shares, which are more widely traded than its voting shares, have climbed about 20% since mid-October. Fueling this confidence are luxury brands Audi and Porsche, which together generate about 70% of the company’s automotive earnings before interest and taxes. VW has also benefited more than peers from the growth in China, which is responsible for 45% of Volkswagen brand sales.
Yet further progress on all fronts looks challenging.
Since 2000, car sales in China increased tenfold, but demand appears to be waning, Morgan Stanley says. VW will suffer if there is any further slowdown, with Volkswagen-branded sales in China down about 8% in November, year over year.
VW’s continued growth also rests on another wobbly pillar: a European car-sales recovery. So the company needs to deliver more cars in the U.S. But it faces big challenges there, too, with Volkswagen-brand sales in the U.S. having fallen 11% through November compared with a year earlier.
ENLARGE
IN COMBO
Meanwhile, VW’s investment budget, high already, may climb further. Capital expenditures for the next five years are projected by the company to expand slightly compared with prior forecasts, to €85.6 billion ($103.6 billion), including an increase of €2 billion, to €24 billion, for the Audi brand alone. The aim is to surpass rival BMW in terms of car sales. But Audi’s automotive operating margin is on a downward trend, having fallen to about 9.4% in the third quarter from about 10.5% for the same period in 2012. Higher expenditures could exacerbate that.
Advertisement
If global demand is lower than expected, then VW must cut costs to improve profitability. To investors’ delight, the company said last year that it would shift its focus to sales and profitability versus expensive deal making. As part of the strategic overhaul, VW is targeting about €10 billion in efficiency savings a year across all 12 of its brands, equivalent to about 5% of the company’s operating costs.
This also could prove to be a struggle. Union representation accounts for half of the company’s supervisory board, making it difficult to trim employment costs in Germany, where most of its workforce is based. For example, VW still makes basic components to help keep its German factories running, which gives the company more control of its manufacturing process but at a higher cost. The company says it will improve efficiency elsewhere, but substantial savings remain elusive.
Even after the recent bounce in share prices, VW still trades at roughly a 20% discount to BMW based on multiples of forward earnings estimates. The challenges VW faces in delivering on its promises will make it tough to bridge that gap.