Volkswagen is Stepping Up to the Plate

Jaguar is a subsidiary of the Indian Tata. Volvo belongs to the Chinese Geely. Dacia is French and Rolls Royce German. Opel, Vauxhall, Citroen, SEAT, Skoda, Lada, Leyland, Porsche or Audi have all been absorbed by rivals. Other brand names have disappeared. Simca, DKW, DAF and Trabant are names few young Europeans even recognize. Saab is the latest victim. Under new Asian ownership, it will produce nothing but electric cars.

No doubt, the car industry in Europe has had its fair share of restructuring. But the mass market industry still suffers from overcapacity. Four years of declining new registrations have exacerbated the problem. From 2007 to 2011, annual car sales fell by 2 million units to a paltry 13 million. To make things worse, newcomers from Korea are aggressively building a presence. Already, Hyundai and Kia have managed to carve out 6% of a declining market.

The trend did not improve in 2012. French automotive sales were down another 14% year-on-year. Italy’s car market reached a 30 year low and Spain was not far behind.

Prolonged European recession is shrinking the pie. Weak players are feeling the heat. For the past fiscal year, Renault, PSA Peugeot-Citroen, Fiat, Opel (GM) and Ford Europe are expected by analysts to report combined total losses of $8 billion. PSA alone lost $2 billion last year and was given a life line by the government. Opel has announced a 10% production cut for the new year. Renault is again moving capacity to North Africa. Fiat is unlikely to break even before 2015. Ford will completely close down its factory in Genk, Belgium.

Nor is the outlook for 2013 any better. European car sales are forecast to fall another 4%. A fifth year of abysmal sales will bring a final consolidation phase in the industry. We are approaching the end game. It is the bottom of the ninth inning. The bases are loaded and the sweeper is stepping up to the plate. Here comes Volkswagen.

Weak players are rapidly getting weaker. Strong players are getting stronger. Volkswagen is steadily building market share and so is the Hyundai/Kia conglomerate. Their competitive advantage is just getting better and better.

Volkswagen’s breakeven capacity utilization has already been brought down to 45%. Its most efficient competitors can only manage 70%.That’s before the massive investments in more flexible production facilities they have budgeted for the next 5 years.

VW is also helped by geographical diversification. In contrast with Fiat, Renault and PSA who are very dependent on the Club Med countries, VW’s sales are strong all over Europe and in emerging markets like China.

Product wise, VW enjoys a worldwide reputation for great engineering. Furthermore, it offers a complete range of products. VW, Skoda and SEAT ( over 4% EBIT margin) cover every segment of the low end market while Audi (12% EBIT) and Porsche (18% EBIT) are up there with BMW and Mercedes. All that while enjoying a strong pipeline of new models. In contrast, Renault, Peugeot or Fiat’s mere survival is highly dependent on the success of one or two yet-to-be-launched models.

Finally, as recently described in the WSJ, Volkswagen is using its very strong balance sheet to offer superior financing. Even after major acquisitions and large capital expenditures, VW still had a net cash position of 9.2 billion euros ($12 billion) at the end of September. There is no way a bankrupt Peugeot can match – let alone sweeten – VW’s low monthly payment programs. Nor can cash-strapped Fiat and Renault.

But even this is not the whole story. All the stars are aligning in favor of this German behemoth. Already, they are major players in the booming Chinese market. But the nationalistic fever which has overtaken the Middle Kingdom lately is giving them an additional boost. Volkswagen is arguably the biggest beneficiary of Chinese consumers’ boycott of Japanese models.

Volkswagen shares are a buy. The fundamentals, as just described, are strong, while the valuation is still very much in line with its peers’. This inconsistency is most likely due to today’s world of risk on/risk off. Investors buy or sell indiscriminately across an industry according to “risk tolerance”. Stocks’ correlation with markets is at an all-time high. This may continue for a while. However, long term investors can count on fundamentals to separate the strong from the weak.

VW deserves a hefty premium to the 0.4 times sales it is trading at today, especially considering its valuable, more profitable Audi and Porsche brands. At the least one can expect VW shares to trade in line with struggling Toyota (TM), which is trading at 0.6X sales. If so, VOW.GR has another 50% upside.

Post a comment or leave a trackback: Trackback URL.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: