Introduction

Car manufacturers fear a possible downturn in the cyclical business of car manufacturing. Worldwide, the production of cars is declining since 2018. In the first three months of 2019, global automobile production was down by more than 6 percent year on year, according to preliminary figures. In June 2019, the production of passenger cars in Germany was even down 24 percent in relation to the same month a year ago. It seems that this does not affect Volkswagen (OTCPK:VWAGY; OTCPK:VLKAF; OTC:VLKPF). With its latest quarter numbers, the company manages again to surprise positively.

Analysis

Despite a poor market environment, the company presented surprisingly good half-year figures in July. While the global automobile production was down by more than 6 percent year on year in the first three months 2019, deliveries to Volkswagen customers were only down 2.8 percent. Sales revenue of Volkswagen grew by 4.9 percent to EUR 125.2 billion compared with the first half of 2018. Operating profit before special items rose by 1.9 percent to EUR 10.0 billion. Volkswagen has now presented another set of good numbers for the third quarter. After providing the highlights of the results, I will analyze these numbers. Here are the highlights of the first nine months of 2019 short and sweet:

  • Group sales revenue up by 6.9 percent to EUR 186.6 billion.
  • Operating profit before special items increases by EUR 1.5 billion to EUR 14.8 billion; improvements especially in the mix and EUR 0.5 billion from fair value on derivatives.
  • Operating profit up EUR 2.7 billion year-on-year at EUR 13.5 billion; negative special items of EUR -1.3 (-2.4) billion relating to the Diesel issue.
  • Profit before tax rises to EUR 14.6 (12.5) billion.
  • Automotive Division’s net cash flow at EUR 8.6 billion, EUR 5.1 billion higher than the low figure for the prior-year period.
  • Net liquidity in the Automotive Division of EUR 19.8 billion.
  • Net cash flow was EUR 2.4 billion, up significantly on the previous year (EUR -0.5 billion).

Volkswagen has also reaffirmed its outlook. Volkswagen continues to expect sales revenue to increase by up to five percent in full-year 2019. The company still anticipates that the operating return before special items will be in the target corridor of four to five percent. However, management lowered delivery expectations. Deliveries to customers are now expected to be at the previous year’s level. So far, the Group had expected a slight increase.

That said, it is once again noticeable that Volkswagen performs above average. Despite the challenging macroeconomic environment. Volkswagen gained additional market share in many regions of the world. The Volkswagen brand delivered a total of 4,514,600 vehicles between January and September (previous year: 4,622,800). The decline of 2.3 percent was significantly smaller than that of the global market as a whole (-5.0 percent). The Audi brand sold 900 (1,107) thousand vehicles worldwide between January and September 2019. This is a decline of 3.6 percent.

(Source: Volkswagen – deliveries by brands)

Otherwise, there is not really a big short-term price potential. However, Volkswagen is weighing options for a potential sale or initial public offering of its Lamborghini brand. Deliveries rose by 83.4 percent. Lamborghini now has a valuation about USD 11 billion, which makes it worth exploring an initial public offering. Long term, on the other hand, Volkswagen faces the same structural fundamental changes towards electric mobility and autonomous driving as the other car manufacturers. In the future, there will be fewer engines and more electric cars (EVs). This will dramatically change production in the automotive and supplier industries. Volkswagen addressed this development heavily, and plans to create an EV segment from the ground up. By 2025, the company plans to build and sell up to 3 million all-electric cars per year – depending on market developments. For this ambitious target, Volkswagen has been budgeted more than EUR 34 billion up to the end of 2022 for e-mobility, autonomous driving, digital connectivity and new mobility services. Additionally, the joint ventures in China will be spending a further €15 billion on the electric offensive over the coming years. While the first results are promising (Volkswagen has already received more than 30,000 reservations for the ID.3 that had its world premiere at the IAA 2019), there is a long road to go. Nevertheless, the first steps here are very promising.

A comparison with Volkswagen’s competitors also shows that Volkswagen is always one of the best-performing companies in terms of growth and profitability. Only the dividend yield is slightly below average. Similarly, the focus should not be too much on the payout ratio, as profits in the industry can fluctuate sharply. In any case, however, the dividend appears to be secure. This is particularly true in view of the increased cash flow (full-year net cash flow is now expected to exceed EUR 1 billion).

On the downside, investors have to take two things into account. The first thing is “Dieselgate.” The second thing is Brexit/trade conflict. However, I consider both scenarios to be priced in.

“Dieselgate” has now cost Volkswagen more than EUR 30 billion. Volkswagen will continue to have to contend with civil claims for damages. Of course, this does not only affect Volkswagen. Daimler (OTCPK:DDAIF; OTCPK:DMLRY) is also suffering as a result. For the third time within a short time, Daimler has to recall hundreds of thousands of diesel cars due to illegal exhaust technologies. In the last quarter, Daimler secured provisions of approximately EUR 2.5 billion to cover legal risks and the costs of the scandal involving excessively high nitrogen oxide emissions. In addition, Daimler set aside one billion euros for recalls due to defective airbags. I don’t think those reserves will be enough. In Germany alone, Daimler had to pay a fine of almost EUR 900 million last month.

As I mentioned in another analysis, a total of around 2.4 million Volkswagen vehicles are affected by the diesel scandal. Hence, German owners of affected Volkswagen cars are entitled to compensation of up to EUR 42 billion. Of course, this seems to be an extreme amount at first.

In this respect, I quantify the risk arising from the model declaratory judgment action at EUR 3.4 billion. That is much less in comparison to the theoretically conceivable sum and should cause investors little headache if they read the numbers of nearly five hundred thousand plaintiffs. In addition, this also applies to possible future lawsuits brought by customers living in Germany. An important limitation period ends at the end of the year. This will significantly reduce the number of potential further plaintiffs. If necessary, a lawsuit will then only be successful over criminal claims. However, the prerequisites for this are much higher. Accordingly, I expect that the waves will smooth over the next one to two years and that Volkswagen will be able to concentrate fully on its operating result.

It seems as if this is also gradually making itself felt in the figures because expenses for settlements, penalties and other legal costs fell in the third quarter from 800 (2018) to 275 million euros. Between January and September, they fell from 2.4 billion euros to 1.3 billion euros. Furthermore, despite these still high levels of costs and capital expenditure (which are expected to be high in the fourth quarter), full-year net cash flow is now expected to exceed EUR 1 billion.

As far as Brexit and trade conflict are concerned, Volkswagen is of course affected by these macro developments. However, there are no real fundamental changes compared to recent months. In this respect, the possible worst-case scenarios and the probabilities of their occurrence are most likely already priced into the price. Only in the event of a surprising escalation do I expect more sensitive consequences. If tariffs affect consumer goods on which people depend, companies have to lower prices or people have to pay more. That’s a simple truth. And indeed, the trade conflict is beginning to have an effect on the ordinary population. Given that, the consequences of the trade war are likely to be felt most strongly in the third and fourth quarters of 2021. In combination with a 10 percent fall in global equity prices, it is to be expected that the global GDP growth will be minus 0.6 percent. But these would affect the entire market and not just Volkswagen. Furthermore, such a scenario of an ongoing economic war that plunges the global economy into the abyss is unlikely. In such a case, both Trump and the Chinese government would act against the premise to which they owe their legitimacy. This legitimacy lies in growth (growth of stock markets, growth of economy and growth of wealth). Trump kept pointing to the bull market and saying he was responsible for that. And vice versa, the Chinese leadership only knows the population behind it, because it has brought the country a great deal of luck and prosperity in a short period of time. Accordingly, both have a vested interest in ending the conflict.

Conclusion

If you want to invest in the car industry sector, you will find a company with a very good momentum in Volkswagen. Among its peers, Volkswagen is always one of the best-performing companies in terms of growth and profitability. Conversely, investors should not get used to the fact that Volkswagen will deliver every quarter like this. Above all, we are still at a time of falling car sales, fierce competition and high investments in future markets. At the very least, however, this shows that Volkswagen is acting from a position of strength. This is a good sign for investors.

If you enjoyed this article and wish to receive updates on my latest research, click “Follow” next to my name at the top of this article, and check “Get email alerts.”

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source link

2019-11-11