Volkswagen AG (OTCPK:VLKAF) H1 2010 (January-June) Earnings Call July 29, 2010 2:00 PM ET
Christine Ritz - Head of Group IR
Hans Pötsch - Member of the Board of Management, Finance and Controlling
Christian Klingler - Member of the Board of Management, Group Sales and Marketing
Jochen Gehrke - Deutsche Bank
Thierry Huon - Exane
Horst Schneider - HSBC
Adam Hull - WestLB
Arndt Ellinghorst - Credit Suisse
Charles Winston - Redburn Partners
Max Warburton - Bernstein
Jose Asumendi - RBS
John Buckland - MF Global
Christian Breitsprecher - Macquarie
John Schwartz - Reuters
Marc Schneider - Handelsbank
Ladies and gentlemen, welcome to Volkswagen's conference call on the results for the period January to June 2010 based on the interim report we published this morning.
I am joined today by Hans Dieter Pötsch, Member of the Board of Management, Volkswagen AG, responsible for Finance and Controlling; and by Christian Klingler, Member of the Board of Management, Volkswagen AG, responsible for Group Sales and Marketing.
As usual, you can also follow the webcast and download the charts from our website, www.volkswagenag.com/ir. Questions can be sent by e-mail or calling. After the presentation, we will first respond to the questions of analysts and later answer those of journalists.
I would now like to hand you over to Mr. Pötsch.
Thank you and allow me to add my warm welcome to those of you joining this call today. In June, we released an ad hoc statement advising that we were expecting a good first half in 2010. I am pleased to report to you today that our unit sales and operating profit have indeed considerably outperformed our initial expectations for the first six months, with unit sales of almost 3.6 million cars, trucks and buses, that's up 500,000 units on the first half of 2009; and with an operating result more than double at €2.8 billion.
As we stated during our Q1 call, the German car market remains weak following the ending of the scrapping support. However, our exposure to the emerging growth markets, including of course China coupled with good performance in the main Western European markets outside Germany and in the U.S., has been key to our positive performance.
Our excellent brand mix has ensured that we are perfectly positioned for the upturn we have seen in the premium sector, while we continue to benefit from excellent design and leading fuel efficiency, combined with localized designs in the demanding volume car business.
Our exposure to heavy trucks is paying off too as the world economy shows some early signs of improvement, with an excellent performance in Scania and good progress at MAN.
Our solid business performance is reflected in the automotive division's net liquidity, which continued to improve, ending the period at an excellent €17.5 billion, which includes the remaining €1.1 billion received in April from the March capital increase. This strong liquidity provides an excellent foundation of our implementation of our Strategy 2018 and will provide protection should the economy turn out be not so favorable, a note of caution I will return to later in the presentation.
But for now, Mr. Klingler, it's over to you.
Ladies and gentlemen, also a warm welcome from my side. On this chart four, you can see the development of the world car market last year through to the first half of this year in comparison to the previous year.
After dramatic decline of 17% in the first half of 2009, world market showed the first signs of relief in the second half of the year. The market recorded further growth of 15% in the first half of 2010. Please bear in mind that most of the growth in the world car market was due to governmental support.
But however, I must add a note of caution. As the car market has started to decline from May 2008, the comparison with the previous year figures shows signs of improvement in relative terms only, while in absolute terms, the market is stabilizing on a very low level. To avoid this statistical distortion, the comparison to the last normal year of 2007 is appropriate, as you can see on chart five.
In the second half of 2009, in many cases, the markets were mainly as a result of the positive influences of the governmental support measures in many markets. The first quarter of 2010 almost reached the same level as in the normal year of 2007, driven by additional registrations of vehicles contracted in late 2009, before the ending of the scrapping incentive programs in many of the major markets.
In the second quarter of 2010, we can see a normalization of the market trend, as the positive effect of incentives programs started to fade out. However, our latest estimations suggest a decline of the overall market in the second half of the year due to the ending of the support measures in major European markets. This will make the second half of 2010 a difficult period for the whole automotive industry.
The car market in Europe, especially Western Europe, is expect to contract further in 2010, while North and South America as well as Africa are said to maintain the recovery, which had already started in 2009. Despite continuous growth in Asia and robust recovery in North America, this year the world car market will fail to reach its pre-crisis level.
Starting with the second quarter of 2009, our deliveries to customers have shown positive year-over-year development. This first half of 2010, the Volkswagen Group again outperformed the overall car market. This was supported by the development in China, with plus 46%, North and South America, plus 19% and 4%, as well as certain Western European countries such as Spain and U.K.
Overall, as a result of our outperformance, we continue to gain global market share. Due to this shift in relative importance of some markets within the regions, we expect a challenging second half of 2010 in terms of market share performance. For example, after a year that was highly influenced by the scrappage incentives in 2010.
The German market is set to lose some of its shares of the total Western European sales. This puts additional pressure on the performance of the Volkswagen Group, as we have an extraordinary strong market position in Germany. Or let's take it differently, we are increasing our market share in Germany, we are increasing our market share in West Europe without Germany, and if you add to that the increase is much less tangible.
Looking at our performance on a regional basis, here you can see the success of the Volkswagen Group in direct comparison to the markets around the world in first half of 2010. We have outperformed the markets in every region with the exception of South America, as Brazilian markets were more strongly than our deliveries with tough competitive situation, new players in the market, and the lifecycle effect of the SpaceFox, which just have launched.
In Central and Eastern Europe, our deliveries to customers declined slightly in comparison to the last year by 0.5%, but even here we are still better than the market which declined by 6%. This decline in this region was caused by several markets, but mainly because of the Hungarian market which contracted heavily by about 50% due to the still severe impact of the crisis on consumption and investment.
Now looking at the performance of the individual brands of the Group. The first half of 2010, our deliveries to customers exceeded last year's level at 15.8%, and all brands achieved an increase in terms of sales. Volkswagen passenger cars deliveries were up by an impressive 16.2% to more than 2.2 million cars, driven by strong demand in China, Western Europe and North America.
Audi recorded the highest growth in the group, delivering 19.1% more cars than last year, up to 555,000 cars. Premium brands only marginally benefited from the stimulus programs in Europe and the United States, but as the world economy begins to recover, we anticipate plus for this sector of the market.
Skoda and SEAT recorded growth, helping them to maintain the market shares in a recovering market environment. Bentley benefited mainly from growing wealth in China, where deliveries more than doubled, as well as some recovery of the U.S. market.
Volkswagen Commercial Vehicles and Scania has participated in the recovery of light and heavy trucks market, especially in Brazil. Deliveries of Volkswagen commercial vehicles in total increased, despite the exclusion of the Brazilian trucks and buses which are now part of MAN since March 2009.
Now turning to the deliveries in absolute numbers by market areas compared to last year. Due to the massive decline of the German car market, about minus 29%, after the end of the scrapping program, our deliveries in Germany decreased only by 15.8%, whereas our deliveries in Western Europe more than compensated this as a whole, increased by 5.4%.
In the Asia-Pacific region, our deliveries were up over 1 million, which means an increase of 45%. Now a few highlights on some of our new models, which will provide a strong base for our sales performance in the coming months. The Volkswagen Jetta is the German-engineered, affordable and sporty compact sedan. It combines agile and efficient trend dynamics, sporty German design with a functional, detail-oriented interior. The Jetta will hit the road in the U.S. in August this year.
The Audi A8 L is a prestigious chauffeur-driven sedan. The comfort and rear-seat entertainment makes it perfect for traveling. Its new panorama glass roof offers more life in sense of space. In combination with the V12 engine, it becomes the most luxury Audi ever. The Audi A8 L will have its market introduction in China in October this year.
The new Volkswagen Polo Sedan will be introduced on the Russian and Indian markets in August this year. Its composition of German-engineering, elegance, high quality perfect convenience and road dynamics make it the new status symbol within its class.
The SEAT Ibiza ST is the first estate which adds functionality to an outstanding sporty design. It improves and enriches the positioning of the Ibiza beauty and technology. Ibiza ST was recently shown at the Geneva Auto Show and has been introduced on the market in May.
Thank you, Mr. Klingler. Mr. Pötsch, can you now please explain how our strong deliveries have been slated into our financial performance?
Yes of course, with pleasure. With significantly higher sales than in the first half of last year, and surprisingly the largest impact on revenue is indeed volume, it's just over €6 billion. Price and mix contributes a third of €1.8 billion with currency in here, the Brazilian real has the most significant impact of plus of €1.6 billion. As we sold our truck facilities in Brazil during the early part of last year, we do not have the benefit of the sale of those trucks this year leaving us with a small negative impact when comparing to last year. On the other hand, Scania is recovering nicely and recorded a step up of €0.8 billion in revenue.
And finally, our financial services division grew sales by €0.5 billion. Turning to operating profit, the positive volume effect was again the major influence in an improvement from €1.2 billion to €2.8 billion versus the first six months of 2009. Combining volume with the price and mix effect leads to a total positive of €1.9 billion. As we commented in the ad-hoc release, we are enjoying a positive impact from foreign currencies to a tune of a further €0.4 billion.
Our strategy of purchasing on a global basis with a long term view on our supply relationships has contributed along side our own ongoing efforts to improve our product costs in engineering and production to saving of €0.6 billion in the first six months despite warning signs of potentially higher raw material costs in 2011 and beyond.
Our target to save €1 billion for 2010 remains, and I am confident that we will comfortably exceed this. Scania continues to lead the truck sector in terms of efficiency and profitability contributing an improvement of just over €0.5 billion. Fixed costs, entity appreciation where €1.2 billion drag on our overall performance due in part to the ramp up costs as the additions to our production network got fully underway. And we also continued to incur higher engineering costs as we invest in our future. Personnel costs were negative in line with our 2010 wage agreement.
And finally, our increased volume also contributed to the higher overall cost. The other negative versus last year refers to the one-off gain booked in 2009 from the sale of our activities in (Resenden). In summary, our operating result was €2.8 billion, up €1.6 billion from the first half of 2009.
Let me now turn to cash flow in the automotive division. Operating cash flow improved 13.3%, €7.3 billion a good performance from Q1 has been attained as we continue disciplined management of our inventory levels.
Moving to cash flows from investing activities. A couple of influences need to be stripped out to get to these underlying performance, including the sale of our Brazil truck interest in 2009 and our investment in Suzuki this year. On a like-for-like basis, the underlying cash flow in investing activities fell from €3.4 billion to €2.6 billion demonstrating our effective investment management. Our CapEx ratio, while remaining at 3.5% from Q1 will rise as the year progresses and we expect to come in closer to our long standing guidance of around 6% of automotive revenues for the full year.
To sum up, despite the investment in Suzuki, in total the net cash flow for the automotive division came to a positive €2.7 billion. Let me now turn to automotive net liquidity in the second quarter we were able to add a further €3.3 billion to the €14.2 we held at the end of the first quarter. The excellent balance of €17.5 billion gives us the foundation to progress with the implementation of our strategy 2018 and our planned merger with Porsche during the course of 2011 free from any short term external impact from the global economy or capital markets.
Now let's take a look at the financial performance of our brands. The Volkswagen passenger car brands, earnings for the first half exceeded €1 billion; that's up significantly on the prior year period. With the new Sharan, delivery is starting after the summer, and the new Passat towards the end of the year, the Volkswagen car brand is in a good position to build on this solid earnings development.
Audi's Q2 margin of over 9% reflects the excellent model line-up, now extended to the groundbreaking Audi A1 and to the peerless all new A8. Heading for a record-breaking year in deliveries, Audi's profits were up over 60% in the first half; Skoda, a good progress in earnings, almost doubling the results versus the first half of last year, while Fiat and Bentley continue to work on improving performance.
Our light-truck brand earned a solid result, with a strong performance in Brazil, the U.K., France and Spain. Scania reported another excellent result this time of €577 million, led by strong demands in South America. The other results include the elimination of intercompany sales and also the adjustment required under IFRS for purchase price accounting with regards to our consolidation of Scania.
Financial services reported an improved result of €362 million. Combining the automotive and financial services division gives a total operating profit of, as I mentioned just over €2.8 billion. The financial result improved to a negative €217 million, and is made up of three main sources, first of all the earnings from the equity consolidation of participations; secondly, the interest income and expense on cash, and certainly valuations on options and other financial instruments, which can be very volatile with large swings in valuation from quarter-to-quarter.
Chinese joint ventures were the main driver of the improvement in the overall financial result, reporting a proportional operating profit of €804 million, almost three times the level of the first half 2009, reflecting our very good sales performance.
Our 49.9% holding in Porsche AG is also included at equity following our investment in December 2009. While the operating business of Porsche was positive in the first half, the earnings included in our results are also subject to a PPA charge, which resulted in a small net loss for the period in our books, as the PPA charge by principle is front-loaded. This leads me to our 2010 outlook which you can read in detail in the interim report.
Our presence in all the key regions around the world, the multi-brand strategy, our technological expertise, and the most up-to-date environmentally friendly and broadest vehicle range that has resulted from that expertise are key advantages for our company. The second half of 2010, Volkswagen group's nine brands will again unveil a large number of new models, thus systematically extending our position in the global markets.
Based on our performance in the first half and our expectations for the second, we anticipate that our deliveries to customers will be significantly higher than in 2009. However, the dynamic growth in our sales revenue and earnings in the first half of 2010 will not continue undiminished in the remainder of the year. The ongoing uncertainty surrounding economic developments could have a negative effect on demand. Across Europe, and in particular in Germany we expect demand to be weak in the remainder of the year in comparison to the second half of 2009.
Tense competition and the difficult operating environment will combine to create a challenging 2010. Nevertheless, we believe that for the full year our sales revenue and the group's operating profit in 2010 will be significantly higher than last year, aided by exchange rate effect and our focus on disciplined cost and investment management.
Mr. Pötsch, thank you very much. We will now begin with the questions and answer part of today's conference call starting first with the questions of analysts.
We'll take our first question from Jochen Gehrke from Deutsche Bank.
Jochen Gehrke - Deutsche Bank
Three questions, if I may. First of all, Mr. Pötsch, you alluded that Forex had about €300 million positive impact in the quarter. With regards to your U.S. activities, could you just quantify, is the U.S. already in profit in Q2? I think previously you said you need Chattanooga to break even, so this was more a 2012 and beyond plan. Has this move in currency brought that a lot further forward? And if so, we should be expecting that.
And then secondly, more technical, on the CapEx side I think you said you are going to be closer to 6%. I think we are hearing that now since many years, and since many years you are running below that rate. Should we really expect a very sharp ramp up, or should we revise down expectations significantly for H2 on that end?
And then, thirdly, really for your Chinese profitability, your operating profits per car in China have significantly expanded in the first half. Was there any special booking in this, and what's the outlook for the second half, knowing that prices seem to be more under pressure in the market?
So the first question is with regard to the currency impact, and you would like to know a little bit more about our U.S. activities, if we had positive earnings or profit in the U.S. in Q2. And the second question is with regard to our CapEx and our guidance of approximately 6%. Is that valid for 2010; if we will achieve this 6%?
And the third question is about our Chinese profitability, if we have done any special booking or is there any special items, and if we can give an outlook for the second half and especially for the fourth quarter.
So to get started with the question on the supportive effects of exchange rate fluctuations, first of all let me say that we indicated in our outlook that we think that exchange rates and their impact on the bottom-line will be a positive contributor to the P&L compared with last year in 2010. Now obviously the U.S. dollar is also a contributing sector, nevertheless as you're also well aware we are specifically short-term, talking heavily hedged for obvious reason and the same holds true also in a significant way for the next two years.
Nevertheless, also, it's clear that as part of the business in the U.S. will still be based on the import of cars, a more stable exchange rate rather than what we had seen a number of months ago where the dollar was higher than 140, is of course a tailwind effect for becoming profitable in the U.S.
But let me state very clearly, we are not building our business model on the basis of any scenarios dealing with exchange rates. The key contributing factor is, as you are well aware, our strategy with regards to the U.S. which is built on introducing cars which are specifically reflecting the market conditions in the U.S., and you are well aware that we very shortly will introduce the new Jetta model.
And with the second key model for the U.S. then which is internally called the new midsized sedan that's an issue for second half of 2011. We will have the basis built to become profitable in the U.S. but we still have to look at the situation, which means it's going to take some two-and-a-half years down the road until we realistically, in a most sustainable basis, will be profitable in the U.S.
And the other comment, just to make sure that there is no misunderstanding, might reflect the situation of our companies in the U.S., which independently from the group situation of course can operate on a profitable level. But if we look at the situation from the group point of view, it still is going to take some time until we are there.
The second question on CapEx, we still stick to our target and it's not totally unusual that we only have a portion of investments seen in the first half, which is decently below the average spend per month. That's the normal cycle of investment throughout the year.
We might be a bit low in the first half of 2010, but from today's point of view I only would say it's creating a certain evidence that we will be around 6% for the full year, which I think is looking at the very sizable investments we have embarked on, with building new plants in India and Russia, in the U.S. and in other places, adding capacity with the product portfolio, is quite an achievement and stands for a tight build policy.
On China, yes, the profit development is quite convincing; unfortunately as I can say there is no special bookings as you called it or anyone else, which would support this profit picture. We are operating on a positive level of profitability and there is no systematic reason that this would disappear for the future.
We will take our next question from Thierry Huon from Exane.
Thierry Huon - Exane
Good afternoon, I have two questions, if I may, one about the staffing costs you mentioned for the plant under construction. Could you share with us the magnitude of this starting cost adjusted; and, when we should see them fading away? And the second question is about the PPA, you mentioned as well for Porsche. Could you give us the number of this PPA during the first half? Thank you.
Thierry, maybe if I didn't understand your first one correctly, then maybe please correct me. I understood that you want to know a little bit more about the ramp up cost for the new plants which are under construction if this still continues or if that will stop this year, is that correct?
Thierry Huon - Exane
Yes, just want to have the magnitude of this starting cost during the first half, and when we could expect them to disappear.
The start of course. And secondly, you would like to know the PPA for the first half with regard to Porsche.
To the first question and I think you might have recognized this in our swing factor analysis for the operating profit comparing the situation the first half 2010 with the first half 2009. In the negative swing on the fixed cost, there is a portion of close to €400 million, which are seeing to be of ramp up costs. So costs related to factories where new structures being in the ramp up phase. Now clearly this is going to continue for a while, because the ramp up, until there is a certain balance between the capacity installed and utilization of that capacity could take as much as twelve months.
So would we need to take into consideration that for the next three or four quarters we will see again this kind of charges for the simple reason that once we are through the process in Russia, we are still in the process in India, and if this is approaching the end of the process, we are possibly in the middle of the process in the U.S. in our plant in Chattanooga. So this is related to our strategy, something which is going to accompany us for quite a while in the next couple of quarters.
On the PPA side, this is first of all just to repeat that, of course now we are talking pretext profit, not operating result. The full year 2010 will have to carry PPA loads of around €700 million and the Porsche is, roughly speaking at least up €200 million plus piece, which is part of that €700 million.
Our next question is from Horst Schneider from HSBC.
Horst Schneider - HSBC
Three questions, if I may. The first one relates to China. As we have seen in the (STD) here, you are planning to increase extent of localization in China. So does that mean that you intend to produce also more Audi models in China in the future, for example, the A7 and other SUVs, or that just refers to the purchase of parts? And the second question that I have is with regard to volumes and pricing. Maybe you could shed some light on the potential sequential quarterly development that we see now here in the second half. So would you agree that eventually here in Q3 the volumes will go down by somewhat 15% to 20%, and then we see the fourth quarter that is slightly above Q3 for you as a Group? And disregard the pricing; I would be interested whether you expect the pricing rather to deteriorate in H2 or whether you expect a stable pricing trend.
What I get from your competitors is that they expect some deterioration of the pricing. So what is your view of that situation? And then the last question that I have is again here on the merger plans with Porsche. We have heard in the last few weeks many news here on these legal cases that are going on in Germany and the U.S. And I would like to know if you can speak to the timetable that you aim for a merger with Porsche in 2011?
So the first question refers to China. And you are mentioning the article and the (STD) today that we will increase the localization rate in China and specifically you are interested to know if we plan to procure our more Audi cars in China. And then the second question is with regard to volume and pricing, you would like to have some more details what will happen in the third quarter and the fourth quarter in terms of pricing or volume wise. And your last question refers to the Porsche merger or our plan to merge with Porsche if we stick to our timetable to merge in the course of 2011?
First of all, on China, I think we need to say that we are currently operating right at the edge in terms of capacity utilization. From that point looking at the situation it goes without saying that we have to add as quick as possible additional capacities to maintain our position in China. And this, as you are well aware, is absolutely on track. Now trading capacity is one thing, of course as China is developing unbelievably fast to a market which has a lot of rules which are not so much different from developed markets, it goes also without saying that we need to add more cars, more derivatives to this market. And this is of course something we have to look at on the Volkswagen side, on the Audi side and also for Skoda, so all the brands which are present are of Volkswagen group as locally built cars in China.
At that point, it was mentioned that we of course will have to build also on our position which currently is a very competitive position because obviously the company very much in the lead of localization in China with a very good performing supplier network available. So just to sum up on that, yes there will be additional cars brought to China to serve the market as best as we can.
Are there SUVs included? Yes. Are there Audi's? Yes, of course. And on the other hand, consistently with the build up of capacities, we will complete cars. That's a matter for our Joint Venture companies in China. We need to also build the supplier network.
For volume and pricing I would like to pass on to Mr. Klingler.
So concerning volumes, the first thing is what we need to say is that the second half of the year as we've shown before will have a total market effect due to the stop essentially in Europe, but not only Europe, several subsidy programs of the government. In general, with the market, second half of the year will not be as bullish as the first half of the year. But anyhow, we believe that our performance will continue to be better than the total market performance. We have no sign of a negative outlook, but we are staying prudent for the things which will come.
Concerning pricing, we see a good situation in pricing in most of the regions. This is due to the enormous success of the new models like all of our brands; we have the pretty comfortable pricing situation today. It is possible that due to the further increase of competition that in several regions this pricing situation could have a small impact, but we don't see into important development.
We believe as well that we can keep to continue our policy which is in terms of incentives being quarter end and not too aggressive and being in a pretty good level in terms of price.
Horst Schneider - HSBC
Sorry; maybe I can ask you another question. So the volumes overall, Q4 will be above Q3? Shall we see the biggest decline now in Q3? Would you agree to that?
We shall see.
So I am going to continue on with the question on the Porsche merger. And first of all to say that by the position Porsche has taken, the Porsche SE more than ever holds that any claims are without any merit, and on that basis there is no reason to think about anything else but the transaction scheme you are well aware about. And this is to say that consequently, still within the year 2010 there will be a shareholder meeting organized before the Porsche SE to take a decision on the capital increase, which then is to be executed in 2011.
And consequently after that, we are preparing everything for the merger. So this is fully in line with the timetable. And there are quite sizable teams established in Porsche and also in Volkswagen to do all the necessary preparations. So it's not a question of any legal claim, but to make sure that there is no misunderstanding. You are well aware that there is a fall-back structure in the agreement with Porsche, which is put-call scheme which would leave the Porsche SE as a holding company.
Now, key reason for that alternative structure clearly is that we need support of all the shareholders in all the two companies separately in the two share classes and of course nobody could guarantee that we'll be able to get the Porsche on this point, I think it's always important to clearly view that whatever structure we are ending up with it's going to be a very robust structure, financially speaking.
Horst Schneider - HSBC
So, even if the claims are still there, you would be allowed to merge?
First of all, there has to be substance in any claim. And then it's a question, which is of course ultimately up to the shareholders.
We will now move to Adam Hull from WestLB.
Adam Hull - WestLB
Firstly, just on the Chinese revenues, it seems to me, it's still a small number, but it's certainly an increasing number. And if you could give us what the revenues into China were in Q1 and maybe just give us a bit of a feel for how that might grow because obviously now, with the (T5) being locally produced, I presume that parts segment from Audi is actually increasing. And maybe you could even tell us what the license fees are?
Secondly, you've talked about a slowdown in H2. I think that is widely known in Europe. But just to give us some indication, do you think VW brand can sustain profit in H2? And could Skoda stay a profit in H2?
And then finally, on the commercial vehicles vans division, you had an impressive margin, 6.8% in Q2. I presume that's being helped by the van improvement in the market and possibly the Panamera shells you make there. But just give us some indication whether that is a little bit of a one-off, or is now that division going to be sustainably into the profit area?
Thank you, you asked three questions for us. The first question relates to China again, if you can give some more details about the Chinese revenues and about our license fees? Then the second question was about the second half of this year about probably slowdown, and you would like to know if the Volkswagen brand and Skoda will stay in profit. And then you are interested in some more detail about the situation at commercial vehicles because they showed significant profit.
On the follow up question on China, first of all you got to say that it is questions where at least so far and I don't think we should this position, we did not publish anything on that. But purely systematically talking, it's clear that if you just take the average number per vehicle and you take the volume to record it in the first half. It's anything, €13 billion, €14 billion. But this is just by my head, rough calculations.
On the license, I do not want to comment for obvious and also competitive reasons. On the possible slowdown in the second half, I think just to avoid misunderstanding here we should make one thing very clear. We think in a, just responsibly dealing it is important to point to what's frame work conditions or underlying factors, which simply tell us that if there is any supporting new factor, which would change the picture, we will see a soft cooling down in the second half in quite a number of developed markets. And I think there is also some chance that in china, we will see a smart and soft cooling down. This doesn’t' mean at all that this would turn any brand of Volkswagen group in a difficult position.
So don't be worried about the profitability in the second half. This is just to say that we need to refer to the economical framework conditions which tell us that it would be wrong to put all the balls into the volume head.
It's just here that there was another question on commercial vehicles. And first of all, it's very clear that commercial vehicle turned up with an impressive performance in the first half, because comparing first half 2009 and 2010 of course we have worst of all do an apples to apples comparison, which means we have to take out the profit recorded by the sale of the Resende entity. Though there is significant improvement which is supported by next month product portfolio, there was specifically our (T5) Multivan car newly introduced in the market that's highly demanded. And in a number of markets, commercial vehicles really turned up with a good performance, costs are under control.
We kept investment belt pretty tight, so that should be a sustainable development.
We will now move to Arndt Ellinghorst from Credit Suisse.
Arndt Ellinghorst - Credit Suisse
Firstly on cash, I think that's also a bit of an important issue looking at companies here. I mean you guys have really impressed the market over the last couple of years with you cash generation and again in the second quarter. Mr Pötsch, can you just explain a bit more strategically, what's going on at Volkswagen? How sustainable such level of cash generation really is? Taking us through your working capital management, and also with the level of provisioning which has been just amazing over the last three quarter alone. I think you put aside additional €2.5 billion in provisions.
So how sustainable really is this? Is Volkswagen a company that is generating something like €3 billion or €4 billion of cash in a year? And obviously as a follow on to that, what are you going to do with this cash? And there is a lot of speculation, and I would also say expectation given your statements in the press that we will see some sort of consolidation in trucks. So, what is your intention with MAN really, could you imagine increasing your stake in MAN?
And then also on the Porsche merger, could you just confirm what you have stated before that when we're getting the Porsche rights issue that this one will be the same in size and price for ordinary and preference shareholders? And that with the rights issue, you will also give us a clear indication of the merger ratio?
So the first question with regard to our cash generation. You would like to know how sustainable is that cash generation, also with regard to working capital, provisioning, that's the one. And the next question is what will we do with all that cash and what is our intention with MAN? And then the last question refers to Porsche and the Porsche issue, if we can give an update or if we can confirm that the volume of the capital increase will be the same volume for pref and ord, and if we will clarify or disclose the merger ratio at this stage.
I think for a number of years, we were introducing some very key elements, which management at Volkswagen, not only in Volkswagen brand, but in all the brands of the group, is focusing on just to make sure that we get the right financial substance for our Strategy 2018.
And it's very clear that we are talking about a very ambitious strategy, there is no reason to deny that, which only can work if we're able to create the right financial foundations. We are still not where we want to be. But we should also not forget that we had a little crisis in the last two years, which interrupted the process which was running quite well in the years already '06, '07, '08.
What we see now is just that we built the bridge to that period, and of course we see the returns of a lot of commitment and of course a lot of hardworking. And the key elements are materialization to avoid complexity, to build cars which perfectly meet customer needs, not only in Germany but also in India and Russia and China and the U.S. And I think just what we see is a confirmation of that policy and strategy. And that's why, of course, what we are about to achieve in 2010 is a huge motivation for the management of Volkswagen to continue on with their policy.
Back to your question in terms of number, it goes without saying that we need to produce a positive net cash flow. And I only had to take the apology that in 2010, in a year which is far away from being a normal year in a negative sense, I'd say, we bought a stake in Suzuki for close to $1.8 billion. Accept that, we will turn out with a decent net positive cash flow number. And we are very positive that we can build up on this.
So that's why, there is no reason that we would not be able to consistently produce positive net cash flow. So the next question on hand is what the hell do we do with the cash on hand. Now, I think you're also aware that we have committed to a number of issues, which partially are pretty much evident and partially are not so easy to be put in a certain size.
But it's very clear we are committed, as I said already, to an ambitious strategy in the regions with a number of new plants coming along with a huge product portfolio, and it's very clear that we have to deal with the risk related to this. That's why I said I would feel comfortable if this company would sit on at least in the automotive division piece of cash in the size of €5 billion.
We are committed to a transaction scheme with regard to Porsche, which in the favored way needs also a good foundation cash-wise once we truly execute the merger. And in the meantime, let's not forget we take it as given that we'll buy the Porsche holding in Salzburg that's a leading European car distributor from the family.
So a number of issues and I do not want to comment on anything else, but obviously there are some more thoughts. So it's clear without saying that there is any necessity to use up all of that cash pile that we're well advised not to lean back, but to continue working to produce the necessary cash streams.
So the other question on Porsche, what I said is that we need approval by the shareholders, both ords and prefs, in the shareholder meetings at Porsche and also Volkswagen to build the basis for a merger. We didn't take any decision on when there is the right timing to introduce a merger ratio. Now, purely systematically talking, it would certainly be supportive if we were able to introduce a merger ratio once we start marketing the capital increase at Porsche.
Arndt Ellinghorst - Credit Suisse
And Mr. Pötsch, you did confirm at our last meeting in November at Porsche that a rights issue on the prefs and ords would go through in similar size, €2.5 billion each side, and also at the same price. Do you want to confirm this now or not?
We always said €5 billion, which is €2.5 million ords, €2.5 million prefs. That's what we said.
Arndt Ellinghorst - Credit Suisse
And you're not commenting on the price?
I am not commenting on the price for a simple reason, because this is also a part of the merger evaluation where the special auditor has to first of all define on whether there is a premium or any share clause or not. And I think you'll certainly understand that this has to be consistent.
We will take our next question from Charles Winston from Redburn Partners.
Charles Winston - Redburn Partners
Just two accounts questions if you don't mind. Firstly, could you give us some sort of breakdown of the financial charges in the quarter? I think they went from about €350 million to €630 million in the industrials division. I guess there is a whole lot of derivatives mark-to-market going on that. I'm just wondering if you could give us some details of that breakdown.
The non-cash provision charges, a large part of the improvement in the second quarter I guess from the fact that they fell from about €1.3 billion in the first quarter to about €400 million in the second. Could you give us any thoughts or guidance as to the rate at which you'd expect to take non-cash provision charges for the rest of the year, in the third and fourth quarter? Thanks a lot.
Charles, you have two questions for us. The first is if we can give a breakdown of financial charges, effect of a derivative marked-to-market, if we can give you some details. And the second one is about non-cash provisioning, if we can give the guidance for the second half or for the full year 2010.
First of all, unfortunately I got to say in principal terms we did not release any specifics other than what is reported in our official report. Maybe a little hint on the financial charges, because there is a special item which is obviously speaking not easy to explain, but needs to be mentioned. Let me put it that way. It has an effect of a negative roughly €100 million and it deals with the evaluation of the options in place, both with lease plan and in that sense of course with the other party owning a piece of lease plan, and with regard to Porsche.
We need to, of course, look at this situation and take a charge for the reasons that between the point in time when we enter into an option agreement and the point in time when it potentially could be executed, we need to charge a certain interest on that basis. So that's quite a sizable number which hit the second quarter specifically, which will not build up. Just to the opposite, it's going to diminish most probably on a certain assumption within the next two years mainly. So this is a hint I can give at this point.
Then on the non-cash charges referring to (technical difficulty), let me have a few words on the principal, if I got your question right. Of course, whenever we're closing the books, as we did at June 30, we make an assessment on the situation. And whether it's the sort of impairment testing or whether it's a straightforward valuation of any warranty risk, it's always related to a very specific business case, which needs to be taken into consideration and which is carrying a certain degree of probability.
I would like to avoid the impression that this is something which is just purely voluntarily or it just for a reason could be charged. This clearly would be in violation of any IFRS rulings. And that's why this is not progressed.
We will take our next question from Max Warburton from Bernstein.
Max Warburton - Bernstein
Just two questions please. The first is coming back to this subject of this very, very large cash pile. Is there any pressure from the labor unions or from lower Saxony to think about funding the pension in a more conventional way like Daimler has done and BMW is in the process of doing? Or is that just not a debate in the company and you are free to use that cash for the other purposes discussed today?
And then the second question. The positive currency boost in Q2, Mr. Pötsch, I think last year you talked about difficult-to-hedge currencies having a negative effect, I think the non-dollar and non-sterling currencies. Is this boost in Q2 the difficult-to-hedge currencies and we've still yet to see the benefit of the improving dollar, or is some of it that U.S. exposure coming through already?
Thank you, Max. So the first one refers to our cash pile. Is there any pressure to fund our pension? And the second question is regard to our currency boost, if we can explain a little bit which currencies are behind that boost and to which currency is that related.
To the first question, pension funding, you might be well aware that's not a real brand new point. A number of years ago, we had some consideration on that. I mean the possibility doesn't really disappear. It's here. And it would be reasonably to take any decision. On the other hand, as I try to elaborate a little bit on it, we've embarked on this strategy and this strategy also needs a good basis in terms of cash and investment side. I think it would be pretty material to take a decision on this, and there is no pressure from anybody on that point.
Currency boost, I can give you a short answer. Yes, you're absolutely right. Consistently speaking, as are heavily hedged in the main currencies, let me put it that way, we suffered quite substantially last year by what I put the difficult-to-hedge currencies, or as you put it. And with the evaluation of the euro, of course, part of the problem disappeared, and that's why these currencies contribute also to the positive support by the currency in the first half of 2010.
Max Warburton - Bernstein
Can I ask a follow-up question on that? At the current exchange rates, when will we see a significant dollar boost? Will we see a significant dollar boost? Is it safe for us analysts to assume that's still, at this rate, a positive to come in 2011 or 2012?
We will see only a little bit more in the second half 2010, and then it's going to increase in '11 and '12.
We will take our next question from Jose Asumendi from RBS.
Jose Asumendi - RBS
I was just wondering if you could just provide a little bit more flavor on the second half in China in terms of demand both for the volume and the premium segment, the visibility you have in both segments and the pricing pressure you face in both. Are you seeing the same pricing pressure in the volume segment as in the premium?
So again, a question about China. I guess it's a question for Mr. Klingler. Which development do we expect in the second half in China, especially the demand in the volume and premium sector and if we see a certain pricing pressure?
China has a pretty impressive story over the last two years. So we're having very strong growth last year and we continue to have a strong growth in the first half of the year. This is a very positive momentum. We believe, however, that the second part of the year will not have the same growth rate in the first part of the year.
We also mentioned already in the beginning of the year in January that we believe the Chinese market could have a growth compared to 2009, and it will be more than 10%. So it's may be 12% to 14%, we shall see.
This is also due to a little bit of the tax changes which had arrived last year in 2009. So the effects of these tax changes have come to reality more in second half of last year. So it's more a question for base effect from last year to this year than something else and the cooling down of the situation.
In China, we still have very strong economic environment, and as you have seen as well from the announcement of the government, the growth in (NYSEARCA:PRB) been cooled down to 10%, which is I would guess for most of our other countries is not cooling down, but heating it up. So the economic base is seen strong and the demand is too strong.
On the other side, what we shall see is that we have as a Volkswagen Group actually no problem in selling the cars we get out of the plant. So we take every car and we sell it to our customers. So we're more in a situation that the cost of production will give us more comfort in increasing our sales in China. This is a very positive tendency and this is as well a positive sign for our prices.
We see as well that other competitors have had unfortunately already the need to reduce the production due to overstock. This is not the situation with us. And as we mentioned before, we have a very strong demand of the cars and especially for the new cars we have given to the market. Like for example, the Golf, which is a dramatic success, or like for example the Tiguan, which is a very, very good success.
If we now come to the second part of the question of the premium brands, we see in general that the premium market is going up. This is a tendency which seems to be pretty logic due to the existence and to the strong existence of the upper class, which is taking profit out of the economical situation. So we believe that this positive momentum will continue. And of course, we will do our best as we have done to keep our performance in line with this cost.
We will take our next question from John Buckland from MF Global.
John Buckland - MF Global
If you can, on China, just say whether you think that the second half volume will actually be down in absolute numbers or up. I mean given the first half performance and your expectation, it could be just double-digit. But that was just a clarification from the previous statements.
But on Audi, obviously a very strong second quarter margin. You have, of course, taken a benefit from the currency. Did the margin improve in the second quarter versus the first quarter and the second quarter last year if you take away the currency benefit? Perhaps you can just quantify that.
And also, with the new Audi A1, should we expect some margin dilution in the coming quarters from the introduction of that model and the increasing volume?
Okay, John, you have more than two questions again. The first question refers to China, which we answered already. But Mr. Klingler said me to add a sentence to that. And then you are interested in Audi, if we can disclose any currency benefits in the Audi profits or the impact on the margin and if we expect any dilution with regard to the margin due to the introduction of the A1?
Concerning your question, all I was saying is that the percentage growth from the first quarter 2009 to 2010 first half of the year may not be the same to the second half of the year, which I mentioned before, due to the market. So on absolute terms, let's say we're staying pretty optimistic.
John Buckland - MF Global
So it won't be a negative?
We're staying pretty optimistic here.
On Audi, the margin of the second quarter was clearly better than in the first quarter and also better than last year. And we are expecting Audi to continue on with that margin level. You should not expect that the A1 would create the dilution on Audi profits. This is also to say that while we launched the A1 to the market, there are a couple of other models which will turn up with impressive margins. So don't be worried about profitability at Audi.
We will now take our next question from Christian Breitsprecher from Macquarie.
Christian Breitsprecher - Macquarie
I have a follow-up question regarding what you said about the merger and potential merger ratio. If I understood correctly, you said that there is also a calculation of a potential premium difference between ord and pref shares. Is that correct? And I thought if we go through the merger, we will have basically a conversion of prefs and ords into prefs and ords of the new entity. Is that a correct assumption? Or will we end up just with the new entity that only has ords?
Though I can repeat again that the question of whether there is a premium or not obviously is very much with the special auditors, which has to be mandated to do the merger evaluation, first of all.
Then you're very much aware about the transaction scheme, which is specifically mentioning the downstream merger, which is to say that in the merger case the shareholders of Porsche SE will receive Volkswagen shares and Volkswagen shares within the respective share classes. So there is no new entity. And I think this answers the question.
Now let's hear what the journalists would like to know. Thank you.
We will now take our next question from John Schwartz from Reuters.
John Schwartz - Reuters
Most questions are already answered, but I have some. I have one. Perhaps, Mr. Pötsch, you could say a little bit more on your plans with MAN. As Arndt Ellinghorst asked about if you could imagine the high stake in MAN, and you didn't especially answer this point. Is there no comment on this point?
And the second question is what are your expectations on the economy in general in the regions Europe, Asia and U.S. for the next months? Can you imagine that VW has earned more in especially one quarter than this second quarter in the history?
There are two questions. The first one is our plans with regard to MAN. And the second one is how are our expectations on the development of the economy in Europe, Asia and the U.S.
John Schwartz - Reuters
May I just add and repeat the third question, because I would like to know if there was a quarter in the history of VW that was stronger than this second quarter in terms of 2010.
Let me get started with the first question on trucks or MAN. I was trying to save a bit of a time, because there was some news flow the last couple of days and the press, which is pretty much elaborating on what is in fact taking place. I think if you reflect the last couple of conference calls for the quarterly results, I manifold times received questions on what's going on it.
I quite often said we are moving closer towards a number of projects where a decent degree of cooperation is taken into consideration. And this is exactly what happened in the last number of months. As the synergistical projects did receive a high degree of being concrete, it was then moved to the press by both the truck companies mainly.
And just to paint a little bit of picture here, just to support these synergistical projects, we created a new position in the management Board of Volkswagen for trucks, and one of our most experienced managers, Dr. Heizmann, took this position. And he will be supporting these projects between the companies Scania and MAN.
And I think it's the quite significant issues which are talked about. The possibilities there include, for example, the cooperation on vehicle components like axles and gear boxes, just to give you examples. And in order to share some R&D efforts between old companies, also then including Volkswagen, there is some consideration taken also on the hybrid drive concepts.
So we believe that this is a very logical and systematic step forward. And again, let me say, as I've said manifold times in the past also, we do not feel in any hurry there.
You wanted, secondly, to have a few comments on how we see the economy developing in the three regions. Maybe I should add a fourth region then. And let me get started with Europe.
Still as we're all aware, some challenges need to be digested. And that's why we think we will most probably see some cooling down of the economy in the next number of months to come. This is not to say that the European economy in total would not be on a positive path. We believe this is the case, but it's going to take quite a bit of time until we are back to former activity levels.
The Asian economy is continuing to be in a more booming type of an economy. Nevertheless, also there, the governments have taken already measures also in China to avoid this growth that is getting out of hand and creating bubbles here and there. That's why also there, it is necessary to keep expectations on a reasonable level, but we would view the economy in a positive shape in most of the Asian markets.
The U.S. is recovering as we saw, but just in the last number of months there was a slight disappointment about the growth rates which showed some signs of weakness. We believe this should not be overestimated because still the investment cycle is quite positive in the U.S., but also in America it's necessary in a number of areas to embark on the process of deleveraging. Also there, it will take quite a while till the economy is back to former levels.
And there we've got another positive example to finalize; that's South America. I think we've seen a pretty positive development there for a number of reasons. We also think that growth rates will probably be a bit stagnant, but still will remain positive.
And to your last question, no, this is not the record second quarter. The record quarter so far was in 2008.
The last question is from Marc Schneider from Handelsbank.
Marc Schneider - Handelsbank
Mr. Pötsch, regarding your comfortable cash position, do you still intend to use further instruments gaining financial liquidity; for example, the convertible bond part by the last AGM or even another capital increase after a certain period of time?
Okay, thank you Marc for that question. So you would like to know if we are intending to do another capital increase or if we would like to use other financial instruments as a convertible or so which (we got a group) for that. Thank you.
No, I think you already gave the answer for this by yourself. We are reasonably comfortable with our liquidity situation. We are able to support our strategic plans, and that's why there are no concrete plans. If and when something could be utilized that's not necessary, we are absolutely in a position to support our strategy in 2010.
Thank you. I would like to thank you very much for taking part in the conference call. Enjoy the rest of the day. Good-bye from Volkswagen.
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