- VW has the largest investment spend, among global automotive manufacturers, into EV and software.
- With plans to build 6 gigafactories by 2030 as well as a unified cell strategy for its EV platform, VW is pushing ahead with high growth in its EV segment.
- VW is ahead of the curve as it is building an in-house battery production capability and investing further upstream, securing battery supply and controlling battery costs.
- Based on my 2025 forecasts, my estimate for VW's target price is EUR313, which implies a solid 75% upside potential.
The transition towards Electric Vehicles (EV) is happening today and gaining momentum as EV penetration accelerates globally. Bloomberg estimates that about 5.6 million passenger EVs will be sold this year, which is almost double that sold in 2020. Furthermore, in 2021, 8% of all vehicles sold were EVs and this number is poised to increase as the EV transition continues over the next decade.
I believe that when looking at global automotive manufacturer incumbents, there is a clear winner in the EV transition race and that is, Volkswagen (OTCPK:VWAGY).
I believe that VW will be a structural winner in the EV transition race due to the following reasons:
- VW's commitment to the transition is the highest. It has the largest investment spend in EV and software, both high growth areas of the future, among global automotive manufacturers over the next 5 years.
- In addition, VW has a clear, ambitious battery strategy to support this. VW has a unified, in-house battery strategy and it will be building 6 new gigafactories by 2030. All these ensure adequate battery supply for its EV rollout.
- VW takes the vertical integration strategy with its upstream investments. I believe that this is key for incumbents in order to have control over their EV transition and lower their overall costs.
Due to their current cheap valuation relative to pure play peers, I believe that this valuation gap will narrow. This will happen as VW proves to the market that their electrification and battery strategy, and in the long term, their software strategy, can be executed well. As such, I am of the opinion that VW is currently a strong buy amongst global automotive manufacturer incumbents. Based on my 2025 forecasts, my estimate for VW's target price is EUR313, which implies a solid 75% upside potential.
Currently, as the largest automotive manufacturers by volume, VW produced about 10 million cars annually under an umbrella of brands. Its Volkswagen brand, Volkswagen Commercial Vehicle, Skoda, SEAT, and Cupra fall under its volume brand. Audi, Bentley, Lamborghini, and Ducati fall under its premium brands. Lastly, Porsche falls under its sports brand.
Although VW was the largest automotive manufacturer globally, its EV production and deliveries were minuscule compared to its Internal Combustion Engine (ICE) vehicles production and deliveries. In 2019, VW sold 70,000 EVs worldwide, representing less than 1% of VW's total vehicles sold in a year. From 2013 to 2019, VW only sold 250,000 EVs worldwide. This is in contrast to the 367,500 EVs Tesla produced in the year 2019 alone.
However, in my view, this started to change when VW launched its new ID3 model, a fully electric car with a carbon-neutral footprint. With this new launch of ID3, it brought VW into a new era, into large-scale EV production. Since then, VW has been going all out into the EV transition as it seeks to compete and regain market share in the EV space and even take over the top spot in the EV space from Tesla by 2025. In March of 2021, VW also had its Power day where it unveiled plans for the Group's battery strategy, which in my view, is a pivotal shift towards the right EV strategy for VW.
For the longest time, large global auto players had the mindset of only shifting to EV mass production when majority of customers start buying EVs and when penetration has become fairly healthy for decent margins to be made for each EV. As such Tesla (TSLA), as a pure play EV player, benefited from the lack of any serious threat from global incumbents as it continued to dominate EV market share. In 2019, Tesla's market share was 18%, up from 12% in 2018 as customers started buying more EVs and Tesla started to gain brand reputation. As shown below, the global EV sales grew at a rapid pace from 2015, with further acceleration in EV sales in both 2020 and 2021.
However, today, Tesla is the one being threatened as the competitive environment has changed dramatically. Many global automotive manufacturers are launching new EV models in the year to come, with many EV startups focusing on pure play EVs set to compete with the leader. In fact, about 100 BEV models are set to be launched by 2024.
With the competitive landscape changing, I believe that it is essential for companies to not only grow faster than the industry, but also control costs to ensure higher margins. In my opinion, the best EV players will be the ones with control over battery production, ensuring self-sufficiency in battery supply as the EV penetration continues to tick upwards.
Heavy investment spend increases competitive moat in EV
I took a deeper dive into VW's investment spend over the years and where they are focusing investments. This will give us a clear roadmap of where they are heading and whether they are consistent and taking serious actions today for their EV transition.
Firstly, the investment spend into new technologies like BEVs and software have increased from 30% of its total investment spend 4 years ago, to 56% today. This shift in the proportion of investments that VW is putting into new technologies, I believe, signals their intentions to go big into the EV transition and invest into the new technologies of the auto industry.
Specifically, looking into the investment spending into software, it has grown from 5% of the total investment spend 4 years ago, to 19% today. In my opinion, this increasing focus on investment spend into software is crucial for VW in the future as the race to be the best EV does not stop at electrification but rather, to be a winner in the EV race, VW needs to have leadership in software as well.
Source: PR 70.
Second, VW investment spend shows greater conviction and commitment into the EV transition. I have collated some of the commitments made by the top global auto players and found that VW is investing more than double some of its competitors over the next 5-year period in e-mobility and software. Also, its $30 billion investment in software is one of the largest in the industry.
Source: Author collated from various company announcements.
VW intends to develop battery production capacity in Europe. With its partners, VW plans to have 6 battery factories in Europe by 2030 to "guarantee the security of supply". These 6 factories are expected to produce up to 240 GWh per year when they are complete. The first gigafactory in Sweden is in collaboration with Northvolt and is expected to commence production in 2023, while its second gigafactory is expected to be in Salzgitter.
VW also revealed its new unified cell strategy. This simply means that VW will take a standardised one-size-fits-all approach to its battery strategy, which will reduce battery costs and improve consumer demand. VW stated that its new unified cell strategy should see entry-level EV battery cost reduced by 50% and reduction in battery cost of up to 30% for volume segment models, due to the differences in cell chemistries utilised in these models.
Entry-level EVs will utilise iron phosphate chemistry, volume models will utilise high manganese, and specific solutions will use nickel manganese cobalt. VW is also looking towards solid-state battery packs in the future as well, which could be a game-changer for VW and the industry. VW is known for its $300 million investment into QuantumScape (QS), which could see positive payoffs as early as 2024.
With its new unified cell strategy, fast charging time to add 280 miles can be reduced from 25 mins today to 12 mins after 2025, reducing the barriers to EVs further and improving VW's value proposition to customers.
VW is currently doing a battery recycling pilot in Salzgitter and in the long term, plans to recycle 97% of all raw materials. This battery recycling plan fits into the idea of a closed-loop system for battery materials and helps secure battery materials and reduce battery costs.
All in all, I believe that VW is finally implementing the right strategy to ensure battery supply and lower battery cost with its unified cell strategy and roll out of 6 gigafactories by 2030 to increase its capacity for EVs in the next decade. In my opinion, VW will be the clear winner in the Europe EV market with its huge investment spend and localised supply chain investments in the region.
Heavy upstream investment for development of in-house battery
I believe that to be a winner in the EV race, companies need to have a vertically integrated strategy.
First, VW started a joint venture with Umicore, which is a Belgium cathode materials company that will provide support to VW supply chain in Europe.
Second, VW acquired Gotion High-Tech in China to secure battery supplies in China. In my opinion, localisation will be the next pivotal shift for EV players as each region will need its own domestic production or supply to meet the increasing demands in the region for EVs.
A last example would be VW's investment in 24M Technologies, which is a US-based battery startup that has redesigned the traditional battery cell that could result in smaller production areas, less carbon emissions, and more recycling opportunities.
VW, as a German auto player, is beating Tesla in Europe. In fact, in 1H21, it was the EV market leader in Europe with 21% market share. Its EV model, ID3, proved to be a popular choice amongst consumers in its first year of launch in 2020.
Source: Jato Dynamics
VW's main edge over Tesla comes from its brand reputation, cheaper pricing, and localised manufacturing facilities.
That said, VW still trails behind Tesla globally as Tesla delivered 627,000 EVs in the first 3 quarters of 2021 and VW sold 293,000 EVs. However, I believe that with the ramping up of new all-electric models by VW, we could start to see VW catch up to Tesla by 2025.
VW trades at a significant discount to pure play EV companies with 1 year forward 2022F P/E of 5.6x and Free Cash Flow yield of 21.5%. I believe that the valuation gap between VW and other EV players will narrow in time as VW proves that it is able to execute its electrification strategy well.
After having done extensive research on VW, a financial model was developed to forecast VW's financials to 2025F (key summary below). Based on a conservative P/E assumption of 12x, and discounting back the terminal value by VW's cost of equity of 12%, I derived the Target Price for VW to be EUR313. Based on the current share price, there is an upside potential of 75% to be made from here.
I believe that a 12x P/E multiple is warranted given VW's leadership in EV and strong business fundamentals. This should give it a premium in its valuation compared to global auto manufacturers that are laggards in the EV transition race.
One big near-term risk for VW is its semiconductor shortage, which has been costly for VW as it has had to reduce production. For VW, its volume brands like Volkswagen, Skoda, and SEAT suffered the most during this semiconductor shortage.
VW CEO Diess remains optimistic that there will be a pickup in semiconductor supply next quarter, but I think we could still see some supply constraints in 2022. As this is a temporary constraint, I believe that this does not impact the fundamentals of VW in the long run, which is what investors should be looking at. Furthermore, I am encouraged that VW is looking beyond the semiconductor shortage to make sure that in the future, VW will not have any issues in battery shortages due to heavy investment in the upstream EV value chain and the heavy investment spend in EVs in the next 5 years.
Worsening consumer sentiment in China
Given that VW has a relatively large exposure in China, there are risks that there could be a more serious slowdown in China with the current pandemic situation. If consumer sentiment turns sour, consumer demand for EVs in China and thus, VW's leadership in China may be threatened.
R&D and capital expenditure spend
There may be a need for a larger R&D and capital expenditure if competitors increase their commitments to the industry, thereby using a threat to the current runway that VW has plotted for itself. If so, this could lead to larger spending needs for VW to maintain or grow market share in the EV space.
VW trails behind in software although I mentioned that they are spending more investment dollars into software as a focus from 2021 to 2026. However, investment spend may not lead to productive software results as key software talent needs to be attracted in order for VW to catch up and succeed peers.
I believe currently, there is a mispricing situation with VW as there are many positives not priced into VW today. I believe this is due to the semiconductor shortage, which is a short-term headwind, in my view, as well as the uncertainty in execution abilities of VW management in its ambitious EV plans. However, as explained earlier, I am of the opinion that VW will be the leader in the EV transition race as other global incumbents are unwilling or unable to match it in terms of having an in-house battery production capability, a unified cell strategy, its huge investment spend on EV and software, its 6 gigafactories to come by 2030, and its huge investment in the EV supply chain. I believe that the target price of EUR313 and thus a 75% upside potential is achievable given its current depressed valuations.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of VWAGY either through stock ownership, options, or other derivatives. 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.
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