Volkswagen Is Not The Next Tesla, But Valuation Seems Attractive
Seeking Alpha Analyst Since 2021
I'm a software engineer based in Europe interested in the stock market. I'm interested in both value and growth companies, as long as they offer good prospects. I'm not a certified financial adviser, no investment advice on my blog, just my thoughts about companies I find noteworthy.
Summary
- Volkswagen was the 2nd biggest producer of electric cars in the world in 2020, but it has a P/E 2022 of 7.65.
- The company plans to invest heavily in electric mobility.
- Profit margins on combustion engine mass-market cars were slim. Will electric cars be more profitable?
In the past couple of years, legacy automakers such as VW were not faring well. Many of them made bad decisions to focus on a diesel engine to reduce CO2 emissions, and it backfired spectacularly. Court battles about cheating on diesel emissions are still lingering today. In 2019 VW Group was P/E around 6, which is a value you see in companies on a death spiral.
From the beginning of 2021, things began to change. In the last week, we have seen a rally. The frenzy started when the company announced it would move more aggressively into the electric car market. Some VW shares (there are two main share classes) went up by 30% one day. At the moment of writing, the most liquid VW VOW3 shares are up 51% YTD. The market is becoming more optimistic, but with a P/E 2022 of 7.65 (according to marketscreener) the company still seems to be valued very cheaply.
Growing market share in China, slim profit margins on mass-market cars
Volkswagen Group comprises several divisions and brands. The most important ones are Volkswagen Passenger Cars, Audi, Porsche, Lamborghini, Seat, Skoda. Besides passenger car segments, they also have a Financial Services division with dealer and customer financing, leasing, banking, insurance activities, and fleet management. There are also brands producing trucks and commercial vehicles – Scania, MAN, Volkswagen Commercial Vehicles.
Within the group, Volkswagen Passenger Cars bring the most sales revenue. Audi, Financial Services, and Porsche are other significant divisions in terms of sales revenue. Many brands were adversely affected by the pandemic, especially Audi and VW Passenger Cars. Despite COVID, Porsche's revenue was flat, Financial Services revenue even increased. Luxury cars produced by Porsche were less affected by pandemics than mass-market vehicles made by the VW brand.
COVID also distorted the operating result in 2020. Porsche and Financial Services made the most significant profits. The contribution of Volkswagen Passenger Cars which brings most significant sales is relatively small in this year. In 2019, before the pandemic, it brought 3.7 billion euros.
Analyzing sales and profit, you can tell that profit margins of the largest brand of the company VW Passenger Cars, are not impressive. It is visible if you look at the net profit margin of each business division.
The relationship you see here is that the more mass-market cars a brand produced, the lower profit margins it has. Even in 2019, Volkswagen Passenger Cars – the biggest brand in sales revenue – had a low-profit margin of 4.28%. Producing cheap cars on a mass scale is not very profitable. At the same time, you can see the Porsche brand's impressive profit margin. Porsche makes luxury cars. There are relatively good results of Audi, Scania, and Czech brand Skoda.
The biggest market in 2020 was Asia-Pacific, including India, Japan, and China, but the vast majority of Asia-Pacific sales are China. In 2019 biggest market was Europe, but in 2020 sales fell in this region because of the pandemic. In China, it dropped as well, but the decrease in sales was smaller.
In a yearly report, Volkswagen states that it is now the most prominent car producer in China in terms of market share. It claims a 19.3% market share. They plan to build two new factories for electric cars in China. Together this will increase production capacity by 600k vehicles per year. In China, VW plans to release three more electric models from the ID family in 2021 and eight models until 2023. In total VV group produced 3.6 million vehicles in China in 2020. China enterprise is a joint venture with a Chinese partner. Across all markets, they do not expect car demand to be back to pre-pandemic levels in 2021 but predict an increase in demand 2022-2025 across all regions and the most significant rise in sales in Asia-Pacific.
The main shareholder of Volkswagen Group is the Porsche-Piëch family, which owns over 30% of shares that give 50% of votes. They own them through holding company Porsche AG – also quoted on German stock exchange (with a discount to VW as for the time of writing, so some see it as a potential opportunity). Other significant shareholders are Qatar Holding and the local government of Lower Saxony, which still holds around 14% of votes since the II World War.
VW as a leader in the electric car market?
The recent rise in interest in Volkswagen started with the announcement of the new strategy. Last Tuesday, CEO Herbert Diess announced that VW group would build six factories of electric vehicle batteries and invest in building 18k charging points across Europe. VW wants to develop its own battery. Currently, they rely on deliveries from LG Chem and a Swedish company founded by the ex-Tesla executive - Northvolt. Soon after this announcement, Northvolt announced it received an offer from VW. VW offered to take more shares in Northvolt, buy a factory belonging to Northvolt, located in German town Salzgitter, and build new factories together. The goal is to make electric cars affordable and drive down batteries' costs by up to 50%.
VW Group is already the market leader in electric cars in Europe and 2nd most prominent seller of electric vehicles globally. In Europe, Tesla's market share went down from 20% to 10% in 2020. Currently, European electric car market is booming. In the first two months of 2021 the market increased by 61% compared with last year. Germany's market alone rose +254% in 2020. The majority of the boom are plug-in hybrids, which allow you to have the best of both worlds. You have some electric battery that will enable you to drive some small distance and get an ICE engine for longer distances.
Substantial state subsidies drive electric vehicle market growth. If you buy an electric car in Germany, you can get up to 9000 EUR state subsidy. The contributions go to plug-in hybrids and purely electric vehicles, which means you can buy a plug-in hybrid, drive on a combustion engine without using the electric battery, and still get money back. State funding is making electric cars more competitive, but governments can't subsidize technology forever. It needs to start bringing benefits to clients and profits to companies. Otherwise, the boom won't last.
Some analysts predict that VW will overtake Tesla as the biggest EV carmaker in 2025, with a 15% EV market share. At the moment, there is still a technological gap between VW and Tesla. It is most clearly visible if you look at in-car software. The new electric model ID.3 was delayed by technical glitches, the software didn't work as expected. Reviews of new electric SUV ID.4 also point out that the software is slower to react and more cumbersome than Tesla. The company needs to reduce the technological distance in this respect.
Another significant risk factor for VW, in my opinion, is that up till now, the mass market car sales was not very profitable, and the majority of VW group sales are still in this segment. VW's leading brand with ICE engine was not lucrative in 2019, with a profit margin of just 4%. Will it be different with mass-market electric vehicles? One example to consider is the Volkswagen e-up model, a small mass-market city car. According to unofficial info in the German business journal, Handelsblatt VW lost 5000 euros per each model. Leaks say that VW did not produce e-up for profit but to avoid regulators' fines for not meeting environmental norms. At the same time, customers flock to this specific electric model. Handelssblatt states you have to wait nine months to get one. It is an unusual case of a product loved by customers but hated by the manufacturer. Will it be different with new models ID.3 and ID.4?
Despite these risks, I think VW group valuation is still cheap, even after a recent increase in price, especially if you compare it with other electric car makers. VW P/E for 2021 is 9.28. For 2022, it is only 7.60, and they predict that demand for their products will be fully back in 2022. 2021 is still the year of the pandemic. Some claim VW is next Tesla, but the companies are different. Tesla's future is growth. It needs to grow with the market or better than the market. They don't have a legacy that drags them down. VW needs to transform old business. They are still at the beginning of this transformation, and it is not sure if it will succeed.
At the same time, some questions apply to both Tesla and VW. The most persistent concern is about profit margins on mass-market EV vehicles. How will the market react if VW sells only electric cars in 2035, they will be the market leader, but profit margins will be low, maybe even lower than margins on selling ICE cars? It is a risk that exists for both Tesla and VW. The difference is that for Tesla, the fall of valuation will be steeper than in the case of VW because VW is cheaper.
Disclaimer: I own VW shares, not planning to sell or buy more at the moment of writing
Analyst's Disclosure: I am/we are long VLKPF.
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.
I own shares of Volkswagen traded on a German stock exchange (this is the most liquid ticker VOW3), not those traded via US brokers and displayed in seeking alpha selector.
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