Volkswagen Earnings Review: North America Sales And Operating Performance In Focus
Volkswagen AG (OTCMKTS:VLKAY) announced an 8.8% year-over-year rise in revenues for the automotive division in Q1, on April 29. [1] This growth was mostly supported by positive currency translations and a positive product mix, due to the relatively higher sales for the luxury brands Audi, Porsche, and Lamborghini. Overall vehicle deliveries for Volkswagen grew only 1.8% in the first quarter, over the year ago period, which hindered the German automaker’s prospects of taking over the global volume sales lead from Toyota, which despite a 2.5% year-over-year decline in unit sales through March, kept the lead over Volkswagen. Increasing volume sales is not the goal for Toyota, which plans to focus on profitability and improving service quality and workers’ skills, and has put off building new manufacturing plants till at least next year. On the other hand, Volkswagen has aggressively pushed for higher scale in the last few years, and lower-than-expected volume sales represent a slight weakness in the group’s automotive operations. In particular, the company was unable to gain from the strong vehicle demand in North America, and witnessed only a small rise in volumes in China–its single largest market.
A lot could change now at Volkswagen, however, which faces a short-term leadership crisis, with the exit of the Chairman and grandson of the inventor of the Volkswagen Beetle, Ferdinand Piech. The Porsche and Piech families that control Volkswagen, were battling over the future leadership of the company. Ferdinand Piech said that he had lost confidence in Chief Executive Martin Winterkorn. The CEO resisted the efforts to oust him, and was backed by the board, which told Mr. Piech they had lost confidence in him as Chairman. Soon after, Mr. Piech resigned from the position of Chairman and from all company functions. Mr. Piech’s resignation has given investors reasons to believe that the group will now focus more on improving its profitability, and ease-off on the aggressive push for more volume sales.
Mr. Winterkorn might stay in place as chief executive for a few more years, and is expected to emphasize more on plugging the structural shortcomings that have prevented the group from achieving higher operating margins. This might be the end of an era, and prompt a shift from more acquisitions to more profitability. Volkswagen’s own luxury saloon Phaeton, which was conceived by Mr. Piech, cost fortunes to build and sold only a few numbers. According to Bernstein Research, the Phaeton lost $2.7 billion or $38,000 per car since it was launched in 2002. [2] With the exit of the Chairman, the Phaeton project, along with other expensive and unprofitable projects in the pipeline, might be shelved.
The turmoil at the helm of Volkswagen might in time pave the way for higher margins, in particular at the namesake passenger vehicle brand, and better performance in North America.
Volkswagen’s Low North America Sales Drag Down The Top Line
Volkswagen failed to capture some of the growth in the U.S. automotive market in the first quarter. Continual slowdown in crude prices has bolstered customer purchasing power, particularly in low fuel-tax markets such as the U.S. This, in turn, has boosted vehicle sales in the country, which witnessed its largest automotive demand since 2006 last year. Auto sales in the U.S. continue to grow this year as well, rising by 5.6% in the first three months. However, Volkswagen’s poor form in the country continued, with sales falling 1.4% year-over-year through March, following a 2% decline in vehicle sales last year. The German automaker has lost out on the strong sales growth in the U.S., which has benefited the company’s chief competitors Toyota and GM this year.
Part of the problem for the Volkswagen-branded vehicles in the U.S. has been a weak SUV/crossover lineup, a segment which grew by 11.8% to 5.38 million units last year, forming approximately one-third of the net light-duty vehicle sales in the country. Volkswagen Passenger Vehicles presently sells only two SUVs in the U.S., the compact Tiguan and the upscale Touareg, and despite a 12.4% rise in overall SUV/crossover volume sales in the first quarter, the total light truck sales for the brand fell approximately 8.5% in the country. The company is now working on a lineup of five new SUVs, aimed directly at the U.S. market, in a bid to turn its fortunes around in the country.
Last year, Volkswagen announced plans of investing $7 billion in North America between 2014-2018 for the purpose of adding capacity and accelerating growth in the country. [3] This is part of the company’s aggressive growth strategy aimed at becoming the highest-selling automaker in the world by 2018. In order to reach this feat, Volkswagen aims to sell around one million vehicles in the U.S. alone by that period. Contrary to the group’s growth estimates, U.S. deliveries dropped 2% to less than 600,000 units last year, reflecting how one million deliveries in the country by 2018, or an annual volume growth rate of 14% through 2018, might be unlikely. Volkswagen will hope to reach as close as possible to its 2018 targets, and expanding its SUV lineup in the U.S. could boost the group’s chances to do so.
Volkswagen Needs To Improve Profitability
The German group’s automotive margins improved to 6.2% in Q1, up from 5.8% in the year ago period. This expansion of operating margins is mainly on the back of higher proportionate operating profits for Audi and Porsche, which reported 9.7% and 15% EBIT margins, respectively, in the first quarter. The Volkswagen Passenger Vehicles division continues to struggle, due to lower volume sales (volumes declined 1.3% year-over-year in Q1), and high research and development costs incurred by the group to push for innovation at the ailing vehicle division. The company is now aiming to save around 10 billion euros ($12.4 billion) through efficiency initiatives, with the target of 5 billion euros worth of cost-savings at its own-branded passenger vehicle division by 2017. [4] In effect, the automaker aims to improve operational return on sales for its passenger cars to at least 6% by 2018, up from 2.5% last year. Operating margins stood at below 2% at Volkswagen Passenger Vehicles this quarter. This division forms approximately 60% of Volkswagen’s vehicle deliveries, but contributes only 8% to the group’s valuation by our estimates, owing to the relatively lower price-points and narrow margins. Curbing extra manufacturing costs and improving efficiency could have an impact on Volkswagen’s overall profitability going forward.
Apart from Volkswagen’s aim of becoming the world’s largest automaker in terms of volumes by 2018, the German auto giant is also looking to improve its operational return on sales to at least 8% for the entire company by that time. Spurring profitability for the namesake passenger car division, increasing implementation of Modular Transverse Toolkit (MQB), which could reduce development costs, start-up costs, and assembly costs associated with setting-up production of a new model, and leveraging the continual strong demand for luxury vehicles, could help the group meet its operating targets in the mid-term.
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