Volkswagen Stock: All About The Long-Term Trends (OTCMKTS:VWAGY)

Today we’re heading back into the autos sector and we’re taking a first look at Wolfsburg’s finest, Volkswagen AG (OTCPK:VWAGY) (OTCPK:VLKAF) (OTC:VWAPY).

1974 was an interesting year for better and for worse: President Nixon resigned over the Watergate scandal, Steely Dan released Pretzel Logic, West Germany won the World Cup and the oil embargo imposed by Arab exporting nations as a retaliation to support in the Yom Kippur war ended. The result was an unsustainable petroleum price and rapidly rising inflation. Almost 50 years later, we find ourselves in a very similar macroeconomic situation. Does this mean a repeat of the 70s for the autos sector? What about the invasion of Ukraine? Aside from the obvious impact of Russian revenues, what are the wider implications?

In reality it’s not as bad as it looks. During the mid 70s, fuel costs were much higher in relation to disposable income at the time, and we can see the pent-up demand in the wake of the pandemic. So though we can’t deny that the macro obstacles have become more pronounced, we believe that this will not be reflected in group revenues, where we actually forecast an increase, but rather the margins. Despite the premium brands within the product portfolio (Audi, Porsche), they only account for just over half of group EBITDA (53%). Therefore, we don’t see the same pricing power as German peers such as the newly spun out Mercedes-Benz Group (OTCPK:DDAIF) or BMW (OTCPK:BMWYY).

Russia (and more importantly Ukraine)

While most people are focussed on Russia where VW has ceased production and exports, the Group CFO stated that the Russian exposure on the balance sheet is less than 0.5%, whereas sales were at roughly 2%. What is cause for concern is the supply of components from Ukraine. Ukraine is a major supplier of wiring to the European autos industry accounting for roughly 10% of the region’s supply.

We have managed to get a more detailed map of the production disruption which the Group is currently undergoing (valid from 10th March).

No production disruption:

1. Wolfsburg (4.9% total production)
2. Liepzig (1.5%)
3. Zuffenhousen (1.2%)

Production disruption:

1. Zwickau (2.2%) – production paused until 28th March
2. Dresden (0.1%) – production paused until 28th March
3. Ingolstadt (1.5%) – production of 2 Audi models suspended until 4th April
4. Neckarsulm (1.7%) – suspension of 4 Audi models until the end of March
5. Boellinger Hoefe (2.1%) – suspension of e-tron GT and R8 suspended until 28th March
6. Poznan & Wrzesnia (1.4% + 1%) – Halt in production from 10th March
7. Kaluga & Nizhny (1.5% + 0.7%) – Shutdown at both Russian plants until further notice

BEV megatrend

So far the outlook has been pretty gloomy but let’s not forget that the autos industry still needs its revolution. Let us not forget that less than 1% of cars on the road globally are not ICE (internal combustion), the EV advent still has to hit. Volkswagen’s BEV sales were up 95.6% in 2021 compared to the previous year. The Group is market leader in Europe where it has 25% of market share and is in second place in North America with plans to keep expanding. VW commented in their call that they remain well on track to reach their 50% EV sales goal by 2030 and to achieve margin parity sooner than expected. The Group plans to concentrate particular focus on China where EV sales have seen a boom: sales in 2021 saw a 4x increase compared to the previous year and VW is targeting doubling sales in 2022.

2021 FY results and valuation

Looking at VW’s end of year results, we note total revenues of €250.2 billion, a 12% increase from the previous year despite selling 6% fewer vehicles. This is testament to the group pricing and portfolio mix. EBIT margin came in at 8% for the year with Q4 being particularly strong at 9.2%, beating consensus by 180 bps and sector average of 6.1%.

The Company also remains committed to a partial spinning out of Porsche later this year which could benefit by giving the brand more freedom as well as letting VW focus on its core offerings – a similar move which we saw with Daimler. The Group’s cash rich balance sheet will also allow VW to continue investing in R&D allowing it to ride the BEV and eventually FCEV trends.

As we have done in the past in our analysis of the autos sector, we are valuing the stock using a SOTP method, whilst slightly increasing our estimates for the premium brands within the portfolio. Our internal team came up with a target price for the preferred stock at 202 Euros per share, implying an upside from the current price of 27%.

Key risks include:

1. Slowdown in Asia, which is a growing market for VW, especially for its BEV business.
2. Prolonged shutdown and further supply bottlenecks thanks to Ukraine invasion.
3. Weaker pricing power compared to more premium peers.

Here is our latest analysis on Ferrari (RACE), one of our top picks for the autos sector.