VWAPY - Volkswagen: Our Thoughts Post Capital Market Day Buy Confirmed

2023-06-29 00:03:51 ET

Summary

• Volkswagen highlights ten key takeaways on how the company will close the profitability gap versus its peers.
• CAPEX on sales will decelerate from the 2023 peak.
• Supportive sum-of-the-part valuation and at a P/E level, the company remains cheap.
• Dieselgate scandal is almost over in the US.

On 21 June, Volkswagen AG ([[VWAGY]], [[VLKAF]], [[VWAPY]]) ( OTC:VLKPF ) hosted a capital market day . The company presented a ton of information, which took us quite a while to digest. Volkswagen laid out its long-awaited mid-term financial target until 2027 and a 2030 strategic plan with a clear emphasis on core EBIT margin evolution, better cash conversion, and a new BEV strategy.

In addition, Volkswagen sets higher revenue and profitability targets with value creation prioritization over volume growth. These were the main elements of change in the company's strategy announced by Oliver Blume (VW's CEO). In numbers, the company aims for sales growth of between 5% and 7% by 2027, which would translate into a decisive turnaround compared to a figure of around +1% recorded in recent years. Going down to the P&L estimates, the group aims to achieve an operating margin between 8% and 10% with a cash conversion ratio of 60%. Regarding shareholder remuneration, the total DPS grew from €3.96 (2017) to €8.76 (2022) per preferred share, with a payout ratio that has grown from 18% to 29%. The goal for the end of the decade is " over 30% ". These targets align with our internal expectations and are less aggressive than Stellantis ( Dare Forward 2030 ) and Renault ( Business Transformation At Full Speed ).

Here at the Lab, we believe that Wall Street is in a " show-me story " attitude, and Q2 results matter more than the CMD's new targets. On the positive news, the group's order book is high, with 1.7 million cars, and we are confident in an upside on the Q2 earnings. Volkswagen highlights ten key takeaways , and we also provide ten updates on how the company will manage this new exciting phase.

How will the company close the profitability gap versus its peers?

1. The Group decided to give more autonomy to its brands regarding financial objectives, strategy, and marketing decisions;
2. While the company is accelerating product development, Cariad, the software unit, will also be open to ' smart ' & strategic new partnerships. Volkswagen might follow Renault's recent development ;
3. Volkswagen expects savings from economies of scale thanks to a unique cell battery solution platform. Starting in 2026, all-electric cars will be based on a single architecture, the Scalable Systems Platform. This might provide significant profitability gains. We are modeling overhead costs reduction of €5 billion at 2027-end (Fig 1);
4. The group continues to identify China as a strategic end market. Sales of cars with internal combustion engines are still predominant in the Asian country and guarantee revenues and good margins. However, the market is looking forward, and Beijing's new measures will support EV sales. Indeed, the Chinese Ministry of Finance announced further tax relief until 2027 for those who buy a "green" car in 2024 and 2025. The Chinese government's commitment in quantitative terms is estimated at 520 billion yuan, approximately €67 billion;
5. Volkswagen's target region is also North America. There is a plan to build a new battery cell factory in Canada. Another key chapter for the future of the entire German group is PowerCo, the company dedicated to battery cell production, which could accelerate its development with an IPO and a strategic investor by 2024. Already included in our estimates, align with the company's strategic CAPEX objectives, we are modeling three new battery plants that will cost approximately €15 billion in the next five years (Fig 2);
6. To reduce costs, the company is reorganizing a new leadership model to shorten decision times on product development;
7. On the CAPEX side, the company confirmed its 5-year plan with €180 billion investments unchanged. In detail, 2023 CAPEX is set at 14.5% and will come down after that. According to the Group, the average CAPEX/revenue (including the R&D expenditure) will be around 12% until 2027, and this is what we are modeling;
8. Volkswagen unit is engaged in a comeback from a 3.6% EBIT margin in 2022 to a 6.5% target in 2026 (Fig 3). The division is preparing an extensive restructuring plan, which includes a savings plan equal to at least €3 billion. On the other hand , Daniela Cavallo, the union representative, is unwilling to accept wage cuts or jobs. Here at the Lab, we expect the automaker to halt hiring in Germany, resulting in a lower headcount over time. In addition, Wolfsburg industrial plan will carry on the ID.3 restyling and a new all-electric SUV model. Looking at the Volkswagen unit, the company aims to cut costs by €10 billion, reduce workforce shift from three to two, and decrease industrial capacity by circa 10%,
9. Volkswagen aims to launch 80% of battery-powered car models by 2030. Audi will be at the forefront of the electrification process;

10. The company has €15 billion book value in over 250 non-controlled entities. The CEO did not provide any additional comment, but we believe there is a strategy for asset disposals (Fig 4).

Fig 1

Fig 2

Fig 3

Fig 4

Conclusion and Valuation

In our estimates, considering that S&P assumes light vehicle sales growth at 3.5% per year until 2027 and considering the BEV's higher market penetration (with higher selling price), we believe that VW's target (5-7%) is conservative. The latest ACEA data shows that new car registrations increased by 18.5% in May, reaching 948,815 vehicles. We are still below pre-Covid levels, but the Volkswagen Group signed a plus 19.5%, outpacing the market and registering 243,013 new cars. Since our last article called " The Most Discounted Auto Stock ," Volkswagen's stock price declined by 3.07%. At 4x 2024 price earnings estimate, the company remains cheap. We understand that investors are reluctant to value Volkswagen on a sum-of-the-part valuation ; however, this provides a solid margin of safety in our investments. For this reason, we continue to value Volkswagen's preferred stock at €202 per share ($220 in ADR).

On a positive note, according to Reuters , Volkswagen is close to finalizing its lawsuits related to the Dieselgate scandal in the United States. The US attorney ruled that Salt Lake and Hillsborough County failed to prove Volkswagen's violation of emission control. In May, the German auto group signed an $85 million settlement agreement with Texas, the latest State to sue VW for the scandal. As a reminder, the Dieselgate scandal dates back to 2015 , when US regulators discovered that Volkswagen designed its diesel vehicles to violate emissions checks. The scandal cost the company more than €30 billion in legal fees, compensation, and fines.

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