VLKPF - Volkswagen: We Double Down On Q2 Results

2023-07-28 12:30:40 ET

Summary

• Volkswagen Group's Q2 profits were lower than expected due to negative effects of commodity hedging and increased competition in China.
• The company confirmed its 2023 financial outlook but slightly lowered its delivery estimates. Volkswagen signed two agreements to unlock Chinese client's growth.
• Compelling valuation and tasty dividend per share. We decided to increase our position.

Here at the Lab, we just concluded our Volkswagen ( VLKAF ) ( VWAPY ) ( VWAGY ) Q2 analysis, and compared to our Q1 release comment , we are not particularly delighted. Last month, the company presented a CMD with higher revenue and margin targets, prioritizing value over volume growth. The CEO raised the 2030 bar with ROS estimates between 8%/10% and a margin recovery story at 9%/11% versus the just released core EBIT margin of 7.3% (and 8.1% from last year).

Q2 results

In Q2, the company reported worse-than-expected earnings due to commodity hedging adverse effects and intensifying Chinese competition, one of VW's key markets. The German automaker's adjusted operating profit reached €5.6 billion, below Wall Street market estimates. Looking at H1, the EBIT reached €11.3 billion with a margin of 7.3% (lower than 2022 results). On a positive note, revenue grew by 18% to 156.3 billion, driven by higher volumes in the EU and North America and a favorable price MIX. First-half deliveries totaled 4.4 million vehicles, up 13% year-on-year. Deliveries of electric vehicles (BEVs) increased by around 50% in H1, representing a 7.4% share of total deliveries and allowing the company to maintain the European market leadership in the segment.

Source: Volkswagen Q2 results presentation

In addition, the company confirmed its 2023 financial estimates. On the other hand, deliveries were slightly revised downwards, from around 9.5 million to a range between 9/9.5 million.

Mare Upside

1. It is essential to report the CEO's words : " There is a clear plan and measurable milestones. In the year's first half, the Volkswagen Group delivered reliably with excellent results, strengthening the company's position in China through technological partnerships .” Indeed, the CEO is trying to reverse the negative Chinese trend, where Tesla and BYD are producing EVs with technology and software adapted to local tastes;
2. In the Q&A analyst call, the company reported a solid order intake in the truck business and the passenger vehicles. In addition, BEV penetration is significantly up on a yearly comparison (Fig 1);
3. The company announced a $700 million investment in a Chinese automaker this Wednesday . The deal gives Volkswagen a 4.99% stake in XPeng ( XPEV ) and a seat on the board. The two partners aim to start selling XPeng's all-electric product offering in Europe as well as jointly produce two new battery-powered VW models for the Chinese market, with the first expected to arrive in 2026 (Fig 2);
4. Still related to China, Volkswagen is also trying to strengthen its local position with an agreement between AUDI and Saic . Volkswagen aims to unlock revenue growth by reaching new Chinese clients and market segments. AUDI products will support the JV development to expand the company's portfolio in the EV offering in a segment where AUDI is not yet present;
5. Through a SPAC, Glencore, with Stellantis and Volkswagen's battery unit (PowerCo) agreed to buy two mines in Brazil. In particular, Volkswagen and Stellantis will each invest $100 million in an operation that aims to create a publicly traded mining company for nickel and copper production. This investment is another sign of how the European OEMs are securing raw materials outside of China, which remains the world's leading producer of battery production. In addition, automakers are trying to source materials from mines that meet higher environmental standards, so they can also get billions of dollars in tax credits on electric cars through the various policies envisaged in the United States, Canada, and Europe. Still related to Brazil, Volkswagen aims to boost its Latam growth. The German car brand is celebrating its 70th anniversary in Brazil, and it was the first country where it built a plant outside its home market. The Latam automotive market is forecasted to increase by 11% annually until 2030, making it one of the fastest-growing areas.

Fig 1

Fig 2

Conclusion and Valuation

We align with the company's H2 2023 estimates to reach a revenue growth between 10% and 15% with an operating ROS of 7.5%. Q3 results should be favored by easing raw material cost pressure and gradually recovering VW's supply chain. Volkswagen still aims to achieve a full-year net cash flow of between €6 and €8 billion; however, as already mentioned, to achieve these goals, the company must return to growth in China. Regarding the valuation, we are looking at Volkswagen with a longer investment time horizon. Here at the Lab, we are used to having a consistent valuation methodology, and our rating target changes happen when there is a real discrepancy vs our long-term thesis.

Our sum-of-the-part valuation is based on four listed companies plus Lamborghini's upside. In detail, Volkswagen owns:

1. 89.72% of Traton which has a market cap of approximately €9.8 billion,
2. 75% of P911 with a market cap of almost €100 billion,
3. 24.77% in Gotion High Tech with a valuation of $1.9 billion,
4. 18.26% in QuantumScape Corp with a market value of $558 million,
5. (if we include Lamborghini and/or Bentley, this potential upside is even higher).

Valuing the four listed companies, we reached an equity value of almost €85 billion vs. a current market cap of €67 billion. This does not include AUDI, Ducati, Lamborghini, Bentley, SKODA, or other brands' performances. On a P/E basis, the company is trading at 4x, and this is not justified. Volkswagen has downside protection from auto luxury products and an upside from mass market production. Therefore, we confirm our long-term buy rating at €196 per share. In addition, we should also mention a tasty dividend per share (7.1% vs an EU industry mean of approximately 4.5%).

Downside risks include: higher CAPEX development, 2) lower market share in China, 3) execution risk in new models, and 4) failure of new collaborations/partnerships.

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