Investors Rush To Raise VW Targets As Profits Gush

Volkswagen’s profits in the second quarter were its best for two years, and the company made so much money that after the news broke some investors began to speculate that Europe’s biggest car manufacturer had so much surplus cash it might be seeking to buy up more rivals.

When the euphoria subsided, investors remembered that VW is already committed to expensive takeover plans with the Porsche deal looming, and has been thinking about buying up the rest of truck-maker MAN. The massive unfunded VW pension plan needs sorting. Weak sales prospects in Europe are also a sobering thought for VW shareholders.

VW’s second quarter net income quadrupled to €1.25 billion from €283 million in the same period of 2009. Sales rose 22 per cent to €33.2 billion. Net cash at VW’s automotive division jumped over 40 per cent to €17.5 billion. VW said its main areas of strength were sales in China, and the U.S., where VW and Audi brands did well.

“The current level of cash seems a ridiculous level of liquidity until one takes account of the €15.3 billion unfunded pension,” said Bernstein Research analyst Max Warburton. “Will VW soon follow BMW and Daimler and properly fund the pension? Or will this cash give VW the flexibility to pursue its merger and acquisition plans,” Warburton said in a report.

Investors scrambled to raise their 2010 and 2011 profit projections for VW, and some said sales prospects for Europe were not as dire as predicted by some.

“We raise our 2010 EBIT (earnings before interest and tax) by €1.2 billion or 39 per cent. We also raise our 2011 EBIT target by €1 billion or 23 per cent,” said J.P.Morgan analyst Ranjit Unnithan.

“We continue to think that European demand may not prove as weak as cautious statements from manufacturers would suggest. VW should benefit from any upside surprise to European volumes, but we prefer the French manufacturers and particularly Peugeot given their greater gearing to European volumes,” Unnithan said.

Wildest expectations
“VW results beat even the wildest expectations,” said Commerzbank analyst Daniel Schwarz.

“Have earnings now peaked? We think not. There is still significant room to improve a three per cent margin business like the VW brand,” Schwarz.

Schwarz said the second half would be tougher for VW, as the core brand and Skoda were only likely to breakeven.

“Still we need to increase our forecast from €2.8 billion (EBIT) to €4.1 billion, based on a €1 billion better than expected second quarter and higher contributions from Audi and Scania,” Schwarz said.

Deutsche Bank’s Gaetan Toulemonde pointed out that VW’s stupendous performance came at the same time that its home market was in retreat.

“We would highlight that VW showed one of the strongest second quarters in corporate history when the German market was in full post scrappage mode, when VW deliveries declined 27 per cent year on year in Germany,” Toulemonde said.

“While the second half is set to decelerate, the main profit contributors of the group – Audi and Scania – should remain very strong,” he said.

Investors wondered that if the second quarter was so good, surely the next move will be down.

Commerzbank’s Schwarz reckoned there were many factors to please VW investors in the future.

“For VW we believe a U.S. plant and the new Jetta will help a return to profitability in the U.S. in 2011, a likely €400 million swing versus 2010,” Schwarz said.

(VW will open its Chattanooga, Tennessee plant next year).

Return to normal
“We expect the German market to return to a normal 3.1 million unit level with VW benefitting the most. With the launch of the Audi A3 in 2011, VW introduces the MQB toolkit with significant savings potential,” he said.

(MQB stands for Modularer QuerBaukasten which will allow VW to design a wide range of vehicles using the same basic engineering components)

There is still the possibility of a big profit improvement at the core VW brand, despite the overall group’s performance in the second quarter.

“There is sufficient scope to improve, with the VW brand at a poor three per cent EBIT margin in a record second quarter,” Schwarz said.