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China, Audi Drive VW To New Profit Highs

VW, Germans Generally, Reaping The Benefits Of Tough Decisions
Negatives Hard To Find; Can VW Avoid Brand Cannibalisation?

Labour Unions Will Surely Soon Be Seeking Their Share 

Volkswagen stunned investors with hugely impressive nine months  profits driven by its performance in China in general and Audi in particular, and experts poured over the numbers trying to find a weak link, and failed.

Max Warburton, senior analyst at Bernstein Research, talked about these “blowout” numbers, adding that the figures seemed to be ushering in a “New era for sector profitability”, with the German industry generally benefitting from harsh cuts made during the recession.

The only negatives; surely labour unions won’t stand idly by and will soon be demanding their share. The protracted takeover of Porsche could cost VW about €8.5 billion, some time.

VW’s nine month net income zoomed to €4 billion, compared with €655 million in the same period of 2009. Nine months operating profit more than tripled to €4.8 billion from €1.5 billion. For the third quarter, net profit rose to €2.1 billion from €172 million a year earlier.

VW cautioned that it would be difficult to match this performance in the current quarter, but some observers said it would now be able to meet its target of reaching 10 million sales a year by 2015, three years earlier than planned.

Audi’s profit margins in the third quarter breached 11 per cent, while the VW brand margin was 2.7 per cent. In the nine months, Audi contributed nearly half of VW’s operating profit.

“This represents a historic peak for Audi, with regard to profitability and absolute contribution to earnings and is a margin level we are not used to in the industry – except for Porsche,” said Commerzbank analyst Daniel Schwarz.

VW’s nine months sales in China rose 39 per cent to 1.48 million vehicles. Audi’s sales there jumped 61 per cent to 174,907. VW’s two Chinese joint ventures generated net income of €1.3 billion in the nine months, compared with €500 million a year earlier.

BHF Bank in Frankfurt said VW expects the Chinese market to increase at a double-digit rate, which will help product mix and profits. The U.S. is expected to breakeven by 2013. There was even some good news for ailing SEAT.

Better utilisation
“Loss-making SEAT will start producing the new Audi A3 in its plants as of 2011, which should contribute to better utilisation and earnings levels,” BHF Bank analyst Aleksej Wunrau said.

Citigroup Global Markets said despite what it called an increased dependence on Audi, the underlying quality of VW’s results was high.

Bernstein Research’s Warburton said investors had been nervous about VW’s prospects in 2010 because its home market was expected to decline 30 per cent, its price-cutting strategy looked dangerous given its high cost base, while there were fears the capital spending budget  might start to surge. Those fears never materialised, or did little damage. Warburton said VW is now generating enough cash to buy Alfa Romeo once a quarter, or Peugeot-Citroen every year.

“What can cause the German industry’s (VW, Mercedes and BMW) soaring profitability to fall back to earth? Currency is the biggest risk, but we remain on alert for cost inflation – one of the reasons the Germans are making so much money is that they cut costs massively in the crisis (BMW and Merc in 2008-9, VW back in 2005-06) and we assume labour and indeed management, R&D etc will want to take back some of the gains that are now piling up as cash on balance sheets,” Warburton said.

IHS Automotive analyst Tim Urquhart did manage to find some question marks over VW’s future, including the fact that the company might be losing profits as brands compete, while the acquisition of Porsche would mean a tough challenge for management to handle 10 brands.  But his conclusion was positive.

“It is the task of managing this increasingly diverse brand portfolio to maximise synergies and efficiencies while ensuring that the brands remain separate and distinct that is perhaps the biggest challenge the company faces,” Urquhart said.

“There are already signs that VW’s management is concerned about the overlap between some brands and resultant sales cannibalisation with specific reference to the relationship between the VW brand and Skoda.”

“With the company mulling further acquisitions, it must work to ensure that senior management focus does not become too diluted or that brand structure becomes too complex. However, if it can manage these issues, the prospects for the VW Group continue to look very good indeed,” Urquhart said.

Neil Winton – November 1, 2010

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