Investors Like VW’s 5-Year Plan But Worry About Unknowns

Investors Like VW’s 5-Year Plan But Worry About Unknowns.

Free Cash Flow Target Suggests Higher Dividends.

“New market participants, especially from China, could cause further market changes. Nobody can predict how the year 2025 actually looks”

Volkswagen’s 5-year financial targets with sales led by SUVs and electric cars impressed investors, although some cautioned that imminent possible shocks to the traditional manufacturers might make long-term goals meaningless.

The highlights of the plan included –

• Operating margin in 2020 – 6.5 per cent to 7.5 per cent, up more than 25 per cent.
• Operating margin in 2025 – 7 per cent to 8 per cent.
• Sales in 2020 25 per cent above 2016’s €217 billion.

The plan also included spending €34 billion on electric cars, autonomous ones, and so-called mobility services by the end of 2022. VW has said 25 per cent of its global car sales in 2025 will be electric only. 

VW also pledged to bring capital spending under control and down to 6 per cent of sales by 2020, from 6.9 per cent in 2016.

German bank NordLB cautioned about trying to predict the future, particularly as the near term poses much that could spell turmoil for the automotive industry, including new technology and unexpected competition.

“The new (VW) goals read quite well at first glance. However, these apply for the period from 2020 and later. Until then, much will happen in the automotive world, including industry crises, problems of individual country markets or corporate weaknesses,” said NordLB analyst Frank Schwope.

“In addition, the automotive world in 2025 will be technologically different, electric cars would lead to market shifts. New market participants, especially from China, could cause further market changes. Nobody can predict how the year 2025 actually looks,” Schwope said.

Higher than the average
Investment researcher Jefferies said the curb on capital spending to 6 per cent suggested annual spending slightly below €14 billion a year, but this was still 6 to 7 per cent higher than the average of the last three years. Jefferies analyst Philippe Houchois expected to see some, but not much, corporate restructuring including the separation of the truck operation.

“We believe current management’s influence on corporate change is relatively limited and would require changes in governance,” Houchois said.

This became less likely after the result of the recent election in Lower Saxony, which led to a coalition between the former ruling Social Democrats (SPD) and the Christian Democrats (CDU). Previously, the SPD had ruled with the Greens. In the run-up to the election it appeared for a while that the CDU would win, and this inspired speculation one of the two state-sponsored VW board members would be an outside expert with a change in direction of the Lower Saxony policy on VW. In the event, the CDU now has a board seat, along with the SPD.

Citi Research liked VW’s new concentration on free cash flow, with a target of €10 billion in 2020.

“That leads to the prospect of a higher dividend payout ratio, which should resonate well with investors,” said Citi Research analyst Michael Tyndall.

Quibbles
“There may be quibbles about the limited change to operating profit guidance but we think that is normal VW conservatism and understandable given the uncertainty around future powertrain mix. Profit growth of about 25 per cent by 2020 will certainly put them well ahead of their German peers. We think there is further scope for positive surprise and reiterate our Buy rating,” Tyndall said.

UBS agreed the free cash flow target was conservative.

“We continue to see VW as the top European (manufacturer) pick, combining a strong earnings/free cash flow story with additional upside from portfolio optimisation,” UBS analyst Patrick Hummel said.

In October, Volkswagen raised its 2017 profit target after reporting earnings rose strongly in the third quarter, with investors believing the company had finally turned the corner after the financially debilitating dieselgate scandal.

Volkswagen EBIT (earnings before interest and taxes) profits rose 15 per cent in the third quarter to €4.13 billion compared with €3.75 billion in the same period of 2016. Operating profit, less emissions scandal costs, fell nearly 50 per cent though to €1.72 billion.

VW brand reported a 3.8 per cent margin compared with 1.5 per cent a year ago, and is closing in on its target of at least 4 per cent by 2020. VW then said it lifted its annual profit outlook and now expects overall operating margin to moderately exceed its earlier stated target of between 6 and 7 per cent for 2017.

T-Roc boost
NordLB’s Schwope, after pointing to the short-term pitfalls said VW’s future is promising, with new models like the T-Roc SUV boosting sales and profits.

“Due to its strong position in China and strong growth in numerous regions we expect the Volkswagen Group to remain the world’s largest car salesman with more than 10.6 million vehicles sold in the current year. We confirm the investment judgement “Buy” for the Volkswagen preference share and raise the price target to €176,” Schwope said.

In late November VW shares were hovering around €169, after starting the year at €136.75.

Another investor impressed by the focus on free cash flow was Barclays Equity Research, which reckoned VW shares have now moved from tarnished to favoured.

“Now the more frequent refrain is that its ‘career risk’ not to own the (VW) shares. Two years ago it was ‘career risk’ to own them,” said Barclays analyst Kristina Church.

Church said the “empire building” of old has shifted to more flexibility, with more focus on electrification and with a strategy focussed on value creation.

Even if the long hoped for structural change never happens, the shares should reach €254, Church said. 

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