VW Cost Cutting Placates Critics.

VW Cost Cutting Placates Critics.

Investors Like Move To Simplify Production, Extra China Information.

“VW has done well the last year and is still continuing to hold a dominant position in the auto market. No meaningful change will occur during this environment”

Volkswagen has done enough to keep potential critics happy for a while yet, but it still can’t shed worries about whether the company exists to serve the shareholders first or its employees.

At VW’s annual press conference in Berlin the company revealed plans to cut costs in some manufacturing, including ending the production of three door Polo small cars. It revealed some details about the profitability of its China operation. But persistent worries about the profitability of the VW brand operation won’t go away. In 2014 VW brand managed a 2.5 per cent profit margin, down from 2.9 per cent in 2013.

CEO Martin Winterkorn told the press conference that about half the planned €5 billion cost cuts at VW brand had been identified.

VW has set itself some big targets. It plans to overtake General Motors and Toyota to be the biggest in the world by 2018 in terms of sales. By 2018, VW’s group pre-tax profit goal is at least eight per cent, and six per cent for VW brand. VW has displeased investors by increasing sales by 30 per cent in five years while profits remained relatively flat. Critics point to the example of Toyota of Japan, which sells roughly the same amount of vehicles but generates close to a 10 per cent profit margin while spending about half as much on research and development as VW.

Long-term critic Professor Ferdinand Dudenhoeffer from the Center for Automotive Research at the University of Duisberg-Essen, said basic restructuring is difficult for VW because of the corporate structure.

The state of Lower Saxony owns one-fifth of VW’s voting shares, and labour leaders have majority control of Volkswagen’s supervisory board, the powerful body that appoints and dismisses members of the management. Any important decisions, such as the building or shuttering of plants, need a two-thirds majority on the board.

Raises headcount, costs
Dudenhoeffer said VW adds to its costs by producing many components that other big manufacturers contract out. This raises headcount and costs.

Analysts were generally positive afterwards.

Daniel Schwarz, auto analyst at Commerzbank, liked VW’s details on its China operation, and detected a changing mood towards shareholders.

“For a company that historically cares more about cars than shareholder value, the annual press meeting offered some positive surprises, e.g on page 197 of the annual report you find – for the first time – detailed information about the Chinese JVs. These contribute some 35 per cent to net income and it can only be good for (share) valuations when the market gets any information beyond EBIT (earnings before interest and tax),” Schwarz said.

Kevin Kelly, managing partner of New York City-based Recon Capital said he liked VW’s plan to raise margins at VW brand by weeding out lower tier models and reducing complexity in manufacturing.

Did he share the pessimism that VW’s corporate structure put a stop to serious rationalization?

“Never say never. European labour markets are structurally different than the more transient U.S. workforce but it appears that corporate governance is really on the backburner. Change will only come to forefront in times of underperformance. VW has done well the last year and is still continuing to hold a dominant position in the auto market. No meaningful change will occur during this environment,” Kelly said.

No word emerged at the meeting about the crucial leadership succession issues. Winterkorn is expected to stand down as CEO next year, while investors are worried about the future leadership as supervisory board chairman Ferdinand Piech is now 77.

Strong quality
Speaking before the press conference, Berenberg Bank auto analyst Adam Hull believes investors underestimate VW’s strong structural positioning and quality.

“We think VW has impressive technology, enviable scale and market positioning in all main markets except for the VW brand in the U.S.,” Hull said.

Arndt Ellinghorst of Evercore ISI was a little less enthusiastic, but still positive.

“2015 is yet another transition year before things might get better. 2016 will hopefully and finally benefit from improved product and savings momentum,” Ellinghorst said

Late last month, VW announced its headline financial numbers for 2014 which showed earnings before interest and tax (EBIT) rose 8.8 per cent to €12.7 billion. The numbers benefitted from big sales gains at Audi and Porsche, but the company warned that 2015’s results might be hampered by troubles in Russia and Brazil.

CAR’s Dudenhoeffer said the VW namesake brand refuses to respond to efforts to improve its bottom line.

Phaeton
“The profitability of VW is lacking because of the brand VW which sells big in the German market where there is heavy discounting. Adventures like the Phaeton don’t help, and there’s a new one on the way” Dudenhoeffer said.

The high-technology Phaeton sits at the top of VW’s range, designed to take sales from Mercedes and BMW. It hasn’t been a success, but VW said it plans to renew it.