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VW Success Might Be The Seed For Decline

Acquisitive VW In Danger Of Looking Like A Conglomerate
But Defensive Quality Paramount As Economic Clouds Gather

VW has delivered most of its organic earnings potential and has also turned itself into an automotive conglomerate

Volkswagen is on the crest of wave with profits and sales surging, but as the company grows it is in danger of undermining some of the attributes which led to its initial success.

According to a report from UBS Investment Research analyst Philippe Houchois, VW’s success, driven by its acquisition of more and more brands which now include Porsche and MAN trucks but probably not Suzuki, has turned the company into a conglomerate looking more like the ill-fated DaimlerChrysler, which investors have learned to loathe not least because they tend to destroy value.

“VW has achieved its long held corporate ambition to displace Daimler as the “King” of German autos. In the process, VW has delivered most of its organic earnings potential and has also turned itself into an automotive conglomerate, with a profile that financial markets have historically discounted sharply,” said Houchois.

“Volkswagen has undergone a phenomenal transformation over the past five years from under-performer to industry leader in product, brand, profit and cash. In the process, VW has also become a conglomerate that increasingly looks like Daimler, or DaimlerChrysler, with a spread of business from small cars to heavy trucks,” Houchois said.

Houchois said he was downgrading his rating of VW to neutral and cutting his forecast for VW’s earnings in 2012 and 2013 by eleven and eight per cent because VW had already delivered most of its organic earnings potential.

Clouds on the horizon
Royal Bank of Scotland analyst Jose Asumendi though is still keen on VW, not least because with clouds on the economic horizon, the company was the only big European manufacturer to generate an operating profit during the last downturn in 2008 and 2009.

Asumendi likes the fact that the two modular platforms are to be launched in 2012 and 2013 which he thinks will accelerate cost savings. He also likes VW’s ambitious plan to finally make money in the U.S., its strong product momentum and its exposure to China.

Despite this optimism, Asumendi has cut his EBIT (earnings before interest and tax) forecast by 12 per cent for 2011, by 19 per cent for 2012, and 18 per cent for 2013, while at the same time reiterating his “buy” call on VW shares.

Meanwhile UBS’s Houchois believes that long term, VW can attain an industrial profit margin of five per cent over three years, but it is his worst case scenario which is perhaps the most telling. His “bear” case, in which the U.S. market deteriorates, and Europe fails to recover leaving VW exposed with overcapacity, still sees a three per cent EBIT margin.

So even if the sky falls in, VW will still be in the black, an unlikely fate for its main competitors.

Neil Winton – October 20, 2011

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