.png)
By: Vito J. Racanelli, Nov. 7, 2018
Volkswagen stock has been in reverse over the past three years, losing nearly 40% from a high of 250 euros ($285) in early 2015 to about €152 recently. That leaves it in 27th place for performance among Germany’s Dax index of 30 stocks over the period.
VW’s equity is down mostly for nonfundamental and fixable cost problems, as we’ll explain below. Despite some significant issues, the Wolfsburg, Germany–based car maker has produced solidly growing profits in the past few years and again in the first nine months of 2018. Admittedly, global car-industry growth appears to be slowing this year.
Nevertheless, operational and valuation factors suggest that the stock is cheap. VW has about 295 million common shares (ticker: VOW.Germany) and 206 million preference shares (VOW3.Germany), with a price of €156, for a total market value of about €77 billion. The preference shares don’t offer a vote but are more liquid than the common shares. The Piech and Porsche families own 52% of VW common stock through Porsche Automobil Holding(PAH3.Germany), and another 20% belongs to the German state of Lower Saxony.
VW bulls say the stock’s low price more than discounts its problems, now that the company’s board has appointed a new, cost-cutting CEO and approved a partial or full divestment of Traton, VW’s truck and bus business. If it’s willing to go further down that road with other VW brands, such as Porsche—and some think it could—a sum-of-the-parts valuation puts the share price over €200. Even without that, VW can improve results by cutting costs after years of high spending on research and development.
The world’s biggest auto maker still suffers reputational and fiscal damage from the 2015 diesel emissions scandal. (VW admitted that it installed software in some vehicles to fool emissions tests in the U.S.) Worldwide, payments to settle the issue are expected to exceed €30 billion.
The knock-on effect has been infighting in the executive suite, with new CEO Herbert Diess, the third helmsman in three years, coming on last April. Complicating matters, more-rigorous European Union emissions standards—the Worldwide Harmonized Light Vehicle Test Procedure—came into effect this year for car makers, with higher costs and production and delivery delays, which has hurt results.
The car market is in a funk, with U.S. sales flattish, Europe doing a bit better, and China—which, as the world’s biggest car market, represents over a third of VW profits—in retreat.
Despite these issues, VW last month reported a solid first nine months for 2018. Car deliveries were up 4.2%, to 8.1 million, and group sales rose 2.7%, to €175 billion, notes Drew Dickson, chief investment officer of Albert Bridge Capital. Operating profit rose to €10.9 billion from €10.6 billion, ahead of expectations.
The stock trades at just five times next year’s consensus earnings-per-share estimate of €28.52. VW, with “unmatched global brand strength” and higher cash flow in the first nine months than all of its European rivals combined, ranks near the peer valuation bottom, notes Arndt Ellinghorst, an Evercore ISI analyst. VW has weathered all of the stages of the cyclical auto industry and “mastered any crisis better than any other car company,” adds the analyst, who rates the stock Outperform and has a €240 target.
Diess, he says, is the most efficiency-driven of recent VW CEOs, and he has ample opportunity for savings. He can achieve them without cutting product quality or content, Ellinghorst says.
VW Costs Expected to Fall
New CEO Herbert Diess has ample targets to cut the carmaker's spending.Source: Evercore ISI
In coming years, the analyst expects VW’s fixed costs—R&D, depreciation, and labor—will plateau at about €62 billion, then fall as a percentage of sales by three to four percentage points from a peak of 27.4% in 2015. Selling, general, and administrative expenses should normalize as the diesel crisis fades, he says. VW has targeted SG&A at 12% of sales in the auto business, down from about 14.1% in 2017. This could yield €4 billion in savings from 2017’s €27.9 billion, Ellinghorst adds.
VW’s conglomerate structure has always hindered valuation, but it appears that the board is re-evaluating which of VW’s many brands aren’t core. That might now allow it to slim down and create value.
“The paradigm of corporate governance and value creation has changed,” adds Dickson. VW has embarked, if tentatively, on a trail blazed by Fiat Chrysler Automobiles (FCAU) when it successfully spun off shares of Ferrari(RACE).
In September, VW said it is pushing forward preparations for a potential spinoff or initial public offering of Traton. “That would have been unheard of four years ago,” says Dickson. VW also reorganized its car lines in April into groups: volume, with the VW and Skoda/Seat brands; premium, such as Audi; and superpremium, which includes Porsche, Lamborghini, Bentley, and Bugatti.
Dickson assigns a market value of €11.5 billion, including debt, or €23 per VW share, for Traton, based on peer valuations. If the superpremium group were separately listed, Dickson says it would be worth about €55 billion to €60 billion, or roughly €114 per current VW share, using a price-to-sales ratio less than half that of Ferrari’s. That would total of about €137 per VW share.
Backing out the theoretical market caps of Traton and the superpremium group from VW’s current valuation leaves VW with a market cap of just €7 billion, equal to about one time its 2019 earnings per share from several major businesses. Among them: Audi, with €66 billion of sales; Chinese joint ventures, where VW’s 2017 profit was €4.8 billion; Skoda/Seat, with €30 billion of sales; and VW itself, with €90 billion of sales. Shares from superpremium and Traton would amount to a dividend of roughly €137 for a stock that trades around €150, says Dickson.
Addition by Subtraction
Based on a sum-of-the-parts valuation, VW investors are getting the stock for just one times earnings if you back out the trucking and Porsche units.
He notes that VW recently poured cold water on a putative superpremium group IPO with a press release stating, “Porsche [brand] does not currently have any plans to pursue a (partial) initial public offering.” A spokesman declined to go beyond that statement this week.
“We really like the word ‘currently’ there,” Dickson quips.
A successful Traton IPO in the first part of 2019 could energize the shares as investors begin pondering a potential separation of the superpremium auto group and its implications for valuation, says Dickson.
Even if a superpremium IPO never happens, Traton alone gives an indication of how cheap the brands inside VW’s house are. The Fiat experience, which saw shareholders reap big benefits from the Ferrari spinoff, suggests VW shares are cheap.
Write to Vito J. Racanelli at vito.racanelli@barrons.com
