Strong Demand in China to Boost Volkswagen’s Q2 Results Amid Low Volumes in the Americas

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Volkswagen AG (OTCMKTS:VLKAY), the second largest automaker in the world behind Toyota, is scheduled to announce its Q2 and half-yearly results on July 31. The automaker sold nearly 5 million vehicles in the first half of the year, with 2.57 million unit sales in the second quarter, up 6% year-over-year. [1] [2] Growth for the German company has mainly come from rebounding European markets and strengthening vehicle demand in emerging economies, especially China, the group’s single largest market. However, a slowdown in the South American automotive market is expected to somewhat hinder top-line growth this quarter. Volkswagen aims to become the world’s largest automaker by 2018, and for this purpose, is aggressively investing in capacity expansions and new model launches. The automaker plans to ramp-up production in North America and launch new products pertaining to its own line of passenger cars, which has struggled in the country so far this year. In addition, despite an uptick in economic activity in Europe, low truck sales due to large-scale pre-buys of Euro 5 trucks in 2013 could bring down commercial vehicles sales for Volkswagen this quarter on a year-over-year basis.

We have a $51.34 price estimate for Volkswagen AG, which is roughly 9% above the current market price.

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Volkswagen’s U.S. Volumes Remain Weak This Quarter

U.S. constituted only 6.8% of the net passenger car volumes for Volkswagen in 2013 (Passenger cars form 92% of the total volumes for Volkswagen). Compared to the 13.8% market share in China, the company holds only 4.8% share in the U.S. automotive industry. Through June as well, Volkswagen’s deliveries in the U.S. declined by 5.3% to 288,000 units, while volumes in the country’s overall vehicle market rose by 4.3%. [3] ((U.S. auto market volumes)) The company hasn’t been able to catch automakers such as GM, Ford and Toyota in the country. While GM sold over 1.455 million units in the U.S. in the first six months, Ford and Toyota sold over 1.265 million and 1.165 million units respectively. In fact, while luxury brands such as Audi, Porsche and Bentley saw strong growth in the U.S., Volkswagen’s volumes in the country were dragged down by poor sales of its own brand of passenger cars, which witnessed 13.4% decline in unit sales to 179,100 in the U.S. through June. Low sales in the U.S., the second largest automotive market in the world, could hamper Volkswagen’s results this quarter.

In a bid to improve competitiveness in North America, the company plans to invest $7 billion in the region between 2014-2018 for the purpose of adding capacity and accelerating growth. [4] As the automotive sector continues to regain momentum in North America following the economic downturn, vehicle production volumes are expected to surpass the previous record of 17.3 million units in 2000 by the next couple of years. Volkswagen has suffered in the U.S. partly due to consumer loyalty towards local companies GM and Ford, and also due to lower penetration in the fast growing segments such as compacts and sports utility vehicles (SUVs) in the country. Recently, the company announced its plans of expanding production in its assembly plant in the U.S. at Chattanooga, Tennessee, to produce a midsize SUV from 2016 onward. Volkswagen could not only evade high transportation costs and import tariffs due to local production, consequently boosting profitability, but could also add meaningful incremental volumes in the U.S. owing to the high demand for SUVs. Total SUV/Crossover market in the U.S. rose by 10.8% through June, constituting nearly one-third of the overall auto volumes in the country.

China Demand to Fuel Growth in Volkswagen’ s Top Line

One of the main reasons why Volkswagen remains the second largest automaker in the world, despite a small share in North America, is because of strong sales in China, the largest automotive market in the world. The group’s volumes in China further rose by 14.5% in the first half of the year to 880,700 units, fueled by increasing disposable incomes and low current vehicle ownership rates. In fact, as compared to the massive 791 vehicles per 1,000 inhabitants in the U.S., China has a low vehicle ownership rate of 79 vehicles per 1,000 inhabitants. [5] Although China’s economic growth is expected to slowdown in comparison to the double-digit growth rates seen in 2010-2011, it is still the world’s fastest growing major economy and continues to attract large-scale investments in the automotive sector. China’s fast growing automotive market is expected to constitute nearly 30% of the global sales by the end of this decade, by our estimates. The country constituted around 17.8% of Volkswagen’s net volumes through June and could continue to bolster sales-growth this quarter.

Volkswagen China and Affiliates contributes 45% to the net valuation of the company, according to our estimates. In particular, the company’s own passenger cars division and Audi saw huge volumes rises in China this quarter, with unit sales growing 18.5% and 17.8% respectively in the country through June. Audi, which formed one-fourth of the net revenues in 2013, is the largest luxury auto brand in China and is expected to continue to derive strong sales from the country this quarter. The locally manufactured compact A3 Sportback started selling in China in March, for which the assembly plant at Foshan was built last year. [6] The model is expected to contribute additional volumes for the company in its first full quarter in China. Demand for luxury compact saloons has been rising in the country as millennial consumers largely prefer cheaper entry-level premium vehicles. Local production of both the A3 and A4 models in China itself have helped Audi to compete on a pricing front, fetching higher consumer demand, and could consequently increase Volkswagen’s net equity income from the country in Q2. [7]

Commercial Vehicles to be Impacted By Low Europe and South America Sales

Scania and MAN contributed roughly 5% and 8% respectively to net revenues for Volkswagen last year. Truck sales are expected to fall for the company in Europe and Latin America in the second quarter. In Europe, with the Euro 6 emission standard going into effect at the beginning of 2014, large-scale pre-buys of Euro 5 vehicles increased truck sales by 38% in the latter half of 2013. [8] Following the panic purchases in 2013, year-over-year volume growth is expected to slightly fall in Q2. On the other hand, slow economic activity in Brazil and Argentina specifically is expected to drag down Latin America commercial vehicle sales. Scania trucks’ order bookings in Europe and Latin America, together constituting almost two-third of net order bookings for the brand, fell 1% and 31% through June. [9] On the other hand, Europe is the most important market for MAN, forming 57% of the net sales last year. Sales for MAN are also expected to be down this quarter, hurt by the pre-buys of Euro 5 vehicles in Europe and unfavorable financing conditions in Brazil. [10]

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Notes:
  1. Volkswagen March sales []
  2. Volkswagen June sales []
  3. Volkswagen monthly deliveries []
  4. Volkswagen to invest $7 billion in North America, wsj.com []
  5. Global vehicles in use []
  6. Audi in China []
  7. Audi press release“ []
  8. Europe will rebound, scania.com []
  9. Scania interim report []
  10. MAN press release []
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