Volkswagen AG (OTCMKTS:VLKAY) stood at the second spot in the global automotive market last year, selling 9.72 million vehicles, quarter of a million shy of Toyota Motor Corp‘s (NYSE:TM) worldwide volumes. But Volkswagen narrowed its gap with the Japanese automaker in the first half of 2014, driven by high vehicle demand in China and rebounding domestic European economies. While Toyota sold 5.097 million vehicles through June, up 3.8% year-over-year, the German company saw 5.9% volume growth during this period to 4.97 million units.   Volkswagen’s figures exclude sales for the commercial vehicle manufacturers Scania and MAN, which when added, could improve the company’s overall sales figure to 5.082 million units, by our estimates.  Although Volkswagen might marginally miss out on the global vehicle sales lead through June, the company is expected to overtake Toyota by the end of the year in terms of volumes. A stronghold in the fast growing Chinese auto market and high demand for luxury brands Audi and Porsche are expected to be the main growth drivers for Volkswagen this year.
However, Toyota’s slight drop in volumes could be a result of the company’s shift in focus away from higher volumes and towards superior quality and improved profitability. The automaker plans to hold-off building of new manufacturing plants until 2016, and focus on expanding margins and new model launches. China and North America, the two largest auto markets, will be crucial for Volkswagen in order to take-over the global sales lead. While Toyota looks keen on China expansion in a bid to keep pace with its chief rivals Volkswagen and General Motors in the country, Volkswagen is also strengthening its North America operations, in addition to building on its solid China positioning, to derive further growth. The German company had earlier outlined its aim of becoming the world’s largest automaker by 2018, which might be achieved this year itself.
We have a $51.34 price estimate for Volkswagen AG, which is roughly 9% above the current market price.
China- Volkswagen No.1 and Expanding Further
Around 1.81 million vehicles were sold by Volkswagen in China in the first six months, up 17.5% year-over-year, and outpacing the 8.4% growth in the overall automotive market in the country.  China is the group’s single largest market and constituted 36.4% of the net volumes during the period. Despite declining volumes in the Americas, Volkswagen has managed to close-in on Toyota’s lead mainly due to strong sales in China, the world’s largest and still the fastest growing automotive industry. China leads the global passenger car market, accounting for 28.6% of all passenger car registrations or sales last year, and is expected to form 30% of all global volumes by 2020. ((“New PC registrations or sales“))
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. The country’s auto market is projected to grow by around 8.3%, down from last year’s 13.9% volume rise.  But foreign automakers such as Volkswagen, GM, Ford and Toyota continue to witness high double-digit growths, as the brand-conscious Chinese consumers tend to prefer globally renowned and popular foreign brands over domestic makers. Vehicle sales in the country are also expected to continue increasing as a fast pace, although slower than the growth rates seen in previous years, due to higher penetration in low-tier cities and rising disposable incomes. 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. 
Apart from the estimated expansion in automotive sales in China, especially for foreign automakers, Volkswagen aims to build on its lead in this market with further capacity additions and new model launches. This could provide the company an edge over Toyota in the race for the global vehicle sales crown.
- Passenger Cars Continue to Grow in China
While the overall growth in China’s auto market slowed from previous years’ levels, this was mainly due to the 3% decline in commercial vehicle volumes that were impacted by slow housing and infrastructural activities. Sales for passenger cars, including sedans, sports utility vehicles (SUVs) and minivans, increased 11%. Volkswagen’s own line of passenger cars, forming nearly 62% of the net volumes through June, witnessed an impressive 18.5% rise in China volumes during the same period. On the other hand, Toyota volumes gained 12% to 465,900 units in China in the first half of the year, however, unit sales fell 7.6% in June on the back of low sales for its passenger cars.  The company said that the fall in Corolla volumes, in anticipation of the revamped version, dragged down sales. Sales for Toyota, along with other Japanese automakers Honda and Nissan, have been slowly recovering following the geopolitical issues between China and Japan a couple of year ago, which invoked consumer concerns regarding purchase of Japanese products.
- Volkswagen Adding Capacity Ahead of Toyota’s Plans
Volkswagen is present in 17 locations across China, with five new facilities opening just last year. This included a new plant at Urumqi in western China, where disposable incomes are expected to rise sharply in the coming years, and a plant in Foshan, which started production of the new Golf, the first vehicle to be built on the Modular Transverse Toolkit (MQB) in China. In 2012, Volkswagen introduced the Modular Transverse Toolkit, which created an extremely flexible vehicle architecture, hence making it possible to produce different models of various brands in different quantities in the same production unit. This is expected to lower production costs for the automaker. Going forward, Volkswagen, in partnership with the SAIC Motor Corporation and the First Automotive Works (FAW) Group, will invest a whopping 18.2 billion euros (nearly $25 billion) in China between 2014-2018, for the purpose of development of green technologies and resource-efficient facilities. Local production helps Volkswagen evade China’s 25% import tariffs, in addition to the value-added and consumption taxes, allowing the company to compete on a pricing front. As part of this expansion, FAW Volkswagen is investing around $2.7 billion to build new manufacturing plants in Qingdao and Tianjin. 
Vehicle demand in China might be slightly affected by the strict emission standards put in place to control pollution. However, in addition to augmenting production capacity to feed the rising vehicle demand in China, Volkswagen is also on a green-drive in the country, in line with the rise in demand for energy-efficient vehicles. The company will launch ten green vehicles in the country by 2018, including launches of the e-Up! and e-Golf this year. This means that Volkswagen is also well poised to make inroads in the electric vehicle market, which presently represents a negligible proportion of the overall market but is anticipated to rapidly rise.
On the other hand, while Toyota plans to reach 2 million annual vehicle sales in China, the company hasn’t provided any time frame for the same. The Japanese automaker presently has three production plants in the country, with a combined annual capacity of one million units.  Toyota plans to launch at least 15 new or revamped models in China by 2017, including introduction of the gas-electric hybrid versions of the sedans Corolla and Levin in 2015. However, the company announced plans of holding-off construction of new plants till 2016, which means that any new major capacity additions will take place only in the longer term.
In addition to launching new models and building production facilities, Volkswagen also plans to increase its dealership network to over 3,600 from around 2,400 presently. The German company is expected to continue growing in China, fueled by the overall swelling market size, improving reach and availability, and the adoption of greener initiatives. Volkswagen will not only grow in terms of volumes, but with increase in sales of electric models and models based on the MQB Toolkit, profitability is also set to rise for the automaker. At present, margins for Volkswagen’s passenger cars slightly trails those of Toyota’s and GM’s. Toyota sold 917,500 vehicles in China last year and expects to sell 1.1 million units this year. On the other hand, Volkswagen, which sold 3.19 units in the country in 2013, is expected to top 3.5 million unit sales this year, thereby further widening its gap with the Japanese automaker in China.Notes:
- Toyota June volumes [↩]
- Volkswagen June volumes [↩]
- Scania interim report [↩]
- Sales and production of automobiles monthly down, yearly up, caam.org [↩]
- China’s auto-sales projection lowered, marketwatch.com [↩]
- Global vehicles in use [↩]
- Nissan, Honda car sales accelerate in China, marketwatch.com [↩]
- Volkswagen press release [↩]
- Toyota global operations [↩]