Volkswagen AG‘s (OTCMKTS:VLKAY) Audi is the second largest luxury automaker in the world behind BMW, and ahead of Mercedes. One of the main reasons why Audi is well positioned in terms of global volumes is because of its lead in China, the second largest and fastest growing premium automotive market presently. Volumes in the country for Audi grew by 17.8% in the first half of the year, constituting 30% of the net volumes for the brand. However, despite posting strong growth in the U.S., Audi volumes lagged those of BMW and Mercedes by over 44% in the country through June. Audi hasn’t been able to catch its compatriots in the U.S. mainly due to the absence of local assembly plants, making vehicles more expensive as they are imported. In addition to the German rivals, Audi also trails Lexus, the luxury vehicle division owned by Toyota Motor Corp (NYSE:TM), in the U.S. As Volkswagen looks to overtake Toyota for the global vehicle sales crown, Audi also aims to close-in on Lexus in the U.S.
Audi constitutes over 21% of Volkswagen’s valuation, according to our estimates, while Lexus forms just over 10% of Toyota’s valuation. We have a $51.34 price estimate for Volkswagen AG, which is roughly 9% above the current market price.
Lexus Paces its Comeback in the United States
While BMW and Mercedes sold more than 150,000 units in the U.S. through June, Lexus came in third with 138,689 unit sales during the period.  However, Lexus outpaced volume rises of both BMW and Mercedes in the country, growing by over 17% in the first six months. Lexus volumes have been recovering in the U.S., after production in Japan was disrupted due to the March earthquake and tsunami in 2011. The brand had been the best-selling premium vehicle brand in the U.S. for eleven years, before both Mercedes and BMW overtook the company in 2011.  However, with a refreshed IS sedan and GX sports utility vehicle (SUV), Lexus will aim to narrow its gap with Mercedes and BMW this year and widen its gap with Audi.
Lexus could further improve its market share with the expansion of production activities in the U.S. At present, the automaker imports all its vehicles except for the RX SUV. The luxury carmaker will now start the production of its best-selling sedan ES 350 in the U.S. by late 2015. Construction of the first Lexus assembly line in the country had already commenced in Kentucky in January. The Lexus ES 350 sold 72,581 units in the U.S. last year, up 29% year-over-year, with the ES models ranking as the fourth highest selling premium vehicle range in the country. The plant will be operational by 2015, and Lexus may be able to supply two-thirds of the ES demand in the U.S. through the production in this plant. With an increase in production within the country, Lexus will be able to evade transportation costs and also somewhat protect itself from unfavorable movements of the Japanese yen against the U.S. dollar. With Lexus sales gaining momentum in the U.S., Audi might not be able to catch up with its Japanese competitor in the country.
Audi to Feed North America Demand through Mexico Plant
U.S. volumes constituted nearly 10% of Audi’s net unit sales in the first six months of the year. Audi volumes rose by 13.6%, less than Lexus’ 17% growth, but more than the volume rises seen by both BMW and Mercedes. Growth for Audi was fueled by introduction of the new compact A3 sedan, selling 7,735 units since its launch in March.  The Audi A3 Cabriolet, A3 TDI, S3 performance sedan and the Q3 crossover will also launch in the U.S. this year, and could further boost volumes for the company in the latter half. The German brand imports its vehicles into the country, keeping the prices high due to import tariffs and large transportation costs. However, Audi plans to ramp-up production in North America by building its first manufacturing facility in the region in Mexico. The new plant at Puebla will open in mid-2016, and will be the exclusive producer of the next-generation Q5 SUV. For this purpose, Audi is investing around $1.3 billion in Mexico for constructing the facility and developing the new model. Year-to-date sales for the mid-size SUV Q5 rose 8.8% in the U.S. and could continue to rise owing to the high demand for luxury crossovers/SUVs in the country. Luxury SUV volumes rose 10.3% in the U.S. through June, constituting 13.3% of the country’s premium vehicle market.
Mexico only ranks 16th in the world in terms of annual vehicle sales, but the country has emerged as an auto export hub, bolstered by lower wages, raw material and operational costs. The country exported around 83% of the 2.93 million vehicles produced in 2013. In fact, the U.S. constituted 68% of these shipments abroad.  Audi will utilize the Mexico plant, which will have an initial production capacity of 170,000 units, to feed the luxury demand in North America, particularly in the U.S. In addition, Audi could earn higher profits on incremental sales due to the cost benefits associated with manufacturing in a low-cost country. Operating margins for Audi presently range between 9-10%, similar to the figures posted by BMW and higher than Mercedes’ 7-7.5% margins. With the new Mexico plant producing the Q5, Audi could narrow its gap with Lexus and its German competitors due to the high demand for smaller-sized luxury SUVs, as well as improve profitability going forward.Notes:
- U.S. auto market volumes [↩]
- Toyota paves road for first U.S.-built Lexus in Kentucky, wallstcheatsheet.com [↩]
- Audi June sales in the U.S. [↩]
- Mexico auto sales climb to highest in six years as lending grows, bloomberg.com [↩]