Can Volkswagen Succeed In India?
One of the reasons why Volkswagen AG (OTCMKTS:VLKAY) has maintained its position as one of the world’s highest-selling vehicle manufacturers, and is in fact bidding to replace Toyota as the single largest automaker this year itself, is due to its stronghold in China, the largest and fastest-growing automotive market. China’s fellow BRIC nation, India, also has a vast potential to grow in terms of vehicle sales, fueled by increasing disposable incomes and investments by automakers around the world. After a rough patch for passenger vehicle sales in the country in the last couple of years, volumes are slowly but surely rebounding. A stable central government, reduced excise duty and positive customer sentiment are bolstering growth in the Indian automobile industry. However, unlike in China, Volkswagen has struggled to raise its volumes in India, hurt by the overall slowdown in passenger vehicle sales, lower penetration in the growth segments and stiff competition.
When Volkswagen entered India in 2010, it had an ambitious aim of grabbing around 20% market share in the country by 2018. But the automaker has struggled, with its non-luxury Skoda and Volkswagen branded vehicle volumes undergoing declines. Premium brands Audi, Porsche and Lamborghini have witnessed increasing volumes in India, but represent a very small proportion of overall Volkswagen sales in India. As the Indian automotive market returns to positive growth, we look at key trends and Volkswagen’s strategy in India, and if it could translate into higher volumes for the automaker in the country.
We have a $48.14 price estimate for Volkswagen AG, which is roughly 14% above the current market price.
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Indian Automotive Market Returning To Growth
India is the world’s seventh largest passenger vehicle market, and was previously estimated to topple Germany, Brazil and Russia to gain three places in the global rankings by 2015. [1] While Germany struggled from the impacts of the double-dip recession and is slowly rebounding, the Russian economy is weaker this year due to ongoing geopolitical tensions with Ukraine, and Brazil is witnessing lower vehicle volumes due to higher interest rates, inflation and negative consumer sentiment. However, despite anticipated tepid volume-growths in these three countries, India’s bid to enter the top-four-passenger-vehicle-markets bracket in the next couple of years looked weak, due to lower than expected economic growth, causing only modest gains in the country’s automotive industry. In fact, after years of positive growth, passenger vehicle volumes in India fell 6% in fiscal 2014 ended March. [2] But the industry has since returned to growth through the last five months, growing by 4.5% year-over-year, with car sales rising by over 5%. [3]
A stable government at the centre and positive consumer sentiment has boosted this reverse in declining trends in passenger vehicle sales in India. In the interim budget 2014-2015, excise duty on small cars was decreased to 8% from 12%, incentivising the purchase of vehicles. In addition, excise duty was reduced to 24% from 30% on sports utility vehicles, 24% from 27% on large cars and 20% from 24% on mid-sized cars. The new government has extended the contracted rates till December. Penetration of vehicles in India is still very low at around 18 per 1,000 individuals. The country’s economy grew by 5.7% in the last quarter, the fastest in over two years, and with increasing disposable incomes, vehicle sales could continue to rise.
Why Volkswagen Hasn’t Been Able To Perform Well In India
Volkswagen has managed to grab only under 4% market share in the Indian passenger vehicle market, since its entry in 2010, mainly due to tepid sales for Volkswagen and Skoda branded vehicles. While Volkswagen’s sales fell by nearly 20% in India in the last fiscal ended March, the company’s own branded vehicles, which form over half the company’s India volumes, witnessed a 24% decline during this period. [4] On the other hand, Skoda’s unit sales were lower in fiscal 2014 than those achieved in fiscal 2011. In India, local manufacturer Maruti Suzuki and foreign automakers Hyundai and Honda control over 70% of the passenger vehicle volumes. [5] Automakers such as Volkswagen, Renault, Fiat and Ford have somewhat failed to grab additional shares in India, which is dominated by Maruti Suzuki with nearly half the passenger car volumes.
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The domination of a handful of automakers in India is mainly due to the large popularity of entry-level compacts, which cater to first-time buyers. Almost one in two new cars sold is an entry-level compact, boosted by government incentives such as lower excise taxes for smaller cars and price-sensitivity of the lesser affluent customers. Volkswagen has positioned itself as a relatively premium brand, and thus doesn’t compete in this high growth segment. Moreover, Volkswagen’s sedan offerings such as Skoda Octavia and Superb and Volkswagen Vento haven’t been able to compete strongly with models such as Maruti Swift Dzire and Honda Amaze. With high growth for entry-level compact cars, and strong brand recognition of Maruti, Hyundai and Honda, which have vast dealership networks across India, Volkswagen’s sales could remain weak in the country, going forward.
How Volkswagen Could Gain From India’s Large Potential
Volkswagen has lowered its market share target in India to 7-8% by 2018, from the previously estimated 20%. If we expect overall passenger vehicle sales to grow at a CAGR of 5% through 2018, a market share of 8% would mean annual unit sales of nearly 250,000 for Volkswagen in the country by then. Although this estimated figure would still represent roughly 2% of global Volkswagen volumes by 2018, improving sales in India could lay a strong foundation for the automaker in the country, going forward.
However, even to achieve the 7-8% market share in India, up from under 4% presently, Volkswagen will look to accelerate its penetration in the country. As part of its mid-term strategy, the group announced that it will launch a new product every year in India starting 2015, and launched the new facelifted model of its Vento sedan this month. While protecting its relatively premium brand image, Volkswagen aims to enter high growth segments such as SUVs and compact sedans, rather than smaller hatchbacks. In fact, between fiscal 2011-2014, compact sedan sales rose by 55%, while hatchback volumes fell by 45% in India. [6] Although smaller cars still form bulk of the passenger car volumes in the country, rising sedan sales highlight how customers are looking to trade-in their smaller cars for larger sedans. With rising proportion and wealth of the middle-class population, coupled with lower current customer penetration for sedans compared to smaller cars, sedan volumes could grow at a steady pace in India, providing growth opportunity for Volkswagen.
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In order to improve competitiveness, Volkswagen will also invest around $250 million in India through the decade, to increase local content sourcing and production and introduce new models. [7] In fact, the group aims to raise the level of locally sourced content in its models in India to 90%, up from around 65-70% presently. Volkswagen aims to expand its production base in India, starting with building engines and gearboxes in the country itself. By further raising local production and content sourcing in India, the company will benefit from the lower manufacturing and operational costs in the country, expanding margins. Profitability could further increase if and when Volkswagen’s volumes in India pick up, and the automaker gains from economies of scale and higher profits on each incremental sale, due to its high fixed-cost base.
Although the impact of increasing local production in India on the company’s profit margins can’t be accurately estimated, cost-effective production could improve the operating margins for Volkswagen’s passenger cars, the least profitable division for the company. We currently expect margins for this division to rise to nearly 7% by the end of our forecast period, from under 6% presently. If the long-term margins rise to 8%, there could be as much as a 12% upside to our current price estimate for Volkswagen.
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- Passenger vehicle sales [↩]
- Passenger vehicle sales in India in fiscal 2014 [↩]
- April-August passenger vehicle sales in India [↩]
- Volkswagen goes local in India to cut costs, lift sales [↩]
- Why is Indian car market so concentrated? [↩]
- Indian hatchback sales slip by 45%; compact sedans witness 55% growth [↩]
- Volkswagen to launch a new product every year [↩]