Volkswagen’s Q3 Results Clouded By Low Volume Sales And Initial Costs Of The Scandal

It has been more than an eventful quarter for Volkswagen AG (OTCMKTS:VLKAY), and not nearly in a good way. The news that the German automaker falsified emission tests first broke in the middle of September, so it might not be a major headwind on the volume sales results for Q3, to be announced on October 28. However, the group has set aside a considerable amount to try to cover some of the expenses related to the scandal, which are expected to massively dent profits. The thing is, even before the news of the scandal broke out, Volkswagen wasn’t exactly firing on all cylinders, with lower than expected volume sales in the U.S. and China — its single largest market, and narrow operating margins weighed down by the namesake brand.

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Deliveries to customers have declined 1.5% year-over-year through the first nine months of the year to 7.43 million vehicles. Volkswagen, which had surpassed Toyota as the highest vehicle seller during the year, has lost the first position again as Toyota sold 7.49 million units through September. Lower volume sales are bound to hurt Volkswagen’s top line in Q3.

It’s a long way back for Volkswagen, after it admitted to falsifying emission test results in the U.S., and later reported that as many as 11 million cars worldwide used the software that would cut emissions while being tested, compared to normal driving conditions. The group faces tens of billions in government fines and settlements, private settlements, recall expenses, and future loss of sales, as we estimate that these costs could run up to $34.5 billion. Of course, the cost could come down depending on how Volkswagen tackles the situation from here on.

The recall is expected to begin at the start of next year. Around 5 million vehicles of the Volkswagen brand, 2.1 million at the premium brand Audi, 1.2 million at Skoda, and 1.8 million light commercial vehicles are reported to have been fitted with the software. Approximately 8 million are in the European Union, while 482,000 and 100,000 vehicles are in the U.S. and Australia. Volkswagen has set aside €6.5 billion ($7.4 billion) to cover the costs of the scandal, and will make a provision for the scandal in the Q3 income statement, but the total cost to the company could end up being much higher, as we have estimated.

Even before the news of the scandal broke out, and potential costs started piling on, Volkswagen’s large overhead expenses and operational inefficiencies, resulting from looking after a highly diversified, yet centralized business, were considered a reason why the group hasn’t been able to improve its profitability. Volkswagen group’s automotive margins are just above 6%, mainly due to the more profitable luxury brands, but this is still much lower than the margins reported by Toyota, which range between 9-10%. Audi’s 9.7%, and Porsche’s industry-leading 15.7% operating margins, are instrumental in pushing Volkswagen’s profitability up. The 2.6% operating margins for the namesake brand are dragging down Volkswagen’s overall profitability. Lower-than-expected volume sales (volumes fell 4.7% year-over-year through September) for the Volkswagen brand, which contributes ~60% to the group’s net volume sales, and high research and development costs incurred by the group to push for innovation, are hurting profitability at the ailing vehicle division. ^[1]

Volkswagen has said it will cut investment by €1 billion ($1.14 billion) a year at its namesake brand, in the wake of the dieselgate scandal, and accelerate its efficiency program. This might be a blessing in disguise since the brand needed a structural overhaul even before the scandal broke out.

This quarter again, with volume sales remaining low, and with the added costs of the scandal, Volkswagen is expected to release a disappointing set of results. In China, the group’s volumes have declined 5.2% year-over-year through September, and although some of this is due to the general tepid economic environment in the country, the German automaker has fared even worse than the overall market. As China comes to terms with its new normal, sales of automobiles have grown only 0.3% year-over-year through the first three quarters in the country. ^[2] Volkswagen is the highest-selling foreign automaker in China, which forms over one-third of the group’s net volumes, but as the namesake brand has struggled in the country, and so has even the luxury brand Audi, sales growth has remained below industry levels.

Although the impact of the emissions scandal will be spread over the next few quarters, as Volkswagen pays for the recalls and fines and further settlements, profits this quarter are expected to be affected by the initial amount set aside to cover the costs of the scandal, and also due to lower volume sales.

See the links below for more information and analysis:

• Volkswagen emissions scandal: what we can learn from history
• Volkswagen: could the cost of the dieselgate scandal be lower than expected?
• Volkswagen has started damage control
• The domino effect of Volkswagen’s emissions scandal
• What could the dieselgate scandal cost Volkswagen?
• Oh Volkswagen, what have you done!
• Volkswagen’s troubles run deep
• How premium automakers are faring in a slower Chinese market
• Volkswagen’s split could be good news
• Trefis analysis: Volkswagen China and Affiliates Vehicles Sold
• Trefis analysis: Volkswagen Passenger Cars, SEAT, LCVs Revenues
• Trefis analysis: Volkswagen Audi Revenues

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1. Volkswagen vehicle deliveries Sept. [↩]
2. China automobile sales [↩]