Volkswagen’s Q3 Results Reflect Weakness That Goes Beyond The Emissions Scandal

It’s a long road back for Volkswagen AG (OTCMKTS:VLKAY), after the German automaker admitted to falsifying emission tests in the U.S. in September. It was reported later on that as many as 11 million vehicles carried the illegal software, and while around 482,000 vehicles affected by this scandal are in the U.S., 8 million are in the European Union. So the impact was broader based than was earlier known. And this scandal continues to take the spotlight when talking about Volkswagen. The €6.7 billion ($7.34 billion) that the group set aside in its Q3 financial statements released on October 28 is the main reason why Volkswagen recorded its first net loss in 15 years. ^[1]

We have a $36 price estimate for Volkswagen, which is above the current market price.

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 Revenues through the first nine months were up 8.5% year-over-year, carrying the positive effects of currency translations and product mix. However, Volkswagen slumped to a net loss of $1.83 billion in Q3, on the back of the added costs of the scandal. But let’s not focus on the scandal for a minute. Barring the costs of the scandal, Volkswagen’s core results weren’t very rosy either. Let’s jot down reasons why Volkswagen appears to be struggling, and these reasons do not include the impact or aftermath of the emissions scandal.

Profitable Growth Is Far From Volkswagen’s Reality Right Now

Operating profit for the quarter fell 0.7% year-over-year, without considering the costs relating to the diesel issue, while margins stood at 6.2%, down from 6.6% a year ago. This compared to Toyota’s 10-11% operating margins.

What bodes well for Volkswagen is its strong-performing premium brands such as Audi and Porsche, which sell on relatively higher price points and carry broader margins. Audi and Porsche reported operating margins of 9.2% and 15.5%, respectively, for the first three quarters of the year. Sales growth for these brands, which outpaced the growths seen by the group’s other brands this quarter, is accretive to the overall margins due to the higher proportionate sales of these more profitable brands. However, the namesake passenger vehicle brand continues to drag down the overall results for the group.

A 4.7% drop in vehicle deliveries for the Volkswagen brand through September, compared to a year ago period, and high costs of investment in research and development, have kept operating margins for the brand, which forms approximately 60% of the net volume sales for the group, below a small 3%. This is weighing down Volkswagen’s overall profitability.

Volumes Aren’t Growing As Expected Either

Volkswagen has for long now focused on aggressive expansion in terms of quantity. While Toyota has predicted its slowdown in vehicle deliveries this year due to the previously decided upon temporary ban on building of new manufacturing plants, Volkswagen has pushed for more volumes. The German group overtook its Japanese competition in terms of volume sales in the first half of the year, to become the world’s highest-selling automaker, but has surrendered the lead after the end of the first three quarters. Volkswagen’s deliveries to customers declined 1.5% year-over-year through the first nine months of the year to 7.43 million vehicles, while Toyota sold 7.49 million units during the same period.

Volkswagen Is Losing Out To Stiff Competition

Much of the decline in unit sales this year for Volkswagen can be attributed to the tepid global macroeconomic environment, where the BRIC countries are no longer driving growth in automotive demand. However, the German group’s core performance in some of the crucial markets has also remained relatively weaker.

Volkswagen hasn’t gained much from the large SUV/Crossover demand in the U.S., where the light-duty vehicle market rose 5% year-over-year through September, on the back of a strong 11.7% rise in sales of light-trucks. In China too, the company’s single largest market, the group’s volumes have declined 5.2% year-over-year through September, and although some of this is due to the general economic slowdown 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. 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, sales growth has remained below industry levels. Volkswagen has lost out to the segment shift to budget SUVs and Crossovers, in particular those made by domestic automakers, in China.

On the other hand, although Audi’s vehicle deliveries rose 3.8% year-over-year through September, the premium brand is also somewhat losing its grip in its largest market — China. The FAW-Volkswagen Chinese joint venture sold 2% fewer vehicles in the country through the first nine months. This compared to Mercedes’ impressive 39% increase in unit sales in China during the same period.

The Group Is Making Some Major Changes

The new CEO Matthias Mueller chalked out a five-point plan to realign the group, which includes tasks related to the emissions scandal such as customer support and investigation, and also plans to pursue major structural changes. 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, and now the CEO has pointed out plans to become a leaner, more efficient business. Part of this strategy will also be the planned investment cut of €1 billion ($1.10 billion) a year at its namesake brand, in the wake of the dieselgate scandal, which will help trim extra costs as the firm focuses on damage control.

Volkswagen has transformed its Strategy 2018 into Strategy 2025, the details of which will be developed over the next few months. The group is looking to take a step back from its previous aggressive pursuit of expansion, and realign its strategy and targets, in a bid to realize more qualitative growth, and not just quantitative growth. How the new plans pan out for Volkswagen will only be known in the next few years, but for now, what is known is that the German group has some major holes to plug.

See the links below for more information and analysis:

• Volkswagen’s Q3 results clouded by low volume sales and initial costs of the scandal
• 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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