No Superfluous Expenditures For Volkswagen In The Near Term


Volkswagen AG (OTCMKTS:VLKAY) is smarting under the repercussions of the dieselgate scandal, and looking to curb extra costs. The emissions scandal was bound to be followed by investigation, a change in personnel, and cost cuts to meet with the new added costs of vehicle recalls, fines, and settlements. And in the last week, Volkswagen announced a €1 billion cut in its planned investments in property, plant, and equipment, investment property, and intangible assets, excluding capitalized development costs, for next year. The figure is now expected to be approximately €12 billion ($12.76 billion), which, although, is still quite sizable, gives the group more leeway to tackle the extra costs brought on due to the scandal.

We have a $32 price estimate for Volkswagen, which is above the current market price.

See Our Complete Analysis For Volkswagen AG

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The group had earlier stated its plans to cut investment by €1 billion ($1.06 billion) a year at its namesake brand, which contributes ~60% of the net volumes, and is weighing down the group’s net profitability, as high capital spending and R&D investments have kept operating margins below 3% at the brand. Through the first nine months of the year, capex stood at €7.34 billion, representing 5.3% of the sales revenue for the automotive division, whereas the figure stood at 5% last year.

Operating margins remain a problem for Volkswagen, which reported its first net loss in 15 years in the last quarter, primarily hurt by the added expense of the emissions scandal. The group’s ambitions to stay ahead of its competition globally has the company spending large on new technologies — which could possibly be curbed, now that the German auto behemoth has to focus first on regrouping, following the dieselgate scandal. The group invested €11.5 billion in research and development last year, representing nearly 6% of the net revenues, more than any other company worldwide. Through September, the company’s automotive business has spent 6.5% of its sales revenue on research and development activities, compared to 3.6% of the sales revenues spent at competitor and compatriot Daimler’s automotive unit.

Volkswagen has given examples on how the group is planning to go about its cost-cutting spree. These include halting construction of the planned new design center in Wolfsburg — saving approximately €100 million right there, while reviewing the construction of a paint shop in Mexico.  The pure-play electric model successor to the company’s ill-fated Phaeton is also being delayed.

A cut in capex shows how the group is ready to let go of planned investments which aren’t absolutely necessary or crucial to growth, as of now, especially when the dieselgate scandal is expected to cause a big $20-$30 billion dent in Volkswagen’s kitty. However, the group has also maintained that it is not exactly ‘slowing down.’  The CEO Matthias Müller announced the intention to increase expenditure on alternative drive technologies by approximately €100 million next year. New developments in electric vehicles and autonomous driving are keeping Volkswagen on its toes, as well. CEO of the Volkswagen Passenger Cars brand, Herbert Diess, earlier stated how the brand’s focus is on building plug-in hybrid electric vehicles with greater range, high-volume electric vehicles with a radius of up to 300 kilometers, a 48-volt power supply system (mild hybrid), as well as ever more efficient diesel, petrol, and CNG concepts.

Apart from helping the company cope with the added costs of the scandal, Volkswagen’s cost cuts might be good for the company’s future. The German group employs roughly 600,000 people and has 119 factories around the world, comprises 12 separate brands, ranging from mass market cars to luxury vehicles to commercial vehicles. The group’s chief rival Toyota, on the other hand, employs only around 330,000 people, delivering a comparable number of vehicles worldwide. The group needs a structural upheaval, one would think. The CEO said how “together with the works council representatives we will make every effort to keep our core workforce on board,” however, trimming the high employee costs could be beneficial to Volkswagen at this time. Labor costs in Germany are rising, boosted by fairly strong economic conditions and the government’s tightened grip on the labor market. This might be alarming for Germany, where wage moderation had earlier bolstered job growth and investment. Rising wage costs could now negatively impact the country’s competitiveness. Rising wage costs are also a major cost driver for automakers, and as over 45% of Volkswagen’s total workforce is in Germany, the incremental expenses are pulling down profitability for the group.

The emissions scandal is expected to cost Volkswagen a couple of tens of billions, or even more, but the group’s ‘retrofitting’ program should help cover some of these costs, if not all. More importantly, the cutback on expenditure on certain pending projects will have a positive impact on the company’s margins. In addition, the emphasis on development of electric vehicles could help push the company in the right direction — where the millennial customer is probably heading.

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