Volkswagen Earnings Preview: China To Offset Poor Sales In The Americas In Q3

Volkswagen AG (OTCMKTS:VLKAY) is scheduled to announce its Q3 results on October 27, coming immediately after the group got approval for its $14.7 billion settlement with customers and U.S. regulators for buybacks and fixes to 475,000 2.0-liter Volkswagen and Audi diesel vehicles fitted with the emissions defeat device. The settlement would mark a step ahead in Volkswagen’s bid to win back customer trust in the U.S., a market it was struggling in even before the news of the scandal broke out. While Volkswagen’s vehicle deliveries in the Americas have declined year-over-year through the first nine months of the year, the growth in China and Europe should boost revenue growth in Q3.

Volkswagen has delivered 7.6 million vehicles through September in 2016, up 2.4% year-over-year. This growth has been spearheaded by the stimulus of growth in China’s vehicle market. According to China Association of Automobile Manufacturers, China’s passenger vehicle sales are up 15% year-over-year through September to 16.75 million units, buoyed by government tax breaks, and high discounts offered by dealers. This includes a high 29% jump in sales in the last month alone. The Volkswagen Passenger Vehicles brand witnessed an impressive 11.4% growth in the country through the first three quarters, which is a positive since the brand has otherwise recorded only a 0.6% rise in overall vehicle deliveries during the same period. Approximately 60% of Volkswagen’s net deliveries are constituted by the namesake brand, which, in turn, delivers half of its vehicles to China. This is why the brand’s solid performance in China, together with its two Chinese Joint Ventures, SAIC Volkswagen and FAW-Volkswagen, is expected to boost Volkswagen’s top line in Q3.

The other winners for Volkswagen in Q3 are expected to be its premium brands Audi and Porsche, which reported 6.2% and 11.3% increases in vehicle deliveries in China, respectively, through September. Growth in the premium brands will also be accretive to Volkswagen’s margin. Audi and Porsche combined formed 15% of the net volume sales, 37% of the top line, and ~60% of the operating profit for Volkswagen last year. This is because the average unit pricing of a luxury car is somewhere close to $44,000, compared to just over $20,000 for the average price of vehicles overall. Given the high fixed cost of manufacturing and distributing a car, a higher purchase price is the biggest guarantor of profitability.

The namesake brand of passenger cars has been the main reason for Volkswagen’s low margins. The brand’s margin stood at 0.3% in Q1 and 1.7% in Q2, due to added expenses and lower sales, lowering the group’s overall operating margin to ~5% in the first half of the year. In comparison, Toyota operates at a 9.5-11% margin. Volkswagen also employs ~2x and ~3x the workers employed by Toyota and GM, respectively, and spends a considerable amount on research and development, weighing on its profitability. Just for reference, while Volkswagen spent 48% of its gross profit on R&D in 2015, Toyota and GM spent 14.7% and 21.8% of their gross profit on R&D, respectively.

Volkswagen is probably in better shape now, after the announcement of its Strategy 2025 and the settlement approval in the U.S., but the headwinds in North America, where the automotive market is slowing down, and South America, where the economic conditions continue to remain weak, will loom large on the financials in the near term. Additionally, expenses related to the diesel issue are also expected to dent earnings. Through the first half, Volkswagen recognized 1.6 billion euros mainly due to higher expenses attributable to the recognition of provisions for legal risks.

The good news for Volkswagen is that its core performance improved from Q1 to Q2, and is expected to improve again in Q3, mainly on the back of higher sales in China and Europe, and growth for its premium brands.

Have more questions on Volkswagen? See the links below.

• Volkswagen Is Losing Share In Europe Thick And Fast
• Volkswagen’s Navistar Partnership Will Open Gates To North America
• The U.S. Automotive Slowdown Is Here And Now
• Where Will Volkswagen’s Revenue And EBITDA Growth Come From Over The Next Three Years?
• By What Percentage Have Volkswagen’s Revenues And EBITDA Grown Over The Last Five Years?
• What Is Volkswagen’s Fundamental Value Based On Expected 2016 Results?
• How Much Have Big Auto Companies Been Investing In Growth Opportunities?
• Has The Emissions Scandal Impacted Volkswagen’s Volume Sales This Year?
• Rundown Of How Volkswagen’s 2015 Results Were Impacted By The Dieselgate Issue
• How Significant Will China Be For Volkswagen By 2020?
• Where Volkswagen Stands Relative To Its Competitors In Crucial Markets
• How Is Audi Holding Up Compared To Its Compatriots In Crucial Markets?
• How Has Volkswagen’s Revenue And EBITDA Composition Changed Over 2012-2016E?
• What Is Volkswagen’s Revenue And EBITDA Breakdown?
• Why Premium Brands Are 3x As Valuable As Non-Premium Brands For Volkswagen
• How Much Will Premium Brands Contribute To Volkswagen’s Top Line By 2018?
• How Does Volkswagen’s China Market Share Compare With Other Foreign Automakers’?
• How Much Does Volkswagen Make On The Sale Of One Porsche, Audi, Skoda And Volkswagen Vehicle?

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