Description

Summary

Volkswagen (VWAPY) preferred US ADR’s have traded horribly and are down over the past 5 years (but up 3% with dividends).  The company’s growth guidance and margins look weaker than most of its peers and the stock seems left for dead.  On a consolidated basis, VWAPY trades at 4.4x forward earnings and 6x free cash flow.  Recent free cash flow guidance for 2024 was also quite uninspiring. 

For some good background info, VOW3 (the European preferred) was written up on VIC here.

Below is how VWAPY (in white) has traded over the past 5 years with the common shares (VWAGY) in blue.  The stock ran up on EV hype in 2021 before crashing in 2022.

For those overseas, VOW is the common ticker and VOW3 is the preferred ticker.  These are listed in Germany.

The preferred shares of Volkswagen (VWAPY and VOY3 GR in Germany) have zero voting rights but are entitled to an extra 6c in dividends per year (as mandated by the company’s Articles of Association).  The common ADR ticker is VWAGY (VOY GR).  1 ADR = 0.1 share of the common/preferred in Germany.

VWAPY and VWAGY have identical economic interests in the company and historically traded inline with one another.  There should be ZERO reason for the ordinary shares to trade higher than the preferred shares, as control of Volkswagen stock is firmly in the hands of 1) the Porsche and the Piech families with 53% of the voting rights (via 31% ownership in the common), 2) the German state of Lower Saxony with 20% and 3) Qatar which owns another 17%.

Here is our summary thesis for buying the preferred (non-voting) shares. 

1)      In September 2022, Volkswagen sold 25% of their stake in Porsche to the public and to the Porsche family.  Porsche is an iconic and extremely profitable brand; its shares took off from its IPO price of €82.50 per share to €120 and have settled now at around €93 (about 8.3x EBITDA which does not seem an egregious multiple for a super luxury brand).  Interestingly, VW Group sold Porsche preferred shares in this offering and continues to hold 75% of the common shares.  The ticker is P911 in Germany, and the share count is 911 million.  Awesome.

2)      Volkswagen also owns Lamborghini, which we think is conservatively worth €17-25 billion (a huge discount to the TEV of  Ferrari, ticker RACE at €74 billion).  RACE sells 14k cars/year and Lamborghini 11k.

3)      Adding up just VW’s 75% stake in Porsche and their 100% stake in Lamborghini totals $16-17 per share of VWAPY.  Including the company’s auto debt of $1.36 per share and assuming their Financial Services business is worth 50% of book (or 8.25x depressed 2023 earnings) and we get $19-21 per share for VWAPY. 

4)      Speaking of Finco, this is a solid business.  FS has had zero negative profit years dating back 20 years. 

5)      This excludes all of their core businesses.  That is 1) Audi, Volkswagen, Bentley, Ducati, Skoda and 2) their commercial truck business (Traton which includes Scania and Navistar and is also listed, 8TRA GY). 

6)      Audi generated about €7 billion of out their €36.5 billion of EBITDA last year.  That is probably worth 6x earnings (inline with BMW and Mercedes), or €20 billion.  Bentley is included in this figure (the Progressive Brand Segment per the company and we backed our our Lambo estimates from this).

7)      Overall VW Group has grown EPS by 3-6% annually dating back to 2013 – depending on which year you want to start with.  That is not terribly impressive, but today with a 7.5% yield, I can get double digit annual returns assuming no more de-rating on the equity.  In other words, we are paid a lot to wait.

8)      With the Porsche and Traton stakes listed, it seems only a matter of time before something, anything happens here to unlock value. I am betting/hoping on Lambo.

We would also mention that Volkswagen is number three in the world in terms of battery electric car sales and in plug-in hybrid electric vehicles.  Right now, EV sales for the company are margin dilutive but in time scale and winding down many of their ICE cars should help. 

At just 2x EBITDA for the non-Porsche and non-Lamborghini automotive businesses, should there be a catalyst, and VWAPY has upside potential of 166% (using 2024 estimates). 

Compared to peers, VWAPY can be purchased for 4.4x 2024 consolidated earnings, vs Ford at 7.1x, GM at 4.9x, Toyota at 10.8x and MBG GY / BMW both at 6.3x 2024 earnings.  GM and Ford have no ultra-premium assets either.

Of course, there are several problems, some potentially structural, that we would point out. 

1)      The company is not looking to spin out the rest of their Porsche shares or seek any other value unlocking deals.

2)      A typical sum of the parts discount can range from 20% to 40%.  That said, at a 40% discount to the parts, the upside is to $18.59.  Which is still over 50% upside owning VWAPY (with dividends) in a year.

3)      Europe continues to feel vulnerable economically.  The energy crisis seems mitigated, but cost problems can also be an overhang to margins.  Just under half of Volkswagen’s factories are in Europe. 

4)      The narrative is dreadful for VW and the stock has underperformed its peer group (underperformed CARZ by 20% in a year).  They are losing share in China (as are all foreign OEM’s as Chinese built EVs and Tesla gain share); VW may not win the EV wars and will just lose more market share which is 21% in Europe (all brands).  That said, EV sales grew 35% last year and the company has gained EV share.

5)      Free cash flow margins are expected to be below average as the company continues to ramp up EV production capacity as well as continuing to produce ICE vehicles.  A double whammy to margings/FCF for perhaps years.

Generally, the downside case is probably $10 for VWAPY, which implies an 8.4% dividend yield. At some point, unless interest rates move a lot higher, there is a level where just the yield provides market type returns and investors are happy owning a yield-y bond like equity. 

Business

Volkswagen AG (VWAGY) owns 10 automotive brands today, including their 75% stake in Porsche AG (DRPRY) which listed in September 2022 (ticker P911 in Germany).  Their largest selling brand is of course Volkswagen, and the VW Group includes several extremely high end brands too, including Lamborghini, Audi, Bugatti, Porsche as mentioned, and Bentley. 

Traton is their commercial vehicle business and pretty small, about 7% of the automotive segment’s operating income. 

Most auto OEMs own large finance businesses as well as their automotive segments.  Volkswagen’s Financial Services segment is solid, with zero negative earning years (unlike GMAC for example).

Financial Services

Here is a long term chart of VW’s FS segment’s net income.

With book equity of €42 billion, the financial services segment earned respectable 6.1% after tax ROE’s last year.

We valued this business at 0.5x book (well below liquidation value).  Leverage is reasonable and the VW Corp finco bonds are BBB+ rated (with 5 year finco bonds yielding 5.4% today).

Automotive Group

The Auto segment is huge and even including underfunded pensions is only 0.2x levered on a debt/EBITDA basis.  Volkswagen employs 668,000 workers in 72 plants around the world.  VW operates over half their plants (38) outside of Europe: 34 plants are located Europe, with 11 of those in Germany. 

Their battery electric vehicles (BEVs) are produced in one plant in the US, 6 in Europe and 2 in China. 

Unlike many of the Japanese auto makers, Volkswagen embraced BEVs early and have quite a bit of traction already in the space.  In 2024, VW expects ~10% market share in BEVs globally.  They are first in share in Europe with 21%, and third behind Tesla and Mercedes in the US at 11% share.

Porsche and Volkswagen have a long history together, as Ferdinand Porsche designed the first Beetle in 1938.  His grandson ages later became the CEO of Volkswagen.  In 2009, Porsche announced their intention to buy out Volkswagen, in minnow swallowing the whale type transaction. 

In 2022, in the largest IPO in European history, VW sold a 25% stake in Porsche at €82.50.  It seemed the first step to unlocking value at the company.

Here are summary financials on Porsche.

 EBITDA grew 9% last year.  Automotive cash flow margins are solid at just under 10%.  Porsche should get a large multiple given its iconic status as a premium brand.  Wealthy buyers of Porsche vehicles are less price sensitive.  Even Porsche’s financial services segment generates above normal ROEs. 

Capitalization

Recent Earnings / Macro Picture

On a consolidated basis, VW auto car sales were up 12% in 2023 and electric vehicles (EV) unit sales were up 35%.

VW global EV market share continues to improve too.  From 6.9% in 2023, management expects 9-11% share in 2024.  It hit 10% in late 2023.

China is seeing a lot of competition and their JV is expecting a decline in operating earnings in 2024.  But we are talking €500 million declines out of €36.5 billion of EBITDA.

On a cash flow basis, the auto segment (everything except the financing business), saw free cash flow of €10.0 billion, down from €10.7 billion in 2022.  These are our figures excluding working capital, which has been lumpy in the past 3 years.  And they include a lot of extra EV spending to build out that technology.

So just based on trailing free cash flow figures, excluding the value of Finco (at only 50% of book), we can buy VWAPY for 4.8x FCF. 

Why the hate on this stock?  Investors are frustrated by the continued lower margins vs their peers and their elevated capex spending.  Oliver Blume, the ex-CEO from Porsche, was supposed to cut costs and improve VW’s lackluster margins.  He did an excellent job while running  Porsche, so we have some faith that the right guy is leading the company.  

For 2024, here is guidance.

Margins look flat, sales growth far lower than last year and free cash flow down.  Indeed, Auto FCF is expected to fall from €10.7 billion to a range of €4.5 to €6.5 billion.  And there is now €4 billion of M&A included in this figure.

VW seems to be spending a lot more on capex, “throwing money at problems” per one analyst we spoke to.

Auto spend (R&D plus capex) will remain quite elevated in 2024, at 14% of sales.  They’ve targeted 11% in 2027 and 9% long term.

Here was one interchange from the call.

“So on your company, your free cash flow last year was over 60% of your current market capitalization. But then your spend is obviously roughly the same number. EUR 37 billion a year is obviously an enormous number. It's bigger than all of your competitors.

The competitors also spend a lot of money in battery factories and stuff like that, but they maybe do it in joint ventures, so it's not on their balance sheet or they use more partnerships. You've talked about more partnerships and stuff today, particularly CARIAD is potentially exciting [with AAPL], I think, but also in battery and other parts of the business. How much do you think you can save off of this current peak level? You talk about 14% to 11%. But I have a lot of questions on literally IB Today asking me when is this going to happen? Is it ever going to happen?

You heard the question on the M&A [the 4 billion], which sounds like another increase in spending. Do you understand the frustration that investors have? You have this incredible potential. Can you give us some cadence on whether you'll be able to bring those investment levels down and whether we should expect that to drop through to the cash flow in the next 2 to 3 years?

Arno Antlitz

I can be -- so in the sake of time, I can be very brief on that. We stick to our plan to bring that number down in relative terms to 11% in 2027 with the runout of combustion engine investment. And eventually, we target for 9% in -- towards 2030, as indicated in the Capital Markets Day, which is then absolutely competitive.”

So, while Toyota crushed numbers with huge hybrid sales and expectations for 14% revenue growth in 2024 (not to mention capex at only 5% of revenue), in comparison VW looks like a bloated car company with the worst margins and worst spending.  But then again, TM trades at 10x earnings today from recent lows in the 7-8x range. 

Our view is simply that frustration levels are extremely high, the stock in the gutter and now expectations at perhaps all time lows.  The stock is priced as if it’s going out of business and our view is that FCF can only improve in time as EV sales reach scale in 2-3 years.

Valuation

On an EV/EBITDA and P/E basis, VW Group is trading at record lows. 

Here is our sum of the parts model.

2.2x automotive EBITDA is typically where VW trades (since 2010).  At 2.0x 2025 EBITDA plus Porsche/Lamborghini/cash/Finco and our uber-bullish scenario is $30+ in a couple of years. We are not expecting this realistically, but note that a full spin off of Lambo (ala the Ferrarri listing) could unlock a lot of value.  Lamborghini operates quite separately from the rest of the businesses.

Peers include the other large global legacy OEMs, including Ford (F) trading at 7.1x 2024 earnings, GM at 4.9x, Toyota (TM) at 10.8x and Mercedes (MBG GY)  and BMW at 6.3x 2024 earnings. 

At 5x 2024 earnings, assuming no spins/sales/catalysts, and VWAPY would trade to $18.50, a good base case and a more reasonable 5.1% yield.

Finally, here is an interesting article from last week that also sums up the story well.

https://www.marketwatch.com/story/volkswagen-and-porsche-se-are-stuck-in-wall-streets-pits-stock-investors-start-your-engines-4e7bcec5?mod=mw_latestnews

Catalyst

No imminent catalysts, but paid nicely to wait for one