Volkswagen Is Back on Track

Overcoming the dieselgate scandal

Author's Avatar
Mar 24, 2017
Article's Main Image

Volkswagen (VLKPY, Financial)(VLKAY, Financial)(XTER:VOW, Financial)(XTER:VOW3, Financial), the $76 billion German auto manufacturer, delivered its fourth quarter and fiscal 2016 sales last week.

For 2016, Volkswagen Group reported a 1.9% sales rise to 217.3 billion euros ($23.5 billion) and an actual profit of 5.14 billion euros – 2.4% profit margin – compared to 1.58 billion euros in loss in 2015.

All these, now impressive, figures even after the VW dieselgate scandal.

In addition, Volkswagen reported 7.5 billion euros special item charges related to legal risks in 2016. In comparison, the car company recorded a 16.2 billion euros charge back in 2015 in connection with the diesel issue*.

*annual report 2015: exceptional charges, in particular for the technical measures planned for the diesel engines affected, repurchases, customer-related mesures and legal risks.

“The last year was a challenging yet remarkably successful year for us," Matthias Müller, CEO of Volkswagen Aktiengesellschaft, said. "In 2016, we set the course for the biggest transformation in the history of the company – while at the same time performing better in our operating business than many thought possible. Volkswagen is back on track.”

Frank Witter, member of the Board of Management and responsible for Volkswagen’s Finance and Controlling, commented on the company's ability to bounce back from the scandal.

“This result demonstrates that the group is financially equipped to bear the consequences of the diesel crisis. All brands contributed to the success of the Volkswagen Group in 2016 by delivering a positive operating result,” Witter said.

Volkswagen ADR shares went up by 0.29% while Standard & Poor's 500 index closed 0.35% down.

Outlook

Briefly, Volkswagen Group expects its sales to grow up to 4% year on year in 2017. Volkswagen anticipates an operating return on sales – operating result to sales revenue – of between 6.0% and 7.0%.

Volkswagen Group had 3.3% operating return on sales in fiscal 2016. Nonetheless, the car company still cited the diesel issue as one of the issues that may affect its figures in fiscal 2017.

02May2017125940.jpg

(Annual Report)

Total return

In recent years, Volkswagen ADR totally underperformed the broader S&P 500 index. According to Morningstar data, the car company returned 3.29% vs. the index’s 19.06% in the past year while having provided flat, 0.06% vs. the index’s 13.52%, in the past five years.

Valuations

Volkswagen’s ADR shares currently trade at a 200.7 times trailing earnings vs. 16.7 times in industry median, according to GuruFocus data. The car company had a price-book (P/B) value of 0.76 times vs. industry median 1.69 and price-sales (P/S) ratio of 0.32 times vs. 0.82 times in industry median.

In addition, Volkswagen had a trailing dividend yield of 0.08% and 18% payout ratio.

Using Reuters data, Volkswagen would have a forward* P/S and earnings-per-share figures of 0.33 times and 8.9 times.

*average sales and earnings-per-share figures used.

02May2017125940.jpg

(Annual Report)

Volkswagen

Volkswagen Group was founded on May 28, 1937, 79 years ago, as the Gesellschaft zur Vorbereitung des Deutschen Volkswagens mbH ("Limited Liability Company for the preparation of the German People's Car", abbreviated to Gezuvor).

Amidst the scandal, Volkswagen Group may have beaten Toyota Motors (TM, Financial) as the world’s largest maker in 2016 (Forbes).

02May2017125941.jpg

(Annual Report)

Volkswagen Group grew its vehicle sales by 3.8% to 10.39 million units in 2016 from 2015 while have grown its production by 3.9% to 10.4 million units.

In 2016, the car company generated 64%, or 138.1 billion euros, of its sales from Europe/Other markets, 16% each from North America and Asia-Pacific – excluding sales from joint venture companies and 4% from South America.

02May2017125941.jpg

(Annual Report)

As shown in the image, Volkswagen delivered the most vehicle units worldwide in the following decreasing manner: Golf, Jetta, Polo, Passat, Lavida, Tiguan, Ĺ  KODA Octavia and Audi A3.

The Volkswagen Group consists of two divisions: the Automotive Division and the Financial Services Division.

Automotive Division

The Automotive Division comprises the Passenger Cars, Commercial Vehicles and Power Engineering Business Areas.

Accordingly, the activities of the Automotive Division comprise the development of vehicles and engines, the production and sale of passenger cars, light commercial vehicles, trucks, buses and motorcycles as well as the genuine parts, large-bore diesel engines, turbomachinery, special gear units, propulsion components and testing systems businesses.

Also, the Ducati brand is allocated to the Audi brand and thus to the Passenger Cars Business Area.

In 2016, Passenger Cars sales grew 0.4% to 150.3 billion euros, or 69% of total Volkswagen Group sales, and delivered 4.17 billion euros in operating results – 3% margin – versus losses of 7 billion euros in 2015.

Commercial Vehicles sales, meanwhile, grew 5.4% to 32.1 billion euros, or 15% of total company sales, and had 2% operating margin.

Sales in Power Engineering Business Areas fell 4.8% to 3.6 billion euros and delivered an operating loss of 217 million euros versus profits of 123 million euros in 2015.

Financial Services Division

The Financial Services Division combines dealer and customer financing, leasing, banking and insurance activities, fleet management and the mobility offerings.

In 2016, sales in the segment grew by 6.5% to 31.3 billion euros, or 14% of total Volkswagen sales, and delivered an operating margin of 8% – highest among the group – in the period.

Key performance metrics and 2025 outlook – six metrics

Operating return on sales

The operating return on sales is the ratio of the operating result to sales revenue.

In 2016, Volkswagen delivered operating return on sales of 3.3% versus -1.9% in 2015. The car company expects its ratio to improve between 7 to 8% in 2025.

Research and development ratio in the Automotive Division

The research and development (R&D) ratio in the Automotive Division shows total research and development costs in relation to sales revenue.

In 2016, Volkswagen had an R&D ratio of 7.3% versus 7.4% in 2015. The company sees this figure at approximately 6% by 2025.

Capex and sales revenue in the Automotive Division

The ratio of capital expenditure (investments in property, plant and equipment, investment property and intangible assets, excluding capitalized development costs) to sales revenue in the Automotive Division reflects both the company's innovative power and future competitiveness.

In 2016, capital expenditures per sales in the division was at 6.9% – similar to 2015. Volkswagen sees this figure at approximately 6%.

Net cash flow in the Automotive Division

Net cash flow in the Automotive Division represents the excess funds from operating activities available for dividend payments. It is calculated as cash flows from operating activities minus cash flows from investing activities attributable to operating activities.

In 2016, Volkswagen had 4.33 billion euros in net cash flow in the division versus 8.89 billion euros the year prior. The company expects this figure at positive to allow a distribution of ratio of 30%.

Net liquidity in the Automotive Division

Net liquidity in the Automotive Division is the total of cash, cash equivalents, securities, loans and one-time deposits not financed by third-party borrowings. To safeguard the car company’s business activities, Volkswagen has formulated the strategic target that net liquidity in the Automotive Division should amount to approximately 10% of the consolidated sales revenue.

In 2016, net liquidity was at 27.18 billion euros – 12.5% of sales – versus 24.52 billion euros the year before. The company sees this figure to be maintained at 10% by 2025.

Return on investment in the Automotive Division

The return on investment (ROI) is used to calculate the return on invested capital for a particular period in the Automotive Division, including the Chinese joint ventures on a proportionate basis, by calculating the ratio of the operating result after tax to average invested capital. If the return on investment (ROI) exceeds the market cost of capital, the value of the company has increased.

In 2016, ROI for the division was 8.2% versus -0.2% in 2015. The company expects this figure to be more than 15% by 2025.

Sales and profits

02May2017125942.jpg

(Annual Report)

Cash, debt and book value

As of December 2016, Volkswagen Group had $36.8 billion in cash, cash equivalents, time deposits and marketable securities. The car company also had 154.8 billion euros in financial liabilities, excluding pension provisions, having represented a debt-equity ratio of 1.67 times versus 1.65 times in 2015.

Volkswagen had 15.3% of 409.7 billion euros in intangibles with a book value of 92.9 billion euros versus 88.27 billion euros in 2015.

02May2017125943.jpg

(Annual Report)

Provisions for pensions

Provisions for pensions are recognized for commitments in the form of retirement, invalidity and dependents’ benefits payable under pension plans.

Cash flow

02May2017125943.jpg

(Annual Report)

For 2016, Volkswagen Group’s cash flows from operations fell 31% to 9.43 billion euros in comparison to 2015. Most of this cash flow decline was in relation to lesser positive change in the company’s other provisions.

Capital expenditures – including capitalized development costs – were 18.9 billion euros, leaving Volkswagen with -9.47 billion euros in free cash (out)flow versus -4.56 billion euros in 2015. Despite this, Volkswagen provided 364 million euros in dividend payouts.

02May2017125944.jpg

(Annual Report)

On average, Volkswagen did not deliver any positive free cash flow in recent years but was successfully able to raise money from share issuance (dilution). Nonetheless, the company did not dilute its shareholders in 2016.

Share issuance, specifically in 2014 and 2015, was related to Volkswagen AG placing unsecured subordinated hybrid notes with an aggregate principal amount of 3 billion euros and 2.5 billion euros via a subsidiary, Volkswagen International Finance N.V. Amsterdam/the Netherlands.

02May2017125944.jpg

(Annual Report)

In 2016, Volkswagen repaid more than it issued in bonds with 9.34 billion euros, and also grew its cash flow inflow from "changes in other financial liabilities."

Conclusion

Despite the recent "dieselgate" blunder that started in late 2015, Volkswagen seemed not to be much affected in terms of overall sales as it delivered growth in business sales, profits and retained acceptable key (company) metrics as well.

Volkswagen seems to have prioritized reducing its debt, but still carries a heavily leveraged balance sheet. Value investors would also dislike the company’s free cash flow development in recent years, accompanied by increasing "other financial liabilities."

There is no question that Volkswagen will see its business thriving in the coming years.

“Volkswagen will remain one of the most successful automakers worldwide in 2025. But we will also be a leading international provider of sustainable mobility and set the standards for new mobility services. And what is at least as important to us: We will be a role model in environmental protection, safety, and integrity,” Müller said.

The car company also implemented a "Strategy 2025" in mid-2016, indicating a goal of having 30 new battery electric-car models and launching its first fully autonomous vehicles by the end of the decade, according to the Wall Street Journal.

02May2017125944.jpg

(Volkswagen ADR Shares and P/B Ratio, GuruFocus)

Meanwhile, the investment analysts covering Volkswagen AG ADR advise the company will underperform and set a target price of $23.55 a share, 22% off from Thursday’s share price of $30.3, according to Financial Times.

Asking a 20% margin from its current book value would indicate a value of $29 per share.

In summary, Volkswagen Group is definitely back but is a hold with a $29 per share price target.

Disclosure: I do not have shares in any of the companies mentioned.

Start a free seven-day trial of Premium Membership to GuruFocus.