EUR 850.00 For Business Accounts Only

Morningstar | Volkswagen Reports 2018 Results, Guides to Improved 2019; Maintaining EUR 230 FVE

No-moat-rated Volkswagen, maker of Audi, Bugatti, Lamborghini, Porsche, SEAT, Skoda, and Volkswagen automobiles, plus MAN, Scania, and Volkswagen commercial trucks, reported full-year 2018 diluted earnings per preference share before special items, or EPS, of EUR 28.57, EUR 3.24 higher than the sell-side consensus but only EUR 0.50 better than the year-ago EPS. Guidance for 2019 includes increased consolidated revenue by as much as 5% and group operating margin in a range of 6.5%-7.5%. We think the market has overly discounted Volkswagen shares for various diesel-related issues as well as increased spending for powertrain electrification. This 4-star-rated stock is attractively valued, trading at a 37% discount to our EUR 230 fair value estimate.

Consolidated revenue increased 3% to EUR 235.8 billion compared with EUR 229.6 billion last year (all prior-year results restated for IFRS 15 revenue recognition). However, operating profit before special items was only slightly higher at EUR 17.1 billion, resulting in a 7.3% operating return on sales, representing a 10-basis point contraction in margin. Volkswagen was ill-prepared for the changeover to WLTP emissions testing procedures resulting in delivery delays to customers and lower overall industry volume in Europe.

Volkswagen also announced an expanded electric vehicle strategy, from what we thought was already an aggressive plan. The company expects to have 70 new electric models by 2028, up from 50 previously planned. Management projects volume on electric platforms in the next 10 years to increase to 22 million from 15 million. Our EUR 230 fair value estimate already includes significantly higher investment from electrification. Volkswagen’s 10-year historical median spending, including R&D expense and capitalized development, is 6.4% of industrial revenue (excludes financial services). We assume an average 7.7% spending level during our Stage I forecast with a 7.3% normalized sustainable midcycle assumption.

Automotive full-year 2018 revenue increased 3% to EUR 203.1 billion, mainly driven by a 10% jump in Volkswagen’s Asia-Pacific region, followed by a 4% increase in South America and a 0.2% increase in Europe and remaining markets, respectively. Though a relatively smaller part of overall revenue, Power Engineering revenue led the increase with a 10% year-over-year gain while commercial vehicle revenue was up 4% compared with the prior year. The company reported record total global volume, including China JVs, of 10.9 million units, up 1.2% from the prior year. Excluding Chinese JV unit volume, deliveries were up by 0.6% but totaled 6.8 million vehicles. Regionally, South America led the advance in volume, rising 13% to 596,000 units. European volume, Volkswagen’s largest market, increased 0.2% to 4.7 million units, despite declining 11% and 4% in the third and fourth quarters, respectively, due to WLTP.

Brand-wise, Porsche and MAN revenue growth led the group with 9% increases, respectively. VW, Scania, Skoda and Seat revenue each improved by 6%, 5%, 4%, and 3%. Bentley, Audi, and VW commercial were offsets, declining 16%, 2%, and 0.3%, respectively.

Even though the worst of the diesel scandal is over in the U.S., our main concern about Volkswagen's stock remains the uncertainty surrounding the ongoing European diesel emission test cheating investigations as well as investigations into collusion among German automakers regarding diesel emission control equipment. We have maintained a EUR 20 billion reduction to our enterprise value to reflect potential litigation in Europe, where criminal investigations into diesel cheating persist.

EU consumer agencies are seeking relief similar to remuneration received by U.S. consumers who had the option to have Volkswagen buy back their vehicles or receive $5,100 cash plus free repair. European consumers were only offered free repair. With regards to the collusion allegations, a fine of EUR 1.040 billion would result in a 1% variance in our EUR 230 fair value estimate. We estimate that if Volkswagen were fined a worst-case EUR 23.5 billion (our estimate based on European Union antitrust law), our fair value estimate would drop to EUR 178 from EUR 230. Under current trading conditions, Volkswagen stock’s 4-star rating would remain intact and the shares would be trading at a 19% discount to a EUR 178 fair value. We also note that the worst-case antitrust outcome scenario did not include any of the EU’s potential “mitigating, leniency, or settlement” factors in calculating the fine.