EUR 850.00 For Business Accounts Only

Morningstar | Volkswagen 1Q Results Impress, 2019 Guidance Confirmed; Maintaining EUR 235 Fair Value Estimate

No-moat rated Volkswagen, maker of Audi, Bugatti, Lamborghini, Porsche, SEAT, Skoda, and Volkswagen automobiles, plus MAN, Scania, and Volkswagen commercial trucks, reported first-quarter diluted earnings per preference share before special items (EPS) of EUR 7.28, impressively trouncing the EUR 6.16 sell-side EPS consensus estimate by EUR 1.12 and EUR 0.82 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%. The stock reacted well, raising nearly 5% on the announcement. Even so, the 4-star rated shares are still attractively valued, trading at a 31% discount to our EUR 235 fair value estimate.

Consolidated revenue increased 3.1% to EUR 60.0 billion compared with EUR 58.2 billion last year. However, consolidated operating profit before JV equity income and special items was 15.2% higher at EUR 4.8 billion, resulting in an 8.1% operating return on sales, representing a 90-basis-point expansion in margin compared with the first quarter of 2018. Management said that the company was still negatively affected, especially with Audi models, by the changeover to WLTP emissions testing procedures in Europe. Even so, first-quarter profitability was 60 basis points above the high end of management's full-year guidance.

Volkswagen has the most aggressive electric vehicle launch objectives of any automaker. The company expects to have 70 new electric models by 2028. Management projects its cumulative volume on electric platforms during the next 10 years will reach 22 million. Our EUR 235 fair value estimate already includes significantly higher investment for electrification. Volkswagen’s 10-year historical median spending, including R&D expense and capitalized development, is 6.7% 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 first-quarter 2019 revenue increased 2.1% to EUR 50.8 billion, driven by a 16.1% jump in Volkswagen’s North America region on an 8.2% increase in the USD/EUR exchange rate, followed by a 4.2% increase in Europe, partially offset by an 8.7% decline in South America (primarily Argentina) and a 6.2% decline in Asia-Pacific region revenue. Though a relatively smaller part of overall revenue, Bentley revenue led the increase with a 29.9% year-over-year pop while commercial vehicle revenue was up 11.9% compared with the prior year. Owing to continued availability issues from WLTP, Audi revenue declined 9.8% versus the first quarter of 2018.

Including China JV sales, the company reported a 6.7% decline in total global volume to 2.8 million units from 3.0 million units in the prior year. Excluding Chinese JV unit volume, deliveries were down by 3.1% and totaled 1.9 million vehicles. Regionally, South America led all volume declines, dropping 12.6% to 125,000 units. European volume, Volkswagen’s largest market, pulled back by 1.9% to 1.2 million units. North America volume partially offset the decliners, with a 4.6% year-over-year increase.

Brandwise, VW Commercial and Skoda volume growth led the group with 10.3% and 7.4% increases, respectively. While being a relatively insignificant part of the total, Bentley's 23.9% volume increase to 2,584 units on sales of the new Continental GT was impressive. Due to the lingering effects of WLTP on Audi and availability of certain models in changeover at Porsche, the two premium brands were the largest detractors from volume in the quarter, dropping 22.6% and 6.6%, 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 European Commission (EC) collusion charges against 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 and resolution to collusion charges still represent substantial risk.

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 regard 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 23.6 billion (our estimate based on European Union antitrust law), our fair value estimate would drop to EUR 187 from EUR 235. Under current trading conditions, Volkswagen stock’s 4-star rating would remain intact and the shares would be trading at a 14% discount to a EUR 187 fair value estimate. 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.