Volkswagen: The Undervalued Giant in the EV Revolution (VLKAF)

The global march towards Electric Vehicles (EVs) is gaining significant momentum, with global sales witnessing almost another two-fold rise in 2022 to 10 million. Volkswagen (OTCPK:VWAGY), a preeminent legacy automaker, has embarked on a determined shift in the last couple of years. It is now poised to secure a substantial slice of the burgeoning EV market. Volkswagen’s prospects in the EV revolution are particularly compelling for several reasons:

• A robust financial position endows Volkswagen with the necessary capital to fuel its transformation into a dominant force in the global EV landscape. The company leads globally in terms of investment in EVs and software, having earmarked a colossal 100 billion USD for this purpose. This investment is underpinned by its steadfast Combustion-engine vehicle (CEV) business.
• In a remarkable feat, the Volkswagen Group has eclipsed Tesla (TSLA) in total sales in Norway – the country with the highest EV penetration. Additionally, it is steadily gaining ground in China – the most significant market presently – where Volkswagen remains the market leader with a current market share of 16%.
• In a testament to its aggressive shift, Volkswagen has attained profit margins comparable to its CEV business almost two years ahead of its planned schedule. This facilitates the company to accelerate its EV operations while maintaining steady profitability.

Given its attractively low P/E ratio of 4.83 and my conviction that Volkswagen will continue to rank among the top three auto manufacturers in the foreseeable future, I consider its shares a compelling “buy”.

Overview

The sheer scale of Volkswagen is often overlooked, given the sprawling nature of its business. The conglomerate encompasses a host of brands, including Volkswagen, Audi, Porsche (OTCPK:POAHY), and Skoda. It also boasts a 90% controlling interest in Traton SE (OTCPK:TRATF), which manufactures trucks under renowned brands such as MAN, Scania, and Navistar. In 2021, Volkswagen outpaced all global car manufacturers in revenue. Nevertheless, of the 8.6 million cars sold that year, merely 453,000 were electric vehicles, constituting roughly 5% of total sales.

In both its car and truck sectors, Volkswagen is poised to expedite the transition toward electrification. The firm aims to move around 700,000 EVs off the production lines in 2022 alone. Furthermore, it has set a target to sell 2.5 million Battery Electric Vehicles (BEVs) by 2025, a figure that would represent about 25% of total sales.

Despite witnessing a decrease in vehicle sales by approximately 25% compared to 2019, Volkswagen’s revenues have increased by 6% over the same period. This contraction in sales is primarily attributed to supply chain disruptions triggered by strict lockdown measures in China and the recent conflict between Russia and Ukraine, which have critically impeded Volkswagen’s Original Equipment Manufacturers’ (OEMs) ability to deliver essential components.

Improving Supply Chains

During Volkswagen’s Q1 earnings call, management provided encouraging sales numbers and guidance, delivering on the previously announced rebound in unit sales after a sluggish H1 2022. The recovery gained momentum over the summer of 2022 and has since accelerated even further. The notable surge was primarily driven by robust sales in China, where deliveries witnessed a remarkable 27% year-on-year increase.

In the first quarter, production ramped up further, and management anticipated further escalation to meet the soaring demand, particularly for their electric vehicle (EV) lineup, including the popular ID.3, ID.5, and ID. Buzz models. Notably, order intake in Western Europe soared by 40% compared to the previous year, underscoring the growing appetite for Volkswagen’s EV offerings.

Supply chain disruptions, specifically semiconductor and wiring harness shortages, have continued to impede production capacity. However, these supply chain challenges have been alleviated over the past 12 months, and further improvements are expected throughout the whole of 2023. This development bodes well for Volkswagen’s sales performance in the second half of 2023. Traton SE, a subsidiary of Volkswagen heavily involved in truck manufacturing, has also been significantly affected by the pervasive supply chain shortages. Production capacity has been constrained to 65%. However, as supply chain conditions gradually ease in the upcoming quarters, both Traton SE and Volkswagen are well-positioned to capitalize on expanding sales opportunities.

Volkswagen’s recent performance indicates a positive trajectory, with recovering unit sales, robust demand for EVs, and optimistic expectations for improved supply chain conditions.

Sum of the Parts Problem

As stated above, the Volkswagen group consists of several notable brands, for which Ryan Daniels laid out a compelling valuation case back in 2019 already. I would argue that little has changed today and that, hypothetically, valuing the Volkswagen brands one by one would result in a higher aggregate valuation, as have the IPOs of Porsche (OTCPK:DRPRF) and Traton respectively shown. Management has realized the issue, which is why it has started segregating the brands and listing some on their own on the market.

Catalysts

Looking ahead, Volkswagen’s stock could see upward momentum driven by several potential catalysts. Firstly, the company’s strong focus on electric vehicles positions it to benefit from the global shift towards sustainable transportation. In particular, the company has acted far quicker than most of its competitors in delivering an answer to Tesla. Most notable here is the differentiation to the other biggest carmaker besides Volkswagen, namely Toyota (TM). As governments worldwide push for stricter emissions regulations, Volkswagen’s robust EV lineup and substantial investment in the sector could drive market share gains. Additionally, the gradual easing of supply chain challenges, as mentioned above, could improve production capabilities, leading to increased deliveries and revenue growth. Investors seeking exposure to the evolving automotive landscape and the growing demand for EVs may find Volkswagen an appealing investment option.

Valuation

In my comprehensive analysis, I have conducted a rigorous Discounted Cash Flow valuation, encompassing various scenarios that reflect outcomes below, on par, and above expectations. To evaluate these alternatives, I have factored in a 50-basis point adjustment both upward and downward from the costs of capital and perpetuity growth rate, aiming to derive a range of fair values for each scenario.

As a baseline, I considered a cost of capital of 8.5%, drawn from a peer group comprising ten established car manufacturers such as BMW (OTCPK:BMWYY), Mercedes (OTCPK:MBGAF), Toyota, and newer electric vehicle companies including Tesla and Rivian (RIVN). Additionally, I incorporated a perpetuity growth rate of 1.5%, which serves as a conservative estimate based on a weighted average of historical GDP growth tied to sales in respective countries.

Given the significant uncertainty surrounding future sales, I adopted a more cautious approach, projecting slower revenue growth for the years 2024, 2025, and 2026. For 2022, my revenue projections are conservative, aligning with the lower end of guidance, while anticipating accelerated growth in 2023 as supply chains improve. Notably, Volkswagen has already achieved EV profit margins on par with their Combustion-engine vehicle counterparts, leading me to consider a long-term EBITDA margin of 14% as a realistic scenario, consistent with historical data.

Based on these assumptions, my model estimates a fair value of $232.37 for Volkswagen’s stock, representing a potential upside of 43.6% from its trading level on May 19th.

Risk Factors

While Volkswagen presents an enticing investment opportunity, several risk factors should be considered. First, there is the potential for increased competition in the EV space, as other automakers strive to gain market share. Additionally, supply chain disruptions and semiconductor shortages could continue to impact production and hinder Volkswagen’s ability to meet growing demand. Furthermore, regulatory changes and shifts in consumer preferences could pose challenges to Volkswagen’s long-term growth and profitability. It is essential for investors to monitor these risks and evaluate Volkswagen’s ability to navigate them effectively.

Conclusion

Volkswagen’s strategic pivot towards electric vehicles positions the company as a formidable contender in the rapidly growing EV market. With a substantial investment in EV technology and a strong presence in key markets like China, Volkswagen is well-positioned to capitalize on the increasing demand for EVs. Despite temporary supply chain challenges, the company’s resilient performance, attractive valuation, and potential for future growth make it an appealing prospect for investors seeking exposure to the evolving automotive landscape.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.