Friday, 29 January 2010

Company Focus – VW AG – St James's and the Giant Piech

VW Share Price (@ 12.36pm 29.01.2010)
- Ordinary : Euro 64.96
- Preference: Euro 57.54

From the Upper East Side and St James's comes news that members of the hedge fund industry have been considering how best to buoy their own coffers, heavily sunk in part by what they consider misrepresentation by Porsche management at the time of the intended VW buy-out.

As history has shown, that intention was given a swift about-turn as over-extended by debt, Porsche was swallowed by VW AG. A second critique comes from institutional investors, concerned at the price VW is paying for Porsche Holdings AG, with the conjecture that the Piech and Porsche families will be the major beneficiaries at the cost of large shareholders.

In Germany, where the machinations of industrial engineering meets financial engineering, Prof. Ferdinand Piech sits centre-stage seemingly unperturbed.

Unquestionably the strongest of the Europeans presently, VW's 2009 turnover has been greatly assisted by still relatively strong sales in its Chinese & Brazilian strong-holds, add to which the benefit provided as a substantial recipient of EU scrappage schemes. The VW Group, its core and satellite brands and a now well entrenched with eco-sub-brands assisting (eg Bluemotion, GreenLine etc) could be argued as having to date largely won the eco-perception battle amongst the public. This volume & profile mix ensured VW had a record number of deliveries in 2009 at 6.29m units (+1.1% YoY). As such VW presently 'sits pretty'.

Beyond the market sqawk, VW has auto-sector strength, in terms of market share, model mix, pricing power with consumers, the introduction of the low-cost A3 platform, industry leading flexible manufacture across sites, and on the back of these the ability to drive economies of scale with international component suppliers relative to local and Euro FX conditions.

Moreover the stated cross-sharing alliance with Suzuki is a positive sector-shifting move. It obviously chosen as a pragmatic alternative to the heavy investment required, and long-pay-back period of a new, advanced tech, small car programme (ie Up! In contrast to 2nd world Fox). We suspect it's manifest agenda was two-fold: To protect still highly prized liquidity on the balance sheet and hasten the launch of a market leading small car under Polo.

At the strategic level, beyond a reduced cost option versus domestic development, the alliance also creates geographic, further fiscal and strategic options and opportunities: Piech has witnessed Machionne and Ghosn develop direct and indirect Indian ties with respectively TATA and Bajaj, and shrewdly sees a possible greater value-adding multi-play via Suzuki with:

1. Europe – possibly replaying the PSA-Toyota manufacturing alliance in a CEE location
2. India – piggy-backing Suzuki-Maruti presence in manufacturing and distribution.
3. Japan – dual forces with enhanced VW presence to take advantage of Toyota woes.
4. S. America – dual forces to squeeze VW competitors (esp Ford & FIAT)
5. Financing – Ability to tap liquid Japanese banks at 0.1% base-rate thru' probable weakening Yen
6. Strategy – Ability to tap into Suzuki's broad and deep 'cars to quads to motor-cycles' capability.

In short, as Europe starts to enter its own 'Kei' car' era, VW wishes to leverage learning and synergies from perhaps the world's best small car maker with expansive personal mobility reach.

Within its core of Western Europe it identifies the A & B segments as its prime targets, given what it sees (or perhaps likes to purvey) as a lack of variant model presence across: notchback, estate, MPV, van , coupe, cabrio & roadster variants.

Q309 reported data shows that VW Group holds #1 in Germany( with 21% market share) , China & Brazil and holds 11.7% of global TIV (up from 10% YoY), but warns of caution for 2010 even if well placed in EM markets such as India and Russia.

The VW brand shows success with Jan-Sept 09 deliveries up 1.5%, September of major benefit seeing a 22.8% (extra-ordinary) single month rise (mainly due to local & global scrappage incentive schemes for lower CO2 emissions smaller cars . Internationally Gol maintains its performance in Mercosaur region whilst in China Jetta, (Newish) Lavida and Passat benefit from the both return 'loyalty' purchases and 'flight to safety' migration from other newer (less proven) Chinese domestic automakers.

In recent presentations (ie Hans Dieter Potsche) VW tries to demonstrate how it created firm foundations through the boom period. This then provides room to proactively manage through the economic trough and maintain focus upon the typical efficiency levers:

a) “Working Capital optimisation” via efficacious inventory management,
b) “Constant CapEx review”,
c) “Maximise Liquidity”,
d) “Cost Discipline”,
e) “Flexible Labour Contracts”,
f) “Managing Production Capacity”.

The Q309 report stated an increased CapEx to Sales Revenue quotient of 5.7% (from 4.9%), now quoted as industry standard, is largely the result of the ratio-effect due to declined sales revenues

VW states that E25.8bn is to be invested over next 3 years (2010-1012), of which E19.9bn CapEx directed at property, pant and equipment. Approximately E10bn of that will be spend directly in Germany, presumably to demonstrate its commitment to the German people and importantly grow favour with Lower Saxony (its 20% 'supervisory' shareholder).

VW Group's product strategy foundations will continue as normal with a "multi-brand modular matrix" strategy previously seen with the A4 platform since the mid 1990s, now extended in technical sophistication and model reach with the slightly smaller FWD A3 platform set (known as MQB) [with the larger RWD set known as MLB]. This includes greater integration of automatic gearboxes which highlights the ambition toward greater US and non-EU mix.

New plant and equipment acquisition and investment are noted relative to construction of a new USA plant due for 'SoP' in 2011, and Porsche (platform & capability) integration with its purchase of the Karmann Osnabruck (niche vehicle) site.

However, amongst the positive SEAT continues to struggle and is the Achilles heal of the group, its offering of married practicality & sportiness effectively unrecognised due to lack of brand resonance amongst consumers. However, after decades of various motorsport campaigning, SEAT has had 2009 WTCC success, the most high profile of which were #1,#2,#3,#4 positions at the Brazilian round. This theoretically creates a launch-pad for the brand in Brazil, with the possibility to leverage SEAT's cultural connections to the 'old world'.

With few other automakers as well placed we conject that Ferdinand Piech will be using his strong corporate performance, with liquidity, to combat institutional investor concerns regards over-payment for the Porsche division. However, it is that corporate liquidity that has also drawn the eyes of the aggrieved US hedge funds and the reported considered $1bn filing.

It is conceivable that this action has been stirred so as to both gain much sought after cash - given the level of recent fund withdrawls - from VW, and to possibly dampen the present Porsche share price so that hedge-funds could purchase Porsche stock at a discount prior to the beginning of the VW's own Porsche stock buy-back. Thus ironically possibly using VW sourced cash to purchase a hiked Porsche stock to help compensate for the original massive losses.

However, recent news highlights that it is the UK's St James's players that prefer a less confrontational approach. There is still much value left in the giant VW 'peach', it appears both St James's and Prof. Peich well recognise that fact.