Kazakov_Volkswagen Fewings

Western Washington University

Volkswagen AG (VOW)Financial Analysis

Aleksandr Kazakov

MBA 541

Professor David Fewings

10/28/14

Executive Summary

Volkswagen is a well-known German automaker and owner of several well-known car

manufacturers such as Porsche, Lamborghini, and Bugatti. Over the last 5 years, VW has posted

incredible growth numbers, nearly doubling their revenues from €105 billion in 2009 to €197

billion in 2013. The bulk of this growth was achieved between 2009 and 2012 as the economy

was rebounding from a global recession. In 2013, VW only posted 2% growth as the global

automobile market stabilized. By 2023, VW is projected to earn over €240 billion in revenue and

net income of €11.3 billion. Ratio analysis show that VW is liquid for an auto company with a

current ratio of 1.03. Only 38% of VW’s assets are funded by debt, and its debt to equity ratio

has decreased from 1.53 to 0.95 over the last five years. The firm’s return on equity and return

on invested capital are at 10% and 3% respectively, significantly down over the past year. The

financial analysis shows that the current stock price of €220 is much lower than its fair value of

€384 meaning that it is a good time to invest. The company is in good shape moving forward.

Despite taking a hit due to the slowdown of the European economy, VW is positioned well in

emerging markets in Asia, South America, Eastern Europe, and North America. Powered by a

culture of research and innovation as well as ambitious leadership, this well diversified company

set for success and is one that investors should invest.

Company Background

Volkswagen Auto Group, headquartered in Wolfsburg, Germany, is Europe’s largest carmaker

and the second largest auto manufacturer in the world behind Toyota. In 2013, Volkswagen

delivered 9.7 million cars to their customers giving them a 12.8% share of the world’s passenger

automobile market. In Western Europe alone, one out of every four new cars sold is made by the

VW group2. Today, Volkswagen owns twelve brands including Audi, Porsche, Bentley, Bugatti,

Lamborghini, and the motorcycle company Ducati. Such a wide range of brands allows VW to

operate in markets ranging including luxury cars, sports cars, commercial vehicles, and small

low-consumption cars. In addition to manufacturing cars, VW produces engines, turbines,

compressors, and transmissions for marine and industrial purpose. The company also offers an

array of financial services including banking, leasing, financing, and insurance. In 2013, VW had

sales of over € 197 billion and profit of € 9.1 billion.

Volkswagen was founded in Germany 1937 with the purpose of producing the “people’s car” or

the Beetle as it is known today. After World War 2, the company grew at a rapid pace and

introduced iconic models such as the Passat and Golf. In 1965, VW began their strategy of

making acquisitions when they purchased Audi, which was followed by acquisitions of SEAT in

the 80’s and Bugatti, Lamborghini, Bentley, and Skoda in the 90’s. The Company continued this

into the new millennium acquiring Scania, MAN, and Porsche. Since 2007, Volkswagen has

been run by Martin Winterkorn, an ambitious and dynamic CEO whose plans include making

Volkswagen in the world’s largest automaker by 20184 . His recent moves include rapidly

expanding VW’s production capabilities by building new assembly plants in China and the U.S.

Financial Analysis

Common Size Income Statement Analysis Appendix A

Looking at the historical common size income statements from the past 5 years, we see periods

of extraordinary growth followed by a dramatic decrease. From 2009 to 2012, the company’s

revenues grew by 21%, 26%, and 21% respectively. However, from 2012 to 2013 the revenue

growth decreased to a modest 2%. After doing some research, I discovered that the rapid growth

was a result of Volkswagen’s expansion into China and other Asian regions that had become

their largest market 3. The decrease in sale in 2013 was a result of a continent-wide economic

downturn in Europe as well as a slowdown in the U.S., VW’s second largest market. The

economic downturns also caused poor sales in South America and an 11% decrease in sales in

India. Overall, the automobile market began showing signs of stabilizing after five years of

significant growth worldwide.

The common size income statement for Volkswagen shows the cost of revenue decreasing from

87% in 2009 to 82% in 2013. This may be a result of economies of scale as sales have almost

doubled over the past 5 years, and has helped increase the gross profit from 13% to 18%. This

increased profit margin can allow Volkswagen to spend more on marketing their vehicles or

spend it on other investments.

Another area of interest within the common size income statement is Other Income. We see other

income grow from 9% to 13% from 2009 to 2012, and suddenly drop to 5% in 2013. A similar

trend happens with net income from continuing operations as it grows from 1% of sales to 11%

in 2012, and then drops to 5% in 2013. It is unusual to see such high numbers from other income

on a balance sheet, but because Volkswagen owns so many carmakers it is possible that this

number is the collective other income from all of their subsidiaries. The downturn in other

income could also be explained by the stabilization of the automobile market in 2013. All other

income expenses remained fairly level. Net income to sales for Volkswagen decreased by 6% in

2013 to 5% of sales after growing from 1% to 11% of sales from 2009 to 2012. The main

contributor to this drop was the drop in other income as well as decreased growth from over 20%

a year to 2%.

Ratio Analysis

Financial Ratios can give us important information that can be used to compare the firm’s

performance to its previous years and to its competitors. Ratios can help assess a firm’s liquidity,

operating profitability, financial decisions, return on equity, and market value.

Liquidity Appendix C – Volkswagen’s current ratio for 2013 is 1.03 meaning that they are in

decent financial health and will be able to pay their current liabilities. However, it is

concerning the ratio has been declining every year from 2009 when the ratio was 1.12.

The firm’s quick ratio has also been on the decline from 0.92 in 2009 to 0.79 in 2013. A

0.79 ratio means that the firm has fewer liquid assets than current liabilities meaning that

it will not be able to cover all of its liabilities without touching inventory. Volkswagen’s

cash ratio is currently 0.32 and has been floating around 0.30 for the past five years with

a jump to 0.65 in 2012. A generally accepted rule states that a healthy cash ratio is one

over 0.50, meaning that Volkswagen does not carry as much cash as they should. Overall,

this is not a very liquid firm which can make creditors and investors apprehensive about

investing in it.

Leverage Appendix C – Volkswagens debt ratio is 0.38 meaning that only 38% of the

company assets are funded by debt. Generally, a debt ratio over 0.50 means that a firm is

highly leveraged, therefore it is desirable to have a debt ratio below 0.50. The debt to

equity ratio has decreased from 1.53 in 2009 to 0.95 in 2013, meaning the company is

now using less debt to fund their growth than they previously have. On one hand it means

that the company is performing better therefore it does not require as much debt to

finance its operations, but on the other had it can mean that the company is not fueling its

growth.

Profitability Appendix C – The return on invested capital ratio tells investors how much

income was generated for the shareholders equity in the company. Volkswagen’s ROIC

has grown from 1% in 2009 to 10% in 2011, but has dipped down to 3% in 2013 due to

the slowdown in growth. The company’s return on assets has also grown in the past 5

years, but has recently decreased to 3%. The return on equity ratio tells how much profit

is generated from the shareholders’ investment. In 2011 and 2012 we see the ROE at

27%, but in 2013 it decreased to 10% meaning the company is no longer generating as

much profit.

These ratios show us that although the company is not very liquid, it is funded mostly by equity

meaning that it does not have large interest expenses. This may also mean that the company is

not borrowing enough to grow at a high rate. We can also see the effect of the economic

downturn and the stabilization of the automobile market on the company’s profitability.

Pro Forma

The pro forma income statement and balance sheet will use assumptions and trend data to

provide 10-year projections of the company’s future financial performance. To project future

sales, a conservative 2% growth rate from 2012 to 2013 was used as such a large and established

company is unlikely to post growth rates of over 20% as it did in the previous 5 years Appendix A.

Cost of goods sold and general expenses were forecasted using a trend on sales. Other income

was projected by using a historic 5% of sales. It was also assumed that the preferred dividend

will remain level for the next 10 years. Overall, the pro forma income statement projections were

in line with their comparative growth and common size percentages with projected sales of €240

billion and net income of €11.3 billion in 2023.

To project future cash balances, 43 days of sales were used which was equal to the days of sales

in 2013. Short-term investments were very different from year to year in the historic financial

statement, and therefore were used as an asset plug. To project accounts receivable, the 2013

days of sales outstanding ratio of 21 days was used and the previous year’s percentage of sales

was used to forecast the always fluctuating other current assets. A percentage of sales was also

used to forecast net property, plant, and equipment as well as deferred income taxes and other

long term assets. A level projection was used for intangible assets and investments as I do not

foresee any major acquisitions by VW in the near future. Other major projections included

deferred taxes and other long term and short term liabilities which were forecasted using the

average percentage of sales over the last two years. Capital leases and pensions were assumed to

remain the same. Due to my very conservative projections, the balances for the first 5 years of

the pro forma projection dropped below the 2013 balance, and did not match it until 2019. I

believe that it is reasonable to assume a slow growth rate for such a large and established

company as Volkswagen, however these projections could be used to assume a worst-case

scenario.

Beta Appendix E

When calculating Volkswagen’s beta, I used weekly data from the previous seven years. This

gave me a better understanding of the behavior of Volkswagen’s stock in years of slow growth

and years of fast growth. For comparison, I used the S&P 500 index. This resulted in a beta of

0.77 meaning that for every dollar change in the market, Volkswagen’s stock increases or

decreases by 70 cents. Because it is less than 1, we can classify Volkswagen stock as having a

weak relationship with the market. In comparison, Morningstar lists a beta of 0.62 which could

mean that they used an older set of data for its projection. Comparing the beta to that of

competitor Daimler AG, we see that VW’s beta is much lower than Daimler’s 1.79 beta. Looking

at yearly betas over the past 5 years, we see it increase from less than 0.20 to over 1.60 at its

peak in 2012. This shows us that VW has moved from being a low risk company to a very fast

growing one within several years, and has now begun its downward trend again.

WACC Appendix F

Volkswagen’s weighted average cost of capital was estimated by first calculating the proportion

of the company financed by debt and equity. The results showed that one third of the company

was financed by debt and the rest by equity. Using a marginal German tax rate of 30%, a beta of

0.77, and a market risk premium of 6.2% 1, I calculated the cost of equity to be 10.1% and the

cost of debt to be 5.5%. Using a risk-free rate of 3.6%, I was able to calculate a weighted average

cost of capital of 8.23%

FCF Appendix D

In order to properly value a firm, it is important to project its future free cash flows. I chose to

use net income instead of EBIT multiplied by one minus the tax average because operating

income did not include large amounts of other income. The reason behind this may lie in the

differences between European and American accounting standards. To calculate Volkswagen’s

future free cash flows for the next 10 years, I subtracted increases VW’s asset operations

accounts from net income and added increases in the liabilities and equity operations accounts.

Using the cash flows, I was able to calculate a fair value per share of €384.00, €160.60 more than

the most recent trading price of €220.00. Using my calculated fair value, I was able to calculate

the firm value by multiplying it by VW’s 295.09 million shares outstanding giving me a firm

value of €113.2 billion Appendix G.

Monte Carlo Analysis Appendix H

In conducting the Monte-Carlo analysis, I tested the effects that various assumptions made in the

pro-forma income statement and balance sheet affected the estimated value per share. To

standardize the results, I chose to use a normal distribution and calculated standard deviations

based on the past five years of data. For projections made on a trend of sales, I used a 0.1

standard deviation. The resulting distribution was then used to explain the uncertainty of the

assumptions and estimated fair value per share.

The first thing that I noticed about the distribution was that it was fairly wide with maximum

value of 686 and a minimum value of 96 with a standard deviation of 93.15. The mean however,

was 383.61 that was just below my calculated fair price of €384. The wide distribution may be as

a result of VW’s inconsistent sales trend where after growing by over 20% annually from 2009

to 2012, the growth rate dropped down to 2% in 2013. The input that had the most effect on

stock price was SGA expense with a maximum of 498.57 and a minimum of 276.88. Cost of

revenue also had a large impact with a maximum of 483.94 and a minimum of 293.86. Both of

these inputs have a positive effect on the stock price. Other operating expense has an upper limit

of 464.7 and a lower limit of 299.31 and had a negative effect on the stock price. Inventories,

receivables, and other income all had very low impact on the value of the stock. Receivables had

a negative effect, inventories had a positive effect, and other income had no impact on the stock

value. In the end, all of the inputs had distributions that contained the fair value of the stock. The

mode and the median for the entire distribution were 414.43 and 383.03 respectively.

SWOT Analysis

Strengths – Volkswagen AG’ has a very broad product portfolio that helps to drive its growth.

The Group produces automobiles for virtually every segment of the market from motorcycles to

cars to commercial vehicles such as busses and trucks. Their variety of brands at different price

points helps them stay competitive across different market segments and leverage the strength of

their It also allows them to maintain a strong presence in key markets around the world including

Western Europe, China, Brazil, US, Russia, Argentina, and Mexico. As of 2014 VW has market

shares of 34.5% in Germany, 24.8% in Western Europe, 15.7% in Eastern Europe, 4.8% in North

America, 17% in South America, and 12.9% in Asia. This gives them a worldwide market share

of 12.8% 6. Finally, they focus strongly on research and development as well as expansion and

improvement of their product portfolio that helps them maintain their leadership across various

segments7. New products in their pipeline include a joint venture with Shanghai Automotive

Industry Corporation as well as a Bentley SUV.

Weaknesses - VW has recently been plagued with frequent product recalls. In 2013, the group

recalled 2.6 million cars worldwide in November, 26,000 in June due to gearbox issues causing

loss in acceleration, and 384,181 in March due to defective direct-shift gearboxes8. Constant

recalls and technical issues technical issues not only decrease customer satisfaction and trust in

the brand, but also show that there may be an even greater problem with VW’s quality control

systems. Correcting these quality issues is essential to maintain sales volume and growth.

Although one of the Group’s large brand portfolio is one of their strengths, it can also be one of

their weaknesses. A low performing can have an impact on the performance of the entire

company. In 2013, sales of passenger cars decreased 3% from 4,850,000 to 4,704, 000. This

correlated with a 1.4 % drop in Skoda sales and a 1% drop in the sales of commercial vehicles9.

Opportunities – Recent trends associated with environmentally friendly hybrid and electric cars

have played to VW’s advantage. There is strong demand for hybrid and electric vehicles in the

U.S., Western Europe, and Asia and according to the International Energy Agency; demand for

hybrid vehicle will reach 6.6 million units by 202010. Over the years, VW has been known for

producing small fuel efficient vehicle and has made significant investments in hopes of

capitalizing on this segment. Another opportunity lies within the economic recovery of the U.S.

Auto sales have increased from 10.4 million in 2009 to over 15.6 million in 2013, and are

expected to reach 17 million in 201711. A strong U.S. economy will can boost VW’s sales and

market share. The Chinese market also offers potential for long term growth. In 2013, auto sales

in China rose 14% to 22 million and are predicted to reach 31 million by 2020. Growth of the

Chinese and U.S. economy can help VW expand and achieve its goal of becoming the world’s

number one auto company by 20185.

Threats – One of the threats facing VW is the European economic environment. Economic

conditions have caused sales to drop to 11.5 million, the lowest point in the last 20 years.

Demand in France and Italy dropped 5.6% and 7.1% respectively. Much of the decline could be

attributed to the debt crisis facing several countries in the European Union, weak economy,

unemployment, and uncertainty of the future12. Therefore, while VW experiences growth abroad,

the downturn in its major market can put pressure on the company. There is also the constant

threat from the competition. The highly competitive automotive industry is likely to become

even more competitive as manufactures move towards globalization and consolidation. It is

important for VW to stay ahead or at least keep pace with the industry developments in regards

to manufacturing, safety, reliability, economy, and customer service to stay competitive and

remain as one of the top automakers in the world. Although environmental awareness is an

opportunity for VW to develop new technologies, it can also be a hindrance to their current

operations. Strict emissions regulations in the EU, particularly for diesel engines, can result in

additional development, manufacturing, and testing costs that could affect the overall margins13.

Porters Five Forces

Bargaining Power of Suppliers – Low

The differentiation among suppliers in the auto industry is very low as they are dealing with

commoditized materials. This makes switching very easy for large companies like VW. That

being said, the large number of automakers can help the supplier find another customer quickly.

Despite this, big automakers can dictate terms to suppliers as they provide them with a lot of

business which would be lost if a large automaker passes them up for a competitor.

Bargaining Power of Customers – High

The sheer amount of automobile brands available on the market gives the consumers many

options to choose from. Low switching costs and long purchase cycles make it vital for the auto

firms to secure customer preference and loyalty through discounts, promotional offers, and brand

image. Consumers generally hold very strong opinions and beliefs when it comes to car

purchases, as it is such a large and long-term investment. This drives the automakers to innovate

and expand their offerings to better serve the consumer needs

Competitive Rivalry – High

The automobile industry is very competitive with rival firms battling in very market segment.

The industry is highly concentrated led by a handful of large multinational car companies. Firms

frequently copy each other’s innovation and designs. Automakers look for any way possible to

elevate their brand in the eyes of consumers as they pursue a larger share of the market. These

include new specifications, fuel mileage, comfort, reliability, and many others.

Threat of Substitutes –High

The sheer number of automakers and brands in the world, make potential substitutes a serious

threat to VW. Only in Germany, VW has to compete with BMW and Daimler-Benz for market

share. Expanding into Asian markets puts the company at risk to piracy to imitators who can

manufacture a virtually identical product but sell it for much less. In low wage countries as well

as large cities, people often use public transportation, motorcycles, or bicycles instead of cars.

This threat is especially high during high oil prices or slowdowns in the economy.

Threat of New Entrants – Low

Entry into the automobile industry is very difficult as it would require heavy investment in

patents, facilities, production, and product development. A new entrant would also require highly

developed processes, supply chains, and distribution networks to compete against large players

in the market. An example is Tesla Motors which after being founded in 2003, did not have its a

profitable quarter until 2013.

Recommendation

Volkswagen has recently been through a setback due to a decline in the economy. The drop in

global auto sales drastically affected its sales growth. However, the company remains strong due

to its diversification and ability to generate other income apart from its auto sales. Owning

brands competing in every segment of the auto industry helps protect Volkswagen from rapid

changes in consumer preferences. Although the company is not very liquid, it is also not very

leveraged and finances one third of its operations with equity. Looking at its beta, we see that its

stock is not very volatile to changes in the stock market. Although the company growth has

slowed down, it has shown bursts of rapid sales growth in the past several years. The company’s

management is ambitious and dynamic striving for a high goal of becoming the number one

automaker in the world. Overall, the analysis showed that Volkswagen AG’s stock is currently

undervalued as it trades at €220 while the estimation provided by this analysis values it at €384.

Thus, my recommendation would be to invest in VW stock.

Works Cited

1. "Financial Control System of the Volkswagen Group." (2009): 1-41. June 2009. Web. 28

Oct. 2014.

2. "The Group." Volkswagen Group. Volkswagen AG, n.d. Web. 28 Oct. 2014.

3. Szczesny, Joseph. "VW Maintains Global Growth Pace." TheDetroitBureaucom RSS.

N.p., 13 Nov. 2013. Web. 29 Oct. 2014.

4. Schultz, Johnathan. "Volkswagen Extends C.E.O. Martin Winterkorn's Contract." Wheels

Volkswagen Extends CEO Martin Winterkorns Contract Comments. N.p., 4 Jan. 2011.

Web. 29 Oct.

5. "Volkswagen AG SWOT Analysis." Volkswagen AG SWOT Analysis (2014): 1-

9. Business Source Complete. Web. 30 Nov. 2014

6. "Volkswagen AG." The World Economic Forum. N.p., n.d. Web. 30 Nov. 2014.

7. "VW Conquers the World." The Economist. The Economist Newspaper, 07 July 2012.

Web. 28 Nov. 2014.

8. Limbach, James. "VW Recalls." ConsumerAffairs. Consumers Unified LLC, n.d. Web.

30 Nov. 2014.

9. "Volkswagen Eyes Passenger Car Sales Growth in the U.S." Forbes. Forbes Magazine,

28 July 2014. Web. 30 Nov. 2014.

10. GLOBAL EV OUTLOOK (2013): 1-41. Apr. 2013. Web. 30 Nov. 2014.

11. O'Leary, Madeline. "U.S. Auto Sales Poised for Sixth Straight Year of

Growth." Bloomberg.com. Bloomberg, 18 Nov. 2014. Web. 28 Nov. 2014.

12. "Western European Car Sales Rise 6% in September." Automotive News Europe. Crain

Communications Inc, 6 Oct. 2014. Web. 30 Nov. 2014.

13. "Reducing CO2 Emissions from Passenger Cars." European Commission. N.p., n.d. Web.

29 Nov. 2014.

Appendix

A

B

C

D

E

F

G

H

@RISK Output Report for Value Performed By: Windows User

Date: Wednesday, February 25, 2015 11:36:42 AM

Workbook Name Kazakov_VolkswagenMBAedit.xlsx

Number of Simulations 1

Number of Iterations

Number of Inputs 7

Number of Outputs 1

Sampling Type Latin Hypercube

Simulation Start Time

Simulation Duration

Random # Generator

Random Seed

Statistics PercentileMinimum 96.30741043 5% 231.56389

Maximum 685.7492295 10% 263.01439

Mean 383.6126815 15% 286.74662

Std Dev 93.14615683 20% 302.23226

Variance 8676.206533 25% 320.75281

Skewness 0.086019994 30% 335.61568

Kurtosis 2.891365087 35% 349.07995

Median 383.0286282 40% 359.76203

Mode 414.4267347 45% 370.28231

Left X 231.56389 50% 383.02863

Left P 5% 55% 393.8912

Right X 542.7597325 60% 404.09386

Right P 95% 65% 414.72839

Diff X 311.1958426 70% 428.88393

Diff P 90% 75% 442.7672

#Errors 0 80% 463.86015

Filter Min 0% 85% 482.15553

Filter Max 100% 90% 505.68534

#Filtered 0 95% 542.75973

Rank Name Lower Upper1 SGA Expenses 276.87963 498.57144

2 Cost of Revenue 293.85839 483.94476

3 Other Operating Expenses299.31448 464.69995

4 Receivables / Plug368.73914 394.15274

5 Inventories / Plug374.2651 398.5579

6 Other Income 374.24917 395.25107

Simulation Summary Information

Change in Output Statistic for Value

1000

2/25/2015 11:35

00:00:02

Mersenne Twister

99

Summary Statistics for Value