Saturday, 29 May 2010

Companies Focus – The Western 8 – BMW AG: A Lean Tuned 4 Cylinder Building

After what has been within BMW history a tumultuous 2 year period between late 2007 and late 2009, the iconic “4 Cylinder” corporate building depicts a slightly leaner-tuned BMW AG. And whilst renowned for its silky-smooth powerful straight-6, the 4-cylinder is a highly apposite sign of down-sized times - the downsizing of engine capacity and engine architecture a powerful emergent trend.

But of course whilst dominant over Munich, BMW AG is far more than a single city entity, with proven production success in South Africa, USA, China, the UK and elsewhere. And whilst undoubtedly Munich-centric, it has reached-out beyond the archetype Germanic-mentality, with the sub-division BMW Group DesignWorks expanding beyond Munich & California with recent opening of a Singaporean centre to both gain consumer cultural input from Asia and broaden its own non-auto product design client base.

Yet whilst BMW has such R&D tendrils, aswell as of course the BMW-Welt centre, it is the prime Car, Motorcycle and Finance divisions to which investors must pay greatest attention to. Other organisational elements, no matter how supposedly interesting, are of a distant secondary importance. Without doubt, whichever complementary functions boost the corporate divisions performance on a quarterly basis is good for the Group en mass, but such cost centres must be constantly reviewed to critically assess cost-benefit.

In the end it is only the numbers that matter, as both investors and the Quandt family owners well know. It may well be the RHS week at Chelsea in London, where the great and the good of high finance meet, but nobody will be led up the garden path or down a dead-end road.

Thus the fact that AGM of 18th May saw 99.99% investor approval for the current BMW exec board and supervisory board spoke volumes for the way large-scale investors viewed BMW's handling of the last 2 years and its position looking forward.

Q1 2010 Performance -

BMW AG's Q1 report highlights the positive change in market circumstances versus a year ago, improved credit access for business and private customers in the west, aswell as the ongoing strength of BRIC+ economies. In all car deliveries were up 315,614 units YoY versus 277,264, so up approximately 14%, whilst motorcycle deliveries too gained with 20,840 units versus 17,232, so up approximately 21% (excluding Husqvana production). Likewise car production was boosted, 320,061 units versus 267,637 units, so up 19.6%, yet motorcycle production remained virtually flat at 30,222 versus 29,111, up 3.8%. These figures presumably demonstrate the level of cars' inventory run-down and re-stock, whilst motorcycles, typically with greater inventory levels at manufacturer and dealer levels maintained a steadier pace.

Importantly this was achieved with a workforce reduction of -3.4% YoY, illustrating restructuring efforts.

Accordantly, top-line revenue grew to E12,443m from E11,509m, and the Group EBIT grew to E449m from E-55m YoY, this made up from Cars' E291m from E251m, Financial Services' E213m from E70, Motorcycles' E32m from E28m, Other Entities E7m from E12m, whilst Eliminations reduced slightly to E-94m from E-96m. At Group level that gave a PbT of E508m from E-198m, with – as seen - the greatest turnaround contributions gained from Cars and Financial Services.
The PaT was E324m from E-152m, giving a similar E0.49 dividend per Ordinary and Preferred share, up from the E0.23 &E-0.23 of the parallel quarter a year previously.

Whilst BMW talks of its expanded vehicle portfolio including X1-series, 5-series GT, Active-Hybrid X6 & A-H 7-series, these models given their launch newness have contributed little in reality. The turnaround revenue 'pulling power' came from 7-series, new 5-series, and critically the efficient inventory and sales management of run-out 3-series. Mini helped to a lesser degree than many (except investment-auto-motives) expected, with essentially flat sales across Cooper & Cooper S, but marked upturn – even though still low figures – for the Base car. Mini reached approximately 49,500 units in Q1 over 43,600 units for Q109, which if annualised shows a 200K capacity for the platform, thus showing inefficiency versus industry norms, and illustrates the need to expand the production capacity of the base; hence Nini Countryman and evolved other BMW compact car variants (see below).

All assisted by the fact that BMW Financial Services was able to access far healthier capital markets between Q309 and Q1 2010, so able to offer improved terms and conditions to customers whilst also allowing BMW to recapture returned cars which it could price to sustain general worldwide residual values.

The Financial business itself generated 7.4% more business over the preceding comparable period, with 243,343 new contracts signed - of which approximately 29% derived from leasing and approximately 71% from credit provision. However, the newly re-opened credit markets meant greater funding options for many customers, and as a result BMW sourced financing dropped by -1.1% on BMW sold new cars. Likewise, its used cars sales saw BMW sourced financing drop by -1.8%. Both would ordinarily be areas for concern, but investment-auto-motives believes that BMW tends to require greater credit-worthiness from its clients and so should see less loan defaults and so returned vehicles compared to less stringent other premium & mass manufacturers. However, general lease & credit figures amongst new and used were lower than expected and should be addressed.

Insurance product sales improved by 14.1%, again typically indicating the tied-in nature of such products with lease and credit deals aswell as the more responsible nature of the BMW client demographic.

Strategy -

BMW has long been seen as the profitability star amongst mass manufacturers, but recent years have witnessed it lose its product conviction, with conflicting portfolio management examples of product convention versus product exploration and proliferation so as to safeguard its core lines yet also compete in new segment territories. However, the company recognises the challenge ahead and set out 'Strategy #1' previously which obviously is set to both improve operational efficiencies and expand sales numbers.

Of particular note is its lacklustre impression on the compact car market after a less than successful acquisition of Rover Cars in the early 1990s, divestment of the Rover Group business with retention/re-creation of Mini as a premium small cars, and under-achieving efforts with its own 1-series, a cramped and initially visually contorted car. A new direction has been set for the conquering of the small car premium segment. Initially eyeing the benefits of alliance ventures with other manufacturers, BMW has rightly instead chosen to exploit the technical and marketing in-roads made by Mini and 1-series, FWD & RWD platforms.

The decision to retain independence means these adapted platforms will furnish a twin-pronged attack on the compact segment, providing both 'space efficient' and 'performance proficient' solutions that can respectively match and beat the benchmark cars at either end of the practical to sporty compact requirement. Thus a new FWD-RWD modular platform is being created with nominal forecasts for 600-800k units p.a., resultant from the synergies of next generation Mini and 1&3-series platforms. Here, the new Countryman's architecture may well be used to offer FWD, RWD and AWD set-ups. Technical management at BMW's Fitz R&D centre will undoubtedly be relieved that the company's NPD culture and processes will remain untainted by external demands or limitations, which may have been the case under an alliance agreement given profitability and time to market demands.

investment-auto-motives welcomes the route chosen which exploits the leverage of proprietary technologies (including now carbon fibre structures), provides scale-efficiencies, does not undermine all important R&D vision and firmly maintains marque identity given its lineage.

Recent debate has improperly aligned BMW and Daimler compact car answers, hinting that both should seek alliances. Daimler's own dilution and move away from original A-class's unique architecture into today's conventional package for A & B class means that it should seek-out alliances to both import more cost-effective 'parallel performance' items, aswell as possibly license its own proprietary technology to the worlds old and new car-makers, as it has done in the past with the likes of Ssangyong.

In short BMW must 'Dominate' to maintain its independence and Quandt family investment-holding demands, whilst Daimler should 'Infiltrate' to further integrate itself into future global design, supply and production needs internally and externally to demonstrate its 'Engineering Excellence' and continued 'Global Grasp'. By doing so it would follow in Audi's footsteps given its adoption of the very conventional Polo platform – and basic rear suspension - for the new A1. Thus whilst Audi and Daimler have greater 'brand latitude' for 'technical generalism', BMW appreciates that it does not; especially not so given its foray into FWD propeller badged cars and probable accusations of hypocrisy for doing so. To deliver a divergent BMW car it knows it must retain its independence.

In an effort to illustrate its future-thinking in personal transport BMW has seemingly moved forward with the MegaCity car project, the important step being the acquisition of a carbon-fibre structures company named SGL Automotive, with an intent to seemingly replicate the Daimler Smart ForTwo effort in both creating a leap-forward vehicle and creating a hub-system production centre. BMW though apparently seeks not only a Leipzig EU build centre, but one in the US at Moses Lake, Washington State, undoubtedly keen to demonstrate its eco-credentials to Washington DC regards green-funding and importantly future CAFE related structures and possible tax-breaks. [NB see also FIAT-Chrysler's own reported R&D efforts in the Seattle area].

Operations -

Looking forward the highlighted new model launches whilst of high margin will be of limited volume, greatest contribution in the vehicle mix to be made from X1 (now 8 months old), 7-series, the aforementioned 5-series and face-lifted 3-series, the greater level of platform sharing between the 5 & 7, and 5 & 3, assisting per unit margins at ex-factory level.

The Touring 5-series variant will buoy income in Q3, as will Mini Countryman, yet whilst internal forecasts for 5-series is no doubt well honed given historical precedence, investment-auto-motives has concerns that Countryman forecasts, and so ultimate contribution, may be less reliable given the possible 'Mini-fatigue' of EU markets – remember perceived to be little changed since 2000 – and so directed at the US, Japan and Asia as a trendy “big little car”.

Within the EU its £17K+ price range may be too expensive for singletons and as the 2nd car, whilst families that buy Japanese soft-roaders and European MPVs etc may be turned off by its comparative impracticality and the ubiquity of the Mini badge in the smaller siblings which pepper the UK, Germany and elsewhere. Even with 4WD the model may need more consumer traction with a tide of advertising and marketing initiatives beyond the present “Life is Out There” YouTube campaign, which only adds to European regional S&M costs and corporate cash burn.

The Mini Coupe and Roadster concepts, although to be produced in far smaller quantities, may also require marketing support. The Coupe's unique cant-rail aesthetic, C-pillar treatment and integrated aerofoil should mark it out as a must-have car for a certain demographic replacing Cooper or Cooper S, but the Roadster although visually cleaner than the 4-seater convertible adds little else and reduces practicality, but importantly both cars face stiff competition from bigger transformable coupe-convertible cars from other manufacturers.

Rolls-Royce has experienced a large decline in Phantom sales over the last year or so given the after-effects of the financial crisis; less so an effect of its age given its iconic status. The £192,000 Ghost was always intended as both a new sporting dimension to the Rolls marque aswell as a cyclical off-set, and so its time in the spotlight has come, an interesting case-study given its head-to-head to Bentley's new £220,000 Mulsanne sedan. Though neither 'won-out' distinctly in press comparison write-ups, the distinct feeling on the ground probably reflects BMW vs VW expectations in that the Rolls will gain greater popularity amongst ('nouveau riche') conquest clients whilst the Bentley will retain its brand-loyal ('old-money') clients. [This an interesting about-turn of events after Phantom's capture of the Establishment and Continental GT's capture of the more recently wealthy). Of importance for BMW will be the small yet still critical level of Phantom returns trading down or 'across' to Ghost, adding little revenue contribution given the £100,000+ differential much of which swallowed in depreciation, yet maintaining customer loyalty. As stated previously in the Q3 report, Rolls Royce will be under pressure to maintain used Phantom residual values to both prop-up new car values and provide stationary asset-values to its dealers.

Regards the core BMW cars business, and the South African Rosslyn plant producing 3-series and has been disrupted by the 3 week strike action by staff at Transnet – the state owned logistics company. Inbound raw materials and parts aswell as outbound finished cars for export have been disrupted, yet thankfully for BMW its lower capacity and devaluation of the Euro versus appreciation of the Rand means any excess export demand during the period is well soaked-up by German plants.

The motorcycle market has broadly been down 12% or so YoY across the Triad, with the only real growth in small engine capacity bikes in Asia, S.America and Spain. Thus the 500cc+ segments look to stay deflated and flat for the immediate future, down -20% YoY, a blow to BMW and others such as Harley-Davidson, Triumph, Norton, Ducatti and the Japanese. A BMW recall of 122,000 motorcycles is being undertaken relative to to 'low failure instance' brake problems on the popular K1200GT. The brake hose replacement process notionally takes only 30 minutes or so, so will undoubtedly be used by BMW to have present clients peruse the new bikes in stock and recall clients will probably be questioned about their interest in bike replacement or accessories upgrade.

BMW financing saw only a 3.2% increase in volume worth of contracts at E5,914m, in what was proven to be a relatively buoyant period versus last year, and so winning new lease and credit contracts without exposing itself to lower quality risk must be a core ambition for Q2 onward; especially so in the best upward trending Americas.

With a reduction over the last 2 years seen in private retail and SME business demand, BMW has had to reach further into (multi-brand) fleet territory. Exacting details of fleet customers are of course confidential and unavailable, but the company must well know it cannot afford to muddy its premium brand image with overt allied-exposure effectively under other 'non-controllable' parties.
Dealer financing arrangements were boosted by 7.9% to E9,635m showing the strength of the factory-dealer inter-relationship, but deposit finance was down -9.2% to E9,627m, the number of custodian accounts down by -6.1% (again, partly foreseen by BMW more severe credit-standing and deposit requirements).

However, versus the likes of VW-Audi with impressive consumer deposit ratios, BMW must improve. Given the similar sums at present it seems that from the big picture perspective that client deposits may be being re-cycled to supply dealer finance. And although wholesale credit markets are contracting again due to the EU sovereign debt concern with spreads increasing, the dealer finance requirement should still be achieved at a lower cost of capital than the lost opportunity to use the client deposit sum as general working capital, added as a cash cushion or other reserve.

Financials -

Group revenues improved, E12,443m vs E11,509m, so up E934,000 set against a constrained CoGS at E10,758m vs E10,457, thus only E301,000, thus showing a basically calculated 2:1 improvement at this top-line improvement.

Headcount has been reduced which bodes well for latter-day overhead cost-savings once the effect of re-structuring costs have been absorbed, yet the pressure to re-stock inventories with newly launched cars and maintain investment rates in plant, machinery and labour-force training has undoubtedly affected cash-flow rates. Of particular note was the reduction in cash-inflow at E1,899m vs E2,426m last year. The cash-outflow rate highlighted the lesser toll of capital investment at E1,245m versus previous E1,702m.

The Balance Sheet depicts an improved high-level picture, with a 2.1% valuation increase since YE2009. Total assets sit at E104,061m vs E101,953. The component elements of the former figure being Non-Current Assets (Long-Term) at E62,846m vs E62,009 at YE, and Current Assets E41,215m vs E39,944m. Unlike the VW AG Balance Sheet which saw a marked improvement in its up & downstream supply-chain credit management to boost its figures, BMW AG has had across the board (indeed across the line-item) movement, nothing spectacular but noticeable in Current-based inventory valuation, trade receivables and cash and cash equivalents.

To balance this E104,061m figure, Equity and Liabilities show that equity interests were reduced, pension provisions were increased, short-term financial liabilities were increased, with Non-Current Liabilities up E4,653m accessing open bond & notes capital markets whilst seemingly at the time secure. As for Current Liabilities, financial liabilities decreased whilst trade payable increased so presumably showing a period of deferred payment 'turnover' from one set of suppliers to another.

As stated the Cash-Book shows a reduction in cash-inflow and reduction in cash-outflow for the period. Other areas of note was the negative Cash & Cash Equivalents differential in the comparison period, the recent E276m change over 3 months far lower than the E1,812 of last year.
Also of impact was the devaluing FX rate on the Groups liquid assets, showing a E141m hit vs last year's lower E41m toll. Obviously the Euro's recent pummeling by the US$ will have a greater impact in Q2 results.

However, the upside is that the Euro's weakness will be of major benefit in allowing BMW – like its peers Daimler & Audi – to garner foreign sales through pricing flexibility of German made cars if its so wishes, especially important for its N.A. Rebound efforts, dollar-pegged Middle Eastern sales and assisting the positive trend in S.America; much of Asian BMW sales satisfied by Chinese & ASEAN regional production.

The FT reports that the Euro is down over 8% on a trade-weighted basis over the last year, with a 10% deflation nominally providing a 0.5% GDP uplift, adding to Germany's already considerable 43% GDP support from exports].

Conclusion -

By virtue of its former 'spring clean' during the depths of the down-turn, BMW AG should be seen to benefit by leading the premium VM pack with pertinent product and converting the availability of wholesale finance into a steady and improving income stream from credit-worthy private and business clients.

The BMW marque appears strong and on the rebound as global markets once again pick the propeller badge as a brand of choice, even with Audi's rise, as the mix of sporting prowess and more conservative yet strongly handsome styling works as a good formulae in new 7, 6, 5, 3 and even 1-series including the popular X1, and the “efficient dynamics” technology lever continues to have effect. A resurgent US and still strong-pulling EM regions should have seen orders filled over the last 2 months to give a continuation of confidence with Q2 figures.

The Rolls-Royce business is seemingly well balanced given the contortions it has had to face, and its 2 car range now adds much needed market and production flexibility, the V12 Ghost taking the marque into long-forgotten yet still highly prevalent sporting-sedan territory. Its relative affordability at 2/3 its counterparts price should maintain steady volume from US, Middle Eastern and Asian clients even if the EU ultra-luxury car market stays depressed.

The real concern is the Mini division given its perceptually aging core 3-door model range, the somewhat limited volumes of higher margin cabrio models, the less than expected sales impact of Traveller - and so limited addition to Mini's overall sales volumes – and the outlined concerns that Countryman may have a harder battle to convince customers than executives believe. Recent press reports talk of the Mini division's independent identity inside the BMW Group, which given its lacklustre performance through the scrappage incentivisation period, could be construed as Munich partially divorcing itself from Oxford operations.

The now canned Rolls-Royce trimmed Mini project - and other such efforts - whilst following in the footsteps of Radford and Wood & Pickett Minis of the 1960s also convey an element of the Brand's diluted identity. As owners of Rover Group, BMW saw the commercial potential for a reborn Mini and should step back into the frey with blue-sky thinking, as opposed to possibly viewing the MegaCity as the natural successor project to a possibly decaying Mini division. Too much has been invested to see the division left aside and possibly wither if Countryman doesn't fulfill its sales remit.

BMW has proven itself operationally adept in re-aligning to the external circumstances that hit the auto-industry so hard. Now it must re-visit its visionary past to ensure the Group as built thus far remains and grows stronger. That will take fresh thought from deep in its Munich, Californian and Singaporean sites, yet the 'deep blue' thinking must be cost contained to ensure what is once again increasingly precious liquidity is being pumped into the heart of the BMW engine and not simply circulated around the ancillaries to little avail.

In short, good expectations given the positive picture, which will provide a morale boost, but no time for unproven over-confidence.

Thursday, 20 May 2010

Companies Focus – The Western 8 – VW AG: A Repeat Prescription from Dr Piech.

Volkswagen has been the undisputed star of the past few years, its innate size, strength and geographic spread placing it well amongst its less structurally robust contemporaries in the VM auto-sector. Piech, Winterkorn, Poetsch and other Board members recognise how important their synergistic, parallel integration, conglomerate formula has been throughout its history, and looking forward wish to maintain that philosophical and revenue generating momentum via the inclusion of Porsche AG and build-up of its truck division interests in advance of the eventual global economic rebound.

With a strong central, quality-perceived VW brand and a price-point 'ladder' of complimentary marques which sit both above and below, the group has built itself to withstand both regional economic vagaries and well placed in the EM regional boom, so underpinning achievable sales expansion. Its efficacious devotion to EM regions perhaps best seen by the illustration of Chinese strategy, early players with most recently the Lavida small saloon – part of the NCS (new compact sedan) exercise . This builds upon previous efforts such as Gol in S. Americaaa, City-Golf iS. Africacaca and Passat in China, all of which utilised previously amortised tooling with demand aligned product . However, now in a new era, the task is to align NPD globally, seen with Lavida.

More of this powerful formula then is the high-line basic tenant to “Strategy 2018”, the corporate ambition announced to investors in London in February. A concise PR release accompanied by detailed presentation, pre-cursing the Q1 2010 success story and the long-term 2018 horizon.

VW Group Performance Q1 2010 -

Q1 2010 saw a general increase of 19.4% in YoY sales. VW badge sales up 23.5% to 945,000 units, Audi sales up 22% to 316,000 units, Skoda sales up 31.7% to 142,000 units and SEAT up 55% to 91,000 units. Group share of the global TIV rose from 11% to 11.6% which is commendable, increasing revenue by 19.4% increase to E28.6bn vs E24bn for last year's comparable quarter.

This gave a revenue of E28.6bn from E24bn, and a near tripling of Q1 operating profit to E848m from E312m last year, and produced a Profit before Tax (PbT) of E703m against E53m a year earlier, E286m of which originated from Chinese JVs. Profit after Tax (PaT) was E473m vs E243m the previous year.

Critically, all important Net Liquidity increased from E10.6bn as at Year End to E14.2bn including a cash outflow of E1.7bn as a result of the new 19.9% stake in Suzuki Motor Corp.

Viewed at a business level Operating Profit / Loss: VW Cars gave E416m (vs E-279m YoY), Audi gave E478m (vs E363m), Skoda gave E100m (vs E28m), SEAT resulted in E-110m loss (vs E-145m), Bentley was E-36m (vs E-52m), whilst demonstrating the suffering of trade-buyers VW Commercial vehicles gave a E-16m loss (which wiped-out the E600m proceeds from VW Brazil's sale to MAN SE). With VW assistance in Brazil, Scania contributed E214m (vs 46m). VW Financial Services gave an operating profit of E167m (vs E156m)

However, as with other manufacturers executives forewarned that the assisted buoyancy of 2009 and early 2010 would not continue if unassisted private consumption stayed at depressed levels, as witnessed by April's sales figures. But this western market slack should continue to be off-set by demand in EM regions, so VW is optimistic about FY2010 beating FY2009 sales, revenue, margins and profitability

Strategy 2018 -

The Group's publicised goal is to overtake Toyota as global No1 and sell over 10m units annually.
To summarise, “Strategy 2018” wishes to: 1) Increase global penetration via >10m units, 2) Reduce investment costs & NPD 'time to market' & assembly time & cost, and increase scale efficiencies via 'modular toolkits', 3) Enable 'capital discipline' of a PbT Margin of >8%, RoI of >16% for Autos Division, RoE of 20% for Finance Division & approx 6% Auto CapEx in PPE/sales, 4) Operating Profit measures, 5) Maximising the cross-group Synergy Potential, 6) Potential 'Upsides' in: Product Extension / N.A market recovery / Commercial Vehicle market recovery / Financial Services better integrated into VW value-chain (presumably for wholesale funding access and lowered cost of capital and VW retail opportunity to greater customers).

Divisional Overview – VW Division (VW, Skoda, SEAT)
Investors' prime focus is inevitably on unit sales numbers, unit margins and achievable forecasts facing a contracting EU market and mixed EM arena. As seen elsewhere, Boards are talking-up technology stories, so off-setting the EU lull with 'jam tomorrow, whiz-bang' PR visibility. Thus VW is exploiting Germany's 'National Platform for Electric Mobility' initiative, with 'e' versions of the new Up A-segment city-car and Golf/Jetta/Lavida blue-e-motion vehicles. This then, with mutual political 'rub-off' with Angela Merkel, pitches Germany's VW against France's Renault as the EU's supposed vanguards in zero-emissions technology. Yet, though 'e' models will be made available, no doubt done so on a very limited basis, as we've seen with BMW's e-Mini. Although the political rhetoric speaks of clean-energy generation – given Germany's lead in this arena – the severely squeezed national budget means its ability to propagate such technology as seen in the recent passed is diminished.

However, one element of exception may be latter-day terms and conditions to the E750bn sovereign debt bail-out package from (largely) Germany & France. This, along with possible QE measures, could be used to have the near-default nations buy-in German & French technology, the relatively large government & municipality vehicle fleets of Greece and Spain used as effectively fabricated demand sources. Even so given similar failed efforts by the likes of PSA within the UK and France, ultimate success looks for such a Club-Med scheme looks unlikely. Greece & Spain would e required to install additional parallel clean-energy infrastructures to those created at heavy EU & national cost already to create a truly sizable scale-efficient zero-energy generation and consumption eco-system. Early efforts are seen, but at a cost run rate that looks ever less digestible.

Thus whilst the zero-CO2 initiatives are welcomed the mid and long-term real-world impact by 2018 will be massively counterpointed by improvement in conventional ICE and Hybrid technology, as now advertised as available here and now with the new Porsche Cayenne S Hybrid.

[NB the 'e-Golf' weighs 240 Kgs more than the standard diesel and whilst having fantastic pull-off from stationary & low speed torque has only 113BHP, with only a 90 mile 'light-foot' range. A long way from the standard car's usability at what will be a very expensive price without VW subsidy].

Ultimately investment-auto-motives suspects VW group will follow Toyota's and Honda's lead in hybrid technology, something by which VW can convert into real 'customer currency' given the integration of Porsche into the group and Ferdinand Porsche's origination of the petrol-electric hybrid in the 1998 Lohner-Porsche.

Thus investment-auto-motives expects VW brand to join its Japanese peers as the propagators of real-world 21st century technology for a Triad & BRIC global audience.

SEAT is being re-orientated as a more conservative brand offering both in terms of vehicle packaging (2-box hatchbacks and 3-box sedans as opposed to sporty mono-boxes) and styling; effectively aborting the more adventurous yesteryear initiative. This then fits in with the times and provides the group with a Southern Mediterranean iteration of Northern Europe's conservative Skoda. A central issue is the capacity efficiency of SEAT's Martorell plant, currently running at only 60%, and being fed with overspill from sister brands such as Audi's Q3. Given SEAT's inability to perform to date it faces a testing uphill battle and like Skoda appears to have to fight as offering more car for the money, a hard task given its small car roots and need to align to smaller car trends.
However, it experienced good demand pull in Q1, increasing 54% YoY due to rebound of the Spanish car market. But given the country's renewed sovereign debt economic woes and so consequences for its large state-employed populous such a demand level looks short-lived.

Skoda itself is increasingly placing itself at the top of the entry sector, so as to differentiate from Kia and Dacia pricing rivals, using a prominent 'face', sheet-metal gravitas and higher quality finishes as the enabler aswell as entering new sub-segments with variants such as the Yeti city SUV.

Audi Division - (Audi, Lamborghini, Bentley, Bugatti)
Audi has been the darling of the premium sector as BMW and Mercedes clientele moves on to try a sportier yet still handsome Audi that sits in perceptional terms equi-distance between its rivals. Its S performance sub-brand has become a real alternative to BMW's overtly set high M sub-brand, whilst it has also made use of its historical functional credentials with 4WD and 'Avant' offerings combined in Q7 and Q5 – the latter smaller vehicle most pertinent to Europe and Asia Moreover it has garnered perhaps greatest success over BMW and Mercedes in the compact category with A3 and newly introduced A1; as well as lateral expansion into pure sportscar territory beyond R8/10 with an upcoming R4. In short Audi has been the premium sector success story of the last decade, something VW will continue to foster and who's sales performance is keenly presented to the investment community.

Lamborghini sales after great success have faltered more so than peers such as more robust Ferrari and indeed stablemate Porsche, its 2 car line-up of Murcielago and Gallardo at respectively their end of, and ¾ or so through, their respective life-cycles. Sant'Agata finds itself increasingly caught between its 'Italian Yesteryear' and 'German Future', the operational limitations of an aged factory and what appear set in their ways workforce set against the technical offerings and demands of its VW parents. Lamborghini must ride-out this demand lull on limited resources given its realistic lowest order importance within the group.

[NB see previous investment-auto-motives' web-log post dated 20.04.2010 for dedicated evaluation]

Bentley introduces its new Mulsanne sports-sedan, intended to be a high-margin car that helps to off-set the reduction in sales if the lower priced GT and GTC Continental series that have served so well in accessing a non-traditional, younger and more flighty buyer set. Although the PR rhetoric announces the car as wholly new and wholly Bentley, investment-auto-motives has been led to believe that major BIW, chassis and electrical systems from the new A8 serves as the basic yet intendedly invisible Mulsanne platform, which delivers quality at reduced costs to Crewe.

Bugatti, having ended the production of Veyron now looks to go into hibernation for a period, whilst possible new product is being developed. That appears to be another A8 derived vehicle in the form of a new sports-sedan titled the 16C Galibier, a merge of Veyron face and Porsche Panamera 4-door coupe side-profile, with 'Atlantique' style rear – so clearly delineated from the more classically traditional 3-box Mulsanne. Though publicly slated for release in 2013, much of course depends upon VW resource prioritisation, and given the real focus on the US and China plus the fact that cars such as Phaeton and Veyron were such business model disasters, investors – unless intended purchasers – may wish to see the development monies ploughed into core operations, and if not put to good work, returned to shareholders.

Porsche AG:
Ongoing integration into the parent group is obviously the intention, but hurdles are arising and seemingly being dealt with.

Firstly is the case of Porsche AG's financial contribution to the group, and the fact that it comes in 'limping' given the state of depressed western markets – though still the leading performer – and the fact that IFRS based write-downs called 'PPA effects' have had to be absorbed. "These accounting charges more than off-set VW's share of profit from Porsche" CFO Hans Dieter Poetsch recently said.

Onto a legal matters, and 6 further Hedge Funds have joined the initial 4 alleging that Porsche SE deliberately misled the market in its hidden acquisition of VW stock as part of its previous takeover bid, using 3rd party proxy buyers and providing misleading public statements of its intentions. The accusation set forward by 35 funds controlled by 10 individuals, is that "the scheme induced the plaintiff funds to establish short positions on VW stock" is the accusation. And that Porsche SE aimed to trigger a massive short squeeze in late Oct 2008 to sell at inflated price and so help rescue the "near bankrupt" group. The plaintiffs include: Glenhill, Elliot, Glenview & Perry, with now the addition of Canyon, DE Shaw, Greenlight, Ironbound Royal Capital, & Tiger Global. Porsche SE stated that it continues to find the accusations without merit/substance, with the case pending in the Southern District NY, with a response required by June 15th. Undoubtedly Porsche will deny the charge and possibly counter with assertion of the old adage regards 'Pots and Kettles' (NB no pun intended vis a vis Herr Poetschee) given the apparent uses of proxy parties as part of standard modus operandi in the HF community. To buoy remaining institutional investors Poetsche insists these legal wranglings will not derail the integration of Porsche into VW, an implicit promise which the plaintiffs hope will place a time squeeze on Porsche to act in their favour in ending the matter.

VW acquired 49.9% of Porsche AG for E3.9bn, expecting 100% control to cost E12.4bn, paid in equity and debt. As investment-auto-motives has stated previously, it suspects the airing of the legal case could in fact be leveraged by both VW AG and Hedge-Fund parties: to effectively depress the Porsche AG stock price for new HF buy-in, and/or stock-returned 'placation', in full knowledge that VW AG will be keen to buy the stock given its VW-Porsche integration pledge; thus a form of witting or unwitting form of event-driven arbitrage.

They may have been looking for Porsche AG to settle the case in Porsche stock, possibly stating that they simply recoup their original positions/holdings, yet recognise the inherent value-rise between June and end of the year.

[NB see previous post 'VW AG - St James's and the Giant Piech of 29.01.2010]

To add to the (possibly inadvertently advantageous) Porsche woes a recall of all new Panamera cars will have dampened market enthusiasm, as will the untimely emergence of the WW2 'forced labour' issue which tends to periodically beset older German corporations and the whole 'Mittelsand'.

Lastly with regards to the Truck Division (VW Commercials, MAN, Scania), there has been on-off conjecture for years about the type of inter-relationship between MAN and Scania, with VW AG acting as both side's protagonist given Dr Piech's desire (indeed the recognised need) to build a strong VW-led truck business that can operate successfully on the global stage in the face of Volvo AB and Japanese, American and Korean others. Seeking to merge the patchy world-wide geographic presence of Scania AB (largely in Europe) with the EU and Latin American centres of MAN SE – the latter formed by amalgamation with VW truck & Bus Brazil, and add additional competence to MAN's JV with Force Motors (trucks) in India

Given the fractious background between both parties as effective competitors, a full blown integration may or may not emerge, depending upon each's individual performance, but through VW persuasion it seems that areas of technical compatibility are being slowly investigated, as is allied procurement, something Piech will be glad to see given the economic environment facing the smaller players within the truck sector at present. Ironically Scania reported good Q1 results so probably post-poning the urgency for deep-level co-operation.

[NB VW and MAN own 59% of share-capital in Scania AB (45.6% &13.4% respectively), and VW owns 29.9% of MAN SE]

Strategic View -
In the goal for profitability, accompanying the ideal of globalised market penetration giving scale volume is the ability to create an efficient new product development process that enables both segment and variant model coverage. Since the early 1990s VW has been the greatest proponent of common platform capability whilst simultaneously demonstrating the ability to faithfully brand-engineer its separate marques. Cost, Time and Quality are the prime issues for all new product development and to be seen to maintain its benchmark lead VW Group extols what it calls its Transition from 1990s Platform Strategy to 2000s Modular Strategy into now the 2010+ Modular Toolkit Strategy. This claims to expand the cross-segment, cross-variant and cross-brand utilisation of core Body, Chassis, Electronic and Powertrain systems.

Undoubtedly key to its brand and product expansion methods has been the ability to cross-pollinate systems/parts from one nominal family member to another. Beyond expected platform & powertrain shared similarities, this cross-fertilisation approach has generated an innate internal NPD flexibility to fill portfolio vacuums or create all new offerings: ie the Audi derived SEAT Exeo, VW LCV derived Skoda Roomster, etc etc. On this basis the world of opportunity can look limitless, providing the ability to create a plethora of vehicle types by which to combat competitors. However, as exemplified by Toyota's 'over-bloating' on its previous quiet mastery of commonisation, if unchecked it can lead to a situation of falling marginal returns. The innate desire for competitiveness or indeed justification of CapEx budgets can lead to paper-based NPD arguments at the programme approval stage which ultimately do not materialise in market.

Thus although the world of opportunity created by ever-sophisticated common parts engineering philosophy is a 'presentation corker' (see for possibly NPD illiterate investment analysts, to convert the real IRR and NPV numbers into RoS & RoE figures often takes a degree of NPD restraint.

As is necessary for all VMs to overcome FX fluctuation and fulfill government industrial growth agendas, VW continues its promote locally sourced parts and assemblies from its target BRIC & NA regions. The US, Brazil and India present little obstacle to continued high integration levels, given the historical existence and/or increasing existence of multinational Tier 1 &2 s, India promoting itself as the small car export hub. Interestingly, China has now started to import low-value or labour intensive parts from its neighbours so effectively discounting the meaningfulness of the localisation percentage which appears at lower rate than elsewhere. A similar effect is apparent in Russia, where a relatively low localisation rate of 10-30% by 2015 reflects both BRIC comparatively high labour rates and a substantial OEM base (especially for VW) throughout the near-by CEE region.

Thus the call for localisation cost savings whilst a darling ideology of capital markets may be somewhat misleading as a guide to reduced cost sourcing, especially so in close-knit transport interconnected regions with emerging trade blocs. Investors should see past the surface of abject localisation given its geographically case relative foibles and instead seek better understanding of the presented percentages. Are they relative to the vehicle parts count or the car's unit based BoM (Bill of Materials) or indeed relative to new programme procurement cost savings. The true understanding is in the detail not in over-simplified generalisations.

Regards the the CO2 and general emissions reduction challenge, the Group has a strong R&D capabilities engendered primarily at Audi and Porsche which is ostensibly trickled-down where cost-benefit can be achieved. The use of fuel efficiency technology in power-train, conventional & LW Steel monocoques, along with pure aluminium alloy and mixed steel/aluminium structural solutions, plus various Chassis and Electrical architecture solutions create a very broad (BIC) palette of 'mix and match' vehicle specification options.

To bolster VW's design and engineering prowess – and importantly deny competitors from building-up their European R&D capabilities – early reports conject that VW AG is looking to secure the purchase of ItalDesign Giugiaro SpA in Italy. This mimicsits capture of Karmann, and so bolsters its Italian presence and importantly generates a formal or informal affiliation with Automobili Lamborghini, which as stated previously may be over-stretched in by its future demands versus capabilities. Furthermore, investment-auto-motives suspects that it is also a vehemently strategic move by VW AG. Given that Giugiaro is presenting a Proton-Badged flexi-powertrain city-car at the Geneva Autoshow; with Proton owning Lotus Group (Engineering & Cars) a company which has been intendedly 'over-run' by ex-Ferrari (ie FIAT) management, Piech et al may fear FIAT's potential use – or perceived use - of a technically disruptive new product appearing from FIAT-Chrysler. So seems to be either taking over Italdesign Giugiaro to either integrate the project into VW or suffocate the project so as not to interfere with VW Up and its own e-vehicle kudos.

Operational View -

As is the present and expected norm, the ending of previous car scrappage schemes set greater toll on all volume manufacturers into 2010, especially so for the EU & US centric 'Western 8'. This retraction of sales has been off-set by still buoyant car-markets in EM areas, especially China.

However, it cannot be ignored that the level of EM economic cooling witnessed over the last 3-6 months may have an adverse effect on EM sales rates and so previous revenue estimations. This condition created by both the previous contraction of Triad export demand and EM government efforts to temper their own inflation rises. For EM administrations this situation may now be exacerbated by the new additional heavy drag of Europe's present macro-economic woes, and so compel them to counter by de-incentivising B2C & B2B local consumption.

This may be of special significance in China as its seeks to restructure its auto-sector, reducing the number of its own auto-producers via consolidation. VW of course remains in a prime position as the China nation's favourite, looking forward to another record sales year and obviously rightly continuing to invest in 2 additional factories and plant in Chengdu & Nanjing, but it will face increased retailing pressures as previous tax incentives are withdrawn and the marketplace becomes 'choppy'. Having been through this situation on previous occasions VW should ride any forthcoming storms created by Chinese brands' price-led, inventory reduction, sales efforts that temporarily churn the marketplace.

Recognising slow but steady North American improvement renewed vigour appears to be being put into re-generating VW brand alongside the massive sales potential for Audi success – presently a minnow versus BMW & Mercedes sales volumes). And so Wolfsburg will be bolstering VWoA's (VW of America) managerial capabilities under Stefan Jacoby and closely assessing the deployment of its US strategy for positive early phase results. As part of its US ambition VW is building a new factory in Chattanooga, Tennessee due for NMS (New Medium Sedan platform – spanning Jetta & Passat) SoP in late 2011; able to contribute 150,000 units per year. The ambition is to generate approximately 1.1m units pa by 2018, holding 6% of the US market share.

Without substantial US manufacturing capability, much of this volume will be imported from Germany, Mexico and China , thus Euro vs Dollar, Peso vs Dollar and Renminbi vs Dollar FX differentials will be key for both large car Audi imports and eventually small & compact car (Polo & Rabbit) imports from the NAFTA region.

Importantly, the heavily de-valued Euro will give VWoA the advantage of better competing against US, Japanese and Korean peers on US soil, circumstances not seen at such a comparative level since the 1960s. Even so, effectively re-positioning the brand 'future-forward' over 2010 will mean VWoA will in all likelihood require heavy marketing (TV, web, quality press – though not 'incentives') spend, and so early profiteering from the US looks unlikely as strategic aims over-ride Quarter on Quarter N.A. Margins. Importantly the VW brand must be successfully re-positioned as premium to Toyota and Honda if it is to sustain it's 5-10% price premium whilst simultaneously growing volume. This is VW's biggest NA challenge given its past of cheap and cheerful transport (Beetle, Mk1/2 Rabbit), Audi's previous late 1980s safety debacle and the very real pressure from not only the Japanese and Koreans, but BMW and Daimler's intention to eat into Polo/Golf/Jetta territory with all new products.

Lastly, even though April YoY sales took a steep decline, Germany will obviously continue to be VW's prime EU market both as a result of national champion and the relatively healthier German economy. Moreover investment-auto-motives expects a 're-patriation effect' of German consumers increasingly buying German-made products as the public's mood is tilted subtly away from its previous broader 'inter-nationalisation' toward the greater German good. This effect, combined with powerful PR efforts such as the VW-Merkel 'rub-off' on eco-tech should mean that Germany's retracted scrappage scheme should not impact as greatly upon deflated car sales, as say that of Italy or indeed the US. Furthermore. Elsewhere around Europe VW should benefit by consumers continued 'flight to affordable quality' amongst more responsible new-car buyers. However, VW must be sensitive to buyer group types and resultant effects.

[NB Today most mainstream car sales are now credit and value driven (as with VW's own O% finance and 2 year's free servicing in the competitive UK), but it must critically identify and segment its buyer types so not to fall into the trap of offering good terms to less than reputable buyers. This is now being witnessed by investment-auto-motives relative to the credit-driven sales impetus of Vauxhall-Opel whose vehicles are to a large extent being absorbed by a different (younger, more ethnically diverse and typically less responsible) demographic. A group which in recent historically was part of the problem in creating a value-destructive, negative feedback loop via debt payment default, requiring vehicle recovery and so generating reduced vehicle residuals which in turn adversely effects used and new inventory asset values and thus damaging balance sheet health].

Hence, a level of resilience amongst within the domestic attitude and demand together with China's buoyant demand will be VW twin pillars across a 2010 in the face of the corporate squeeze of reduced sales and continued need for investment.

2010 sees an increased level of new vehicle launches, more so than for some years, with in all 21 new (and important variant) models across its 10 brands (including VW commercial), as one would expect spanning both high-margin vehicles (eg Toureg, Passat, A8, A7, R8 V10 Spyder, Cayenne & Cayenne Hybrid, GT Supersports Convertible, Gallardo Superleggara). And amongst volume vehicles (eg Polo BlueMotion, NCS-Jetta, Touran, Alhambra, Ibiza Sport Tourer, Caddy and Amorok)

[NB Amorok is a JV programme using the renowned Toyota Hi-Lux as a base for VW efforts to create a presence in the (large global) 1-tonne pick-up market, so expanding its involvement and credibility within the commercial vehicle sector. This, investment-auto-motives believes could lead possibly to a shared Toyota-VW production agreement at Toyota's US Mid-size & Large truck manufacturing site in San Antonio, Texas, since Tundra sales have not met the N.A. forecast.
A fundamental rationale may also be argued that in a shrinking US & global SUV market that the VW-Toyota alliance could be formed for many if not all SUV & Pick-Up development programmes, thus reducing capex drag and increasing unit margins for both parties and provide a dual attack on both GM and Ford market masters – though this would take a great deal of strategic planning and corporate willingness for a long-term battle . Additionally VW may wish to access Toyota's large Minivan products as a replacement to the FIAT-Chrysler sourced Routan].

Ultimately for VW Group, good product cadence, its broad brand and product portfolio and a level of comfort afforded by previous conservative, pragmatic executive attitude, however still allows VW to operationally punch high, and initiate its global production ambitions via new Chinese, Indian, Russian and US plants.

Looking briefly at at the Financial Services Division and “VW Bank” outperforms the captive finance houses of its European peers by a sizable amount. By 30.09.09 VW had customer deposits of E19bn, versus E13bn at Daimler, E10bn at BMW, E1bn at RCI Banque, E0.4bn at Banque PSA, and E0 at Ford Credit Europe (though we must recognise that since US owned Ford Europe is not directly comparable). However, once again the advantages of VW's innate size and financing conservatism regards capital reserves is demonstrated, especially when compared to #2 ranked PSA.

However, the comparative % EBIT contribution of Finance vs Cars has been declining over the last 7 year, markedly so from 2004 onward, and no 2009 details were shown after slim '06-08 given the credit-driven push that raised car sales and so Car's EBIT in those years. That latter-day 'slimness' demonstrates VW divergence from reliance on Financial Services as the sector was undergoing major convulsion and reform, and absence of 2009 figures indicates that VW was intendedly very shy in using FS as a then unstable pillar, instead requiring greater customer deposit demands which by its nature separated the responsible from irresponsible and provided its substantial capital liquidity cushion.

Financial View -

In the Q1 2010 presentation Winterkorn and Potsche delighted in highlighting the Group's essential business model advantages over rivals, primarily the leverage of volume scale efficiencies and tiered brand stable with high-tier margin advantage. Thus able to outperform all but 1 of the mass-market and all but 1 of the premium-market players during the heart of the downturn. Proffering 1.6% EBIT margin versus typically loss-making Japanese and Euro peers, only beaten by Hyundai's impressive 7.0% given its innate structural advantages. Per premium players, VW proffered its 1.6% EBIT margin versus loss making German peers, only beaten by (consistently sector leading) Porsche's 10.3%.

Thus the 'industrial shape' of the Group allows it a level of anti-cyclical reprieve, as witnessed in previous recessions, which also promoted a stable credit rating over the last 30 months as others wavered considerably.

VW rightly prides itself on maintaining financial flexibility via good liquid-assets and cash-at-hand levels. However, the resurgence of the 'PIGS' sovereign debt issue may continue to hamper wholesale capital access for all across European capital markets, especially so in the contested states. This was recently demonstrated by VW's postponement of its Spanish car-loan backed bond issuance programme called 'Driver Espana One'. Given Spain's previous position as best placed of the 'PIGS', this raises the concern that only an overtly high cost of capital will be available directly from these capital markets in the near future, and so precludes tenable access. For VW, this will presumably have an impact on both SEATs company aspirations and a knock-on effect as an effectively temporarily closed funding avenue for the Group at large.

Thus it appears that VW will have to exploit internal German, US & Asian company retained cash for further liquidity requirements or possibly tap these regions more amenable capital markets, even though the US's NYSE and S&P500 has stumbled recently. Unlike Daimler's NYSE-Euronext de-listing investment-auto-motives expects VW AG to maintain its US listing so as to demonstrate its corporate commitment to the nation.

The real near and mid-term issue is of course the heavily weakened Euro. In approximately 6 months the Euro has fallen from $1.50 to $1.23. Whilst this provides VW with additional pricing flexibility in foreign markets - very necessary in NA - to help boost local market-share - the disadvantage is that top-line inbound revenue may fall once US market incentives have been absorbed and after the FX conversion back into Euros. It is imagined however that given group global ambitions that to partially defray this concern locally generated revenue will be maintained by VWoA or VW India and pumped back into its local efforts at both investment level and to bolster vehicle buy-backs so as to try and control local residual values.

As previously stated Q1 2010 offered good news with a doubling of profit from a year earlier.
Gross Turnover in Q1 was E28,647m (vs last year's E23,999), up 19.3%. [Of this Automotive gave E25,454m (vs E20,923m) whilst Financial Services gave E3,192m (vs E3,076m)]. Cost cutting measures ensured that CoGS increased by a lesser 14.3%, E-24,542m (vs E21,472m). Gross Profit came in at E4,105m (vs E2,527m), whilst after other distribution & administrative deductions, Operating Profit came in at E848m (vs E312m).

VW's equities portfolio boosted investment income to E204m (vs E71m), but other interests (possibly counter-party hedge backs) dragged by E-350m (vs E332m). Thus giving a Financial Result of E-145m (vs E-261) so showing investment loss improvement as one would expect given the typical rebound conditions.

Thus, the Operating Profit minus Financial Result gave a PbT of E703m (vs E52m), which after tax considerations gave a PaT (ie Net Income) of E473m (vs E243m). Deducting E50m (vs E-20m) for 'minority interests' gave E423m (vs (E263m) for full or partial shareholder dividend. The Ordinary Dividend was paid at E1.03, whilst Preferred Dividend at E1.09.

This immediately lifted its share price by 2.4% to E74.35, but since immersed in the general stocks sell-off the company now resides at E69.07 for Pref Shares (and E68.05 for Ord Shares), down a heavy 2.88 on previous trading, yet still showing its resilience relative to an out-performance compared to the DAX, DJ EuroStoxx 50, FTSE 100, Dow Jones and S&P 500.

Presently the combined Ordinary & Preferred Share based MarketCap now sits at approximately E31.83bn.

Looking to the Balance Sheet. (Non-Current) Long-Term Assets rose to E104,712m (vs E99,402m) of which the greatest increased component was investment/financial assets, plugging much of the fill-up between Q109 and Q1 2010. Intangible Assets rose to E13,134m (vs E12,907m).
Current Assets rose to E83,409m (vs E77,776m), of which the greatest assist was in the level of Receivables & Other Financial Assets (presumably extended loans) up by approximately 21% - demonstrating vastly improved control of creditor payment schedules, possibly offering dealer-group loans for speedier payment terms on vehicles received. Beyond this inventories rose as did cash & equivalents and marketable securities. Total Assets rose to E188,121m (vs E177,178m).

Set against Assets is of course Liabilities and Equity. (Non-Current) Long-Term Liabilities rose to
E73,938m (vs E70,215m) of which the greatest component is financial liabilities, nearly 3 times the size of pension liabilities provision. Current Liabilities rose to E72,292m (vs E69,534m), with a growth of Trade Liabilities showing leverage over suppliers so as to defer payment, with other liabilities rising to E22,609m (vs E18,703m).
Equity rose to E41,892m (vs 37,430m) much of which was the previous E4bn re-capitalisation exercise. Of course Total Liabilities & Equity is thus a parallel E188,121m (vs E177,178).

Conclusion -

VW is bullish about global TIV growth over the 8 period, with using Global Insight data, expectations that the Global TIV grows by 43% from 62.4m units to 89m units annually. Of that the US see a massive 56% from 12.6m to 19.5m units, W.Europe up 12% from 14.9m to 16.6m units, E.Europe up 117% from 2.8m to 6.0m units, Japan up 1% from 4.4m to 4.5m units, China up 52% from 12.6m to 19.2m units, India up 100% from 2m to 4m units, S.America up 42% from 4.3m to 6.1m units, and RoW up 48% from 8.9m to 13.1m units pa.

These are of course in reality 'guestimate' figures based on a married guestimate GDP growth and consumer vehicle take-up scenarios. Most corporations inevitably over-bake the optimism pie using more positive independent data to enthuse investors. And it appears VW may be no exception given its and the whole auto-sector's need to generate much needed investor buoyancy and stay on the hold or buy roster of large institutionals as general stock market volatility threatens to return. Much the same can realistically be said about the electric car announcement, far more style than substance at present, and has been the PR story for many a volume and niche manufacturer during these lean times.

In contrast the grass roots structural improvement such as Polo's 15% reduced assembly time and firm grasp on Sales vs CoGs ratio, aswell as investments in near 'ready-made' facilitiesssss such as Karmann's Osnabruck site and now seemingly ItalDesign Giugiaro highlight the cherry-picking of R&D and niche assembly centres that can be better exploited at lower cost inside the VW fold.

Of critical importance will of course be the eventual integration of Porsche AG/SE, the time-frame of which and concomitant fiscal contribution will be balanced by the cost of either passifying or fighting external parties. If investment-auto-motives' conjecture that a depressed Porsche stock could be useful to both VW AG and hedge-funds, then the battle may be ultimately advantageous to both.

Opposite the Sports-Luxury sector, in the Small Car sector, VW will be exploring its use of its new Suzuki stake to gain access to its Indian Low Cost capabilities, with consequence to run-on Fox, new Up and possibly next generation Polo. Just as VW has a massive medium size car capability with SAIC in China, so it will want a similar advantage in 'small car India' care of Suzuki, adding to its Indian production footprint.

In the important near term that affects stock purchase behavior even though the western region's constrained sales outlook may be a shadow, the depreciated Euro assists in a slowly re-awakening US market and China looks set to deliver steady sales probably undented by the PRC's governmental efforts to defuse its housing inflation, given that in China vehicle sales and house-prices are not as closely correlated as in the west.

Of all the volume manufacturers and even premium producers VW Group is perhaps best placed to leverage its global scale and quality reputation, and appears to be able to make good its efforts on continued internal cost containment in the face of macro-level and input-cost headwinds. VW's cars section is perhaps the sector's best arbiter of mass-customisation, with the timely incorporation of Porsche both adding not only additional volume but critically advanced capability internal resources and the ability to balance NPD and platform transfer costs between its 2 primary car divisions.

To this end, for the near and mid-term, VW is best placed to ride the present dynamics of global car markets both where customer attrition is ongoing and importantly where new customers are amassing.

Exactly how the VW story beyond Q1 2010 evolves for the investor can be gained from investment-auto-motives' company & stock performance expectations note.

Wednesday, 12 May 2010

Companies Focus – The Western 8 – Dealing with a Triple Speed Triad and Balancing the Asian Volume vs Profit Mix

The investment community welcomed the multi-agent $1 trillion bail-out of what seemed probable contagion default of Greece, Portugal, Spain and perhaps even Ireland. Yet, certain commentators still question the fundamental long-term growth capability of southern Europe and Ireland; and rightly so given their intrinsically weak economic structures after the credit bubble burst.

Furthermore, the more far-sighted re-raise concerns about this measure effectively morphing directly or indirectly into additional QE injection; effectively pumping extra liquidity into a presently over-valued region. The IMF, ECB & Fed monies will be used to purchase 'PIGS' debt, and the effect was immediately strongly felt as bond-spreads eased greatly, but there is a prevailing dilemma that the liquidity may be circulated through the capital markets and possibly re-boosted equities after the recent sell-off. Dangerously, especially so in the smaller and more reactive capital markets of the affected nations.

At a macro level this will only eventually generate even greater instability as eventually these 'assisted' stock values falter when the reality of little productivity and a value-dwindled asset-base comes to the fore, even with a propped-up Euro.

So whilst Northern Europe's governments, companies and consumers are being economically ratcheted-down in the face of fiscal consolidation, it seems that Southern Europe could be in danger of thinking that a delusional happy ending has come to solve their nightmare, but that may not be the case and from respective political and public viewpoints the North vs South divide has turned into a chasm. Germany, the main determinants will no doubt continue its bi-polar rhetoric, Kohl's words for the unity project re-echoed whilst Merkel subtly derides the Med nations, but also quietly appreciates the competitiveness that Euro denominated German exports have gained across the globe. Thus partially good news for VW, BMW and Daimler.

Relative to a possibly stagnant EU, Japan stays in its endemic low growth pattern; one which tries to continually re-cycle its large savings glut, yet balance its cost-base against ever reduced on-shore manufacturing productivity and meet its increasing social costs. If we take Toyota's Q1 results as a n indication, the strengthened Yen has been successfully combated by cross the board cost reductions at overhead and variable levels. Given the speed and size of Toyota's turnaround, that bodes well for others such as Honda, Nissan and even Mitsubishi – though the results will be respectively diminishing given each's respectively smaller leverage over their cost structures

In the face of this the optimistic, re-buoyed US looks to try and maintain its growth path; the best in Triad economic region over the last year or so. Part of that paper-based success story has been the 'saving' of GM and Chrysler, the invisible reality of the nation's sunk cost in GM especially noted in the blogosphere, even if Whitacre & Ratner hail the supposedly “re-payed” loan and comfortable position. In the lead-up to any IPO the capital markets will take greater convincing, and that will need to be done well, to avoid speculators turning over the New GM stock almost immediately and so creating a roll-a-coaster rise, free-fall dip and lengthy flat-lining.

As a general result the Boards and CEO's of European & US-Euro auto-makers are under renewed pressures, and their efforts will very probably be more of the recent same – talking-up the West helped by credit-driven incentives and fleet sales, but searching the East desperately for conquest and renewed custom to counter-balance and underpin global sales.

Thus today automakers face an all-round squeeze of macro and micro-level pressures:

1.massively raised input (sheet-steel) costs after the recent Miner-Processor talks (+20-25%)
2.having to increase supplier volume orders to combat supplier input costs investment implementing ever greater cross-segment 'flexi-platform' solutions
4.thus improving capacity efficiently of under-utilised plants
5.yet with the challenge of selling in post-scrappage constrained EU & US markets

For investors an apt quote comes from the US Rock group's Blondie's 'Europa' album from 30 years ago, EU makers face being “thoughtlessly locked into phase 2 grid-lock...keyed-up...on its rims”. This may be an over-terse description, but no question that “The Tide was High” but it is retracting.

Having faced a previous economic 'grid-lock' in 2008/9 which should have slain the weak, saved by major government interventionism, the EU players now once again undertake their never-ending march for volume capture. That dichotomy is part and parcel for autos & parts investors, both long and short-term. Either way at such times the funds or fiscal-breaks seemingly keep flowing, either in the national interest by fearful politicos, or by relatively risk-averse institutionals and SWFs which sway toward safe-heaven slow-growth but asset-backed entities such as utilities and industrials.

Yet this dualistic, mutually related, investment theorem which underpinned 2008/9 that arguably generated investment sector 'themes' over sector 'picks' is now coming to a close as the ability of governments and central banks becomes increasingly untenable given the over-stretch to effectively underpin the common EU ideal.

Instead, as mentioned by investment-auto-motives' Spring “post-card'”campaign, the West's auto-sector is once again being re-fractured, something seemingly recognised by the likes of Elkann & Marchionne at FIAT given their recent courting of investors with FIAT's massively re-orientated business model of separated Cars & Industrials.

Thus move away from mutually inter-dependent and inter-supportive divisions is designed to create investor transparency and divisional autonomy, and has set the investor grapevine a flutter with some parties pushing other conglomerates such as Daimler to follow suit with its Truck section. But of course everything must be judged on an individual basis, and to this end FIAT Group was never a true comparable to its western peers, more akin to its commercial partner TATA; though far slimmer and with differing sales ratios for its cars vs capital goods and services.

This then sets the basic picture for the remainder of Q2 and into Q3. One of newly changed EU consumer circumstances, which will typically demand either cash burn by those with government provided low-cost liquidity pots, or the settling of new (ie secondary) equities offerings such as VW, and for those that bridge these 2 'banks' of the river such as Renault-Nissan a dualistic approach.

All 3 of the US players that also operate in Europe saw their futures buoyed in 2009, achieved via either independent credibility in Ford's case – the markets only darling -, by massive cash injection in GM's case, and via pseudo 'partnership' in Chrysler's case.

The following posts re-run the previous over-view that considered the positions and investment potential of all Western 8, and so will analyse:

VW Group
BMW Group
Daimler Group
Ford Motor Co
New GM
FIAT-Chrysler Group
PSA Group

Comparatively depressed mainstream consumption means ongoing re-alignment for the mass manufacturers, with ever greater pressure to gain market share in BRIC and (notionally called) EM regions.

[NB though as many have correctly stated investors need another coda other than EM].

Eyes are upon the executive and luxury manufacturing set, such products enjoying a renewed upswing as the plethora of global SME businesses and corporations took-on new models with relative aplomb as rationally: “low depreciation company assets” and emotionally as: “post-crisis self-rewards”

The EU's TIV in 2010 is expectantly going to be down by -9% to 15%, the former figure much dependent on the strength of the private sector to re-infuse consumer optimism via jobs and output data. That outcome could ironically be the case as ongoing fear over sovereign debt problems that puts liquidity primarily to work in EU and UK large-cap and mid-cap companies.

As the private consumer baulks, so Sales and Marketing Directors at the biggest VMs will be looking to fleet and rentals to maintain factory output and so any kind of leverage over their whole value-chain. Furthermore, a key element for them will be the decision rational between chasing Asian volume to increase their foothold and critical per unit profitability which sets not only the basis for future expectations but also the perceptional standard in market. The Western 8 must all stand firm and make an innate quality statement in their pricing structure of new models. This of course is less so for some of the yesteryear models that are used as new cars entry points, but in this case the value-gap between old and new must be perpetuated – and of course all will be following VW's Chinese lead in this arena.

Once again those best placed with brand credibility, moderately aspirant vehicle portfolio spread, good product cadence, BIC capacity utilisation credible strategies , cash-cushions and access to low cost of capital will pull away and create a decisive story in the 2010 race. The fundamentals will tell all now that market frothiness is thankfully falling away.

Ultimately, as with Blondie's former recessionary era album titles, “AutoAmerican” & “Europa”, there will be a level of “Rapture” and “Follow Me” for those companies that used the shock period of the last few years to re-strengthen themselves to cater to today's investor's demands. Their present remit is to curry future investment favour by playing Blondie's “Picture This”.

As ever, investment-auto-motives remains on hand to review just how well those pictures have been painted. To re-iterate the Spring/Summer campaign: undertaking its own Art of Work in probing beneath the surface and conjoining the investment opportunities.

Thursday, 6 May 2010

Micro Level Trends – Vehicle Hire – 'Rent Seeking' in a Dollar-Thrifty yet Improving Environment.

Integral to the very foundations of economic theory is the idea of 'rent'. It, of course, relates to the external requirement and use of a capital good and embodies the very heart of limited resources made available for productive use within a market that distinctly presents a demand vs supply differential. Whether related to its agricultural origins or latter-day use as an enabling agent in financial arbitrage, the rental model has been with man from the outset of bartering to the sophisticated evolution of capital markets and loaned stock.

Beyond Wall Street and into Main Street, in the modern era the phrase 'rental' is perhaps most obviously associated with the the rental car, even if the income generation of domestic/commercial building usage far exceeds the revenue of temporarily loaned vehicles

Yet perhaps the greatest real-world, legendary example of 'rental for arbitrage' involved a 1960s rental company brazenly linked to 1960s youth-culture, the episode when Hertz touted for hire the muscular Shelby Mustang GT350H and testosterone fueled traffic-light-draggers rented the car for wagered suburban ¼ mile races. [NB the 'H' referred to , and history was re-lived with a 2007 Ford-Hertz concept ].

The episode was largely a PR stunt and ironically given the economic intent of its customers, in was a value-destructive exercise for Hertz (and indeed its insurers) which had to absorb the financial losses on wrecked, stolen and 'vandalised' cars which had performance parts pilfered.

The automotive rental market, as one can imagine, has been typically dependent upon the economic cycle, booming in its early positive rise stages, tailing-off as people and businesses become stable enough to buy their own vehicles yet with an event-driven need and suffering once again in the economic downturn. Having been out of favour in the west for nigh on 3 years, automotive rental numbers have started to pick-up once again with what appear green economic shoots.

To combat dependency on one customer group, the business development of what became the big rental firms soon recognised the advantage of multi-segment coverage, so expanded beyond cars to encompass self-drive vans and light/medium trucks, even 'AgCon' heavy equipment to maximise diversification (eg HERC) and latterly (in Hertz's case) into the used vehicle auction sector – so as to better control its released vehicle flow and values, aswell as benefiting from the sector's growth. Thus providing breadth aswell depth at the core rental service level, through the targeting different car-user types, businessmen of differing seniority, the general corporate fleet as well as the typical holiday-bound leisure user. In turn, service differentiation was installed giving preferential treatment to Gold level customers and the like.

In time the marketplace developed as new entrants joined – typically at the lower end. Companies consolidated, honed their business models relative to their needs (seen with the Hertz's 1994 absorption into Ford and later 2005 IPO) and so from the mid 1990s until 2007 stability reigned as all rental companies enjoyed a growing slices of a growing pie and sought out operational efficiencies via volume growth and proficiency goals via vertical and horizontal integration.
Moreover, to increase service differentiation and grow margin new service-product lines were established, Hertz as instigator with evolution of alternative 'Collection Cars' with innate orientations: starting with 'Fun', joined by 'Prestige' and latterly promoted 'Green' reflected by typically the Corvette ZHZ, Audi A6 and Toyota Prius amongst their other peer models and OEMs.

Thus until early 2009 the US set primarily consisted of: Hertz, Avis-Budget, Dollar-Thrifty, Enterprise, National, Alamo and Advantage – the latter bought out by Hertz at this time under Chapter 11 proceedings.[see later note]. The majority of names are recognisable the world over, with Europcar the largest foreigner in NA, whilst the likes of Ace, Kemwel and Payless operate at the smaller scale. With Hertz, Budget, Enterprise, Ryder, U-Haul and Penske.
The economic downturn hit the auto-rental arena hard and in a matter of months what were usually empty car lots over-flowed with unrequired stock. Moreover companies had to find additional lot space to store the cars or sell them at hefty discounts so adding to overhead costs, undermining innate capital-asset values and degrading the normative secondary revenue stream from its used fleet dealers. To add to the pressure, the plethora of indistinct, typically town/district-based small-time operators of cars and vans (typically bought on manufacturers captive finance house credit schemes) were able to under-cut given their owner-manager flexibility, recognising that price, not vehicle newness or quality service had become the determinant factor for many.

[NB Indeed the structural shift in the sector and changes in societal trends at large have tempted new start-up entrants such as City Car Club, ZipCar, WhipCar and many others to offer largely city-based services. These predominantly use company-owned vehicles, but the latter designed for privately/individual-owned cars, the latter to supposedly “sweat one's capital assets” - thus trying to make individuals act like car rental companies.

This daring approach that tries to turn-around what it considers irrationally 'in-built' perceptions regards car ownership, yet seemingly ignores the very real rationalities that lay under the surface of emotionality. From the basic that investment-auto-motives has learned it hopes to rent-out typically upmarket cars for mainstream or less rates, so seemingly setting out a high-risk yet low reward for the 3rd party renter. It seems to have the hallmarks of the modern '350H effect'].

Back to the sector incumbents, and from late 2007 it was the same bleak picture for all the large well known western multi-nationals, as with the auto-sector at industry at large. The rental arena was always set to undergo contraction, consolidation and renewal.

As the largest entities the likes of Hertz were always set to survive, its value on a relatively stable upward incline as the economic picture brightened. But such fundamentals-driven valuation appears not the case for all; the mid-size players like Dollar-Thrifty Auto Group benefiting greatly since seen as target prey by trade-buyers. And that has come to pass as Hertz's diversification strategy, striving further toward the leisure/holiday-maker segment and effectively adding 2 more brands to its Hertz and Advantage stable.

[NB Hertz out-bid Enterprise for the Advantage business in early 2009, having developed in-house the 'SimplyWheelz' sub-brand in 2007 with roll-out in Orlando's holiday-hub. SimplyWheelz's intention is as a low-cost operator, so mimics the 'low-service' IT reliant operational efficiency of the low-cost airlines model, able to marry a scant 'front-of-desk' with sizable behind the scenes group capabilities, itself 'synergised' by Hertz's backroom operations. Presently Advantage appears to be run at arms length to maintain customer loyalty but it is presumed its operations are being fully integrated, probably using SimplyWheelz's IT infrastructure, as it is imagined would Dollar-Thrifty if obtained].

In what at first glance appears a utility-type sector, one would expect listed competitors to be on a par, little movement difference between established players. Yet 2009/10 proved that market perception was all.

Hertz's stock price has lifted from an 18 month low of approximately $1.50 to a recent high of $15.60 or so, before settling at $13.35 at market close on 04.05.2010. This parallels the likes of Ford's performance in the same time-frame as a stock-floated large company having to undergo massive re-structuring yet with optimism regards riding the back of the turned consumption wave.

However, Dollar-Thrifty Auto Group makes that sound performance look positively vapid – even when by big picture standards it should not. As an sector peer comparator Dollar-Thrifty has in 14 months (3rd March 09 to 3rd May 2010 close) shot from $00.62 to $50.70 ! Its extreme price movement reflects the investment community's view of it from that of “dead-man walking” as expectant sector casualty to now the sector star since it proffered best ever Q1 results with a $27.3m Net Income (giving 91 cents per undiluted share) compared to a previous Q109 Net Loss of $-8.9m, and came under Hertz's $1.2bn gaze (at $41 plus stock per share).

Now buoyed by interest from Avis-Budget, apparently offering a “substantially higher offer”.

Typically the courting shenanigans has begun, with Avis-Budget Chairman & CEO Ronald Nelson publicly castigating Dollar-Thrifty's executives for not exploring his company's improved offer, and furthermore appearing to deter other offers. The letter sent to the financial press is obviously designed to have Dollar-Thrifty's shareholders take an active stance, which it seems they recently have done. As part of the aftermath, market speculators appear to have done him the favour and dis-favour of proving his higher valuation ultimately correct. The price climb though perhaps too steep for his liking. But at least it should theoretically open the ears of increasingly activist stock-holders – private and institutional.

[NB. especially so since many insurance companies themselves seek profitable portfolio company exit options amongst in the face of prevalent future pay-out funding gaps].

In answer, Dollar-Thrifty made a COMTEX statement stating that (under responsible fiduciary terms to shareholders that) it “would be willing to entertain a substantially higher offer”. Little surprise there then, as it tries to raise the stakes of a bidding war..

To give greater context, Avis-Budget has been in effectively a re-building mode since it was spun-out from Cedent group in 2006, a holding company that had strong inter-connected travel and hospitality sector interests. Today, although with greater autonomy Avis-Budget is having to fight harder than ever since the badly (corporately) timed 2007 recession, thus must react given its own growth ambitions and level of competitor threat from above in terms of Hertz financial muscle, from its mid-market peers, and from below in terms of the highly ambitious small-fry.

So inevitably, the question emerges, “is this the beginning of a 're-set' for the American and thus European and elsewhere car rental sectors?”

If the take-over of Dollar-Thrifty succeeds, as seems the intended case and so creating a new sector giant, how do the fundamentals of the picture alter? What does this mean for the remaining mid-sized corporations (ie Enterprise, National, Alamo)? Critically, what opportunity for additional investor excitement, generated via strategy changes, M&A or alliance formations? Is the natural reaction that of reactionary M&As in search of scale and geographic spread, or an emergence of sub-segment inter-peer linkages?

Given that Dollar-Thrifty has 1,558 company and franchise locations, if the victors, Hertz would immediately boost its world-wide locations from 8,100 to 9,658 (or so) whilst Avis Budget would grow from 6,700 or so to 8,250. Of course these numbers are only initial and largely operationally academic given the subsequent results of operational integration reducing site numbers to avoid overlap.

Beyond the scale issue of customer-facing geographic spread, is of course the issue of purchasing power from aut-makers. Unlike previous years when rental companies had long-term contractual allegiances with the Detroit 3, the advent of foreign motor company transplant factories on US soil and the increasing private purchase popularity of typically Japanese & S. Korean foreign cars, plus above all the need to create as broad a supply pool to allow inter-auto-maker bargaining (and arguably to cater to differing regional tastes) means that the rental companies are far more promiscuous in their buying habits than yesteryear.

That is bad news for the domestic Big 3 who had enjoyed a cosy relationship (especially so Chrysler with Dollar-Thrifty) but of course these days enables the foreign others to boost sales,, especially Hyundai-Kia given its own US & global growth plans.

Throughout history the car-makers and renters have had an on-off love affair, the former amiable counter-parts when private sales are low (as we see today) but less so in buoyant economic times when those long-term contracts mean a portion of their high-demand cars have been pre-ordered at low per unit profit margins. Historically a case of swings and roundabouts which is witnessed today.

[NB FIAT's Marchionne will undoubtedly try and have Dollar-Thrifty re-ignite their Chrysler relationship so as to boost US sales of its renewed & face-lifted Chrysler, Dodge & Jeep ranges – very probably providing sizable discount in NA and in Europe on FIAT products to help generate the production scale he seeks].

The correlate to the motor manufacturers is important, since all need to rebalance the lost volume from the retraction of (inter)national scrappage schemes.

And as such it could well be the right time in the economic cycle for typically competitive rental firms – especially in the mid and low tiers - to exploit the volume manufacturers own 'tight' times and inter-rivalry, by creating purchase consortiums – much in the same way that in the mining industry RioTinto and BHP Billiton are trying to do so as to effectively separate their upstream (input) activities for the benefit of their downstream (output) activities.

The saga between Hertz and Avis-Budget over Dollar-Thrifty will undoubtedly continue, and in the meantime, as ever broker-dealer houses and the remaining strong hedge-funds will be sizing up the victor and vanquished; seeking rent on any loaned-out stock. 'Deal Fever' may not be apparent yet given Hertz's self-proclaimed “comfort” in its position and offer, but it seems that as a precursor to the inevitable volume increase in purchased cars, there will continue to be frenetic trade movements on the trade volumes of all 3 vehicle renters.

But, beyond the mid-term sector re-shuffle, vehicle rental companies and their car-suppliers must keep and eye on the fringes of their domain. Just as Rent-a-Wreck slowly grew in its network and popularity over past decades, on a far more ambitious course appear to be the Chinese, the likes of the UK's Ling's (hire and lease) Cars undoubtedly a seedling for China's future vehicle export and foreign service ambitions. Hertz and Avis-Budget are concerned with their balance of power, whilst ultimately both may be hindered by China's desire to further buoy its balance of payments account.