Green Transformation or Financial Catastrophe? Volkswagen's Turbulent Path into the Future

Declining Market Share Across All Markets

In recent years, there has been a noticeable slow decline in the growth dynamics of traditional automotive from the continent, at the expense of cheaper cars often offering similar solutions. Not only the Volkswagen Group but the entire car production sector in Germany is facing difficulties. The problems for German manufacturers began in China, where the company started losing market share to Chinese competitors. This may be due to the lower cost of purchasing cars compared to Western competition, while offering similar quality and technical solutions. This is possible thanks to significant government investments, cheap labor, and rich resources of key minerals. There are also suspicions of stealing and using know-how, which could be observed in the high similarity of Xiaomi SU7 to Porsche Taycan.

Consequently, this caused a decrease in the Volkswagen group's market share in their leading territory, Europe. In the CEE region, there is a clear decrease in competitiveness, at the expense of Chinese counterparts. In Western Europe, this has been observable only since the first quarter of 2024. This led to a quick reaction from the EU and the imposition of new tariffs. For individual manufacturers, they range from 17.4% to 37.6%, which is in addition to the 10% tariff rate that already applied to all electric cars imported from China.

Main Sources of Revenue for the Group

The Volkswagen Group achieved significant sales growth in 2023. The largest contributions came from the Volkswagen, Audi, Škoda, and SEAT brands. Western Europe, North America, and South America were the main growth markets for most of the group's brands.

• Volkswagen: Sold 4.9 million vehicles in 2023, benefiting from the popularity of ID., Tiguan, and T-Roc models.
• Audi: As a premium brand, achieved 1.9 million vehicles sold, with sales successes for Q5, A3, and Q4 e-tron models.
• SEAT and CUPRA: Together sold 519,000 vehicles, with CUPRA recording an impressive growth of 50.9%.
• Škoda: Sold 867,000 vehicles, noting an increase of 18.5%.
• Porsche: The luxury brand achieved sales of 320,000 vehicles.
• Lamborghini: The ultra-premium brand recorded sales of 10,600 vehicles. Bentley sold 13,100 vehicles.
• Volkswagen Commercial Vehicles: Sold 409,000 light commercial vehicles.
• TRATON Group: Sold 339,000 trucks and buses.

China remains the largest single market for the Volkswagen Group, with deliveries of 3.2 million vehicles in 2023 and a market share of 14.5%. Particularly impressive was the growth in the electric vehicle segment by 23% to 190,820 units. Europe continues to be a key market for most of the group's brands, with significant sales increases, especially in Western Europe.

North America is becoming an increasingly important market for many of the group's brands, with particularly strong growth for Volkswagen Passenger Cars, Audi, and Porsche. South America also recorded significant sales increases, especially for the Volkswagen Passenger Cars and Volkswagen Commercial Vehicles brands.

Volkswagen Law and Complex Ownership Structure

Volkswagen's governance structure is unique in the corporate world and has deep roots in the company's history. A key element is the Volkswagen Law, established in 1960, which was created in response to the need to protect the interests of employees and the local government after the company was transformed into a public limited company.

The Volkswagen Law contains two key provisions that are fundamental to the company's governance structure. The first requires a majority of over 80% of shareholder votes for decisions that would normally require a 75% majority. This provision gives Lower Saxony, which holds 20% of voting rights, an effective veto right on key issues. The second provision requires the consent of two-thirds of the 20-member supervisory board for decisions regarding the construction or relocation of production facilities. These regulations significantly strengthen the position of employees and the local government in the company's decision-making processes, which is unique compared to other global corporations.

Volkswagen's ownership structure is unusual. The company has two types of shares: ordinary shares with voting rights and preferred shares without voting rights but with a slightly higher dividend. In 2023, ordinary shares offered a 7.6% dividend, while preferred shares offered 8.1%, which translated to 9 and 9.06 euros per share dividend, respectively. This dualistic share structure leads to a situation where control over the company is not directly proportional to ownership share.

Source: xStation

This ownership structure has significant implications for trading Volkswagen shares. Ordinary shares (VOW in Germany, VWAGY in USA) are less liquid because about 90% of them are in the hands of three long-term investors: the Porsche family, Qatar, and the state of Lower Saxony. On the other hand, preferred shares (VOW3 in Germany, VWAPY in USA) are more liquid and thus more readily available. This difference in liquidity can lead to significant discrepancies in the prices of both types of shares, which has occurred in the past and attracted investors' attention.

The largest shareholder is Porsche SE, controlled by the Porsche and Piëch families, which owns 31.9% of shares, translating to controlling 53.3% of voting rights. Lower Saxony owns 11.8% of shares and 20% of voting rights, and Qatar Investment Authority 10.5% of shares and 17% of voting rights. This concentration of ownership and voting rights in the hands of a few key shareholders has a significant impact on the company's management and strategic decision-making.

Volkswagen's supervisory board consists of 20 members, half of whom represent employees and half shareholders. Lower Saxony has the right to appoint two board members, which further strengthens its position. Such a structure of the supervisory board is characteristic of the German corporate governance model, known as "co-determination" (Mitbestimmung).

The influence of employee representatives and Lower Saxony on Volkswagen's management is significant and goes beyond typical employee-employer relations in other companies. Since the 1990s, there have been guarantees excluding forced layoffs of employees in Germany. About 44% of the company's over 650,000 employees are employed in Germany, despite the domestic market accounting for only 13% of total vehicle sales.

Difficult Times Have Come for German Car Manufacturers

The Volkswagen Group is currently facing a series of serious challenges that test its adaptability and competitiveness. One of the problems is production issues. The company has built a global network of factories capable of producing up to 14 million vehicles annually, but in 2023 it produced only 9.24 million. This disproportion is a huge burden on the company's cost efficiency. CFO Arno Antlitz emphasized that the company lost about 500,000 car sales, which corresponds to the production of two factories. This situation is forcing Volkswagen to consider unprecedented steps, including the potential closure of factories in Germany, which has never happened before in the company's 87-year history.

China, being the largest single market for the Volkswagen Group, poses an increasing challenge. Although the company delivered 3.2 million vehicles in China in 2023 (an increase of 1.6% year-on-year), its market share fell to 14.5% from 15.1% in the previous year. This trend is particularly worrying in the context of growing competition from local electric vehicle manufacturers who are rapidly gaining market share.

The slow adoption of electric vehicles in Europe poses another challenge. In the first quarter of 2024, Volkswagen's electric vehicle sales in Europe fell by 24% compared to the previous year, while sales in China increased by 91%. Potential financial and production losses for European car manufacturers, including Volkswagen, may be much larger than previously predicted. According to a warning from Renault's CEO, Luca de Meo, European car manufacturers could face penalties of up to 15 billion euros if they do not meet EU emission standards. To meet CO2 emission standards, manufacturers may be forced to reduce production by more than 2.5 million vehicles. This potential production limitation is particularly significant in the context of Volkswagen's previously mentioned production capacity surplus.

Volkswagen's cost structure compared to the competition also poses a significant challenge. The company employs about 44% of its over 650,000 employees in Germany, despite the domestic market accounting for only 13% of total vehicle sales. This disproportion significantly affects operating costs and limits the company's competitiveness in the global market. CFO Arno Antlitz emphasized the urgent need for changes, stating that the company has "a year, maybe two" to reverse the situation.

German Manufacturer Prepares Ground for Layoffs

Volkswagen has terminated six long-term agreements with employees, including an agreement guaranteeing employment until 2029. One of the agreements has been protecting the employment of about 120,000 employees since 1994. The company wants to increase its competitiveness by planning workforce reductions through voluntary departures and early retirements. Some severance packages could reach up to 450,000 euros. The changes also affect salaries and recruitment.

The termination of agreements may lead to mass layoffs at Volkswagen. The company wants to reduce costs (by 20%) and shorten product development time (from 50 to 36 months), which may force it to close German factories. Trade unions oppose these plans and propose alternative solutions, such as switching to a 4-day work week.

Despite difficulties, Volkswagen is investing in 30 new models in 2024, focusing on electrification. The goal is to create affordable electric cars (below 25,000 euros) by 2025.

Are Volkswagen Shares Properly Valued by the Market?

The share price is currently near historic lows, which often raises the question among investors whether this is a good time to consider investing.

Volkswagen's difficult situation has been particularly reflected in the forward P/E ratio. It is in a downward trend and is currently at the lowest levels in years. All this is happening in conjunction with a declining share price and decreasing revenue dynamics.

BMW's forward P/E ratio, although lower than historically, remains at a higher level than Volkswagen's, suggesting greater investor confidence. BMW's share price shows greater stability and resilience to market fluctuations than Volkswagen's. These differences may result from BMW's positioning in the premium segment, which potentially provides greater resilience to market changes and industry challenges, while offering a higher margin.

Toyota shows a stronger market position than European competitors. It owes this to its focus on offering increasingly better quality hybrid cars. Its share price has clearly risen in recent years, which indicates investor confidence. Toyota's forward P/E ratio, although lower than historical values, remains at a much higher level than Volkswagen's and BMW's, suggesting better growth prospects and greater resilience to industry challenges. The focus on offering increasingly better quality hybrid cars, instead of trying to compete among electric cars, appeals to investors.

As part of the cost minimization strategy, a scenario of reducing or removing the dividend is also being considered. In 2023, ordinary shares offered a 7.6% dividend, while preferred shares offered 8.1%. The lack of dividend in 2015 was related to Dieselgate, which may give the Volkswagen group an argument to reduce the dividend again, which cost the company 4.5 billion euros in 2023.

There is also a very large differentiation in terms of operating profit margin within the Volkswagen group. VW passenger cars, accounting for nearly 60% of revenue, have a margin of 4%. Audi, the second largest in terms of size, performs well, allowing the company to retain over 10% of revenue. This result is also close to BMW's operating profit margin. As we can see, premium brands allow for a better return on production capacity. Porsche performs best in this respect with a margin exceeding 15%, and Lamborghini with 27.2%. Premium and luxury brands remain the most profitable, while everyday passenger cars are mainly tasked with covering operating costs with minimal profit.

The valuation of the most profitable brands may allow for understanding the situation of the entire group. Dr Ing hc F Porsche AG currently has a valuation of 30 billion euros, of which 75% is controlled by the Volkswagen group. According to Bloomberg Intelligence calculations, Lamborghini was valued as a separate company at 20 billion euros in 2023. The company recently entered into a joint venture with American car manufacturer Rivian and plans to invest a total of $5 billion in the company, whose current capitalization is $13.86 billion. Volkswagen sees significant synergy in this that would allow for the improvement of electric cars.

The current capitalization of the entire group is just under 50 billion euros. Some analysts therefore believe that by buying Volkswagen shares, you also get the Porsche and Lamborghini brands, as well as potential benefits from cooperation with Rivian at no additional cost. However, it's worth remembering that the controlling stake in Volkswagen Group AG (31.9% of share capital, 53.3% of ordinary shares) belongs to another company, Porsche SE. Porsche SE is controlled by the Porsche-Piëch family. The right of veto also belongs to Lower Saxony, which may be one of the difficulties in managing the company.

The Path to Raise Profitability with Increasing Competition

The Volkswagen Group, one of the giants of the German automotive industry, faces numerous challenges, particularly due to intense competition from Chinese manufacturers. The company is losing market share not only in China but also in its traditional markets such as Europe. In response, Volkswagen has developed a cost reduction plan which, although it may save the company, includes controversial measures such as potential layoffs and factory closures. This plan aims to address issues related to high cost structure and production inefficiency. However, the success of this strategy is uncertain, especially in the context of the Chinese automotive sector, where significant government subsidies allow for much lower prices of electric vehicles. Without similar support from Europe and relaxation of regulations, Volkswagen's rescue plan may prove impossible to implement. The company's complicated ownership structure, including the Porsche-Piëch family and the state of Lower Saxony, further complicates the introduction of rapid changes. Despite these challenges, Volkswagen is intensively investing in electrification and new models, striving to produce affordable electric vehicles by 2025, although the path to profitability remains uncertain.

Maksymilian Kuch,

Stock Market Analyst XTB