Value Column von Hans Peter Schupp

19 SEPTEMBER 2024

Car industry in distress! A buying opportunity ?

Hans Peter Schupp, managing partner of Fidecum AG and portfolio manager of the Contrarian Value Euroland Fund (ISIN: LU0370217092) takes a close look at the automotive industry

“BMW (ISIN: DE0005190003) shocks with profit warning”, ‘MERCEDES-BENZ (ISIN: DE0007100000) – share in dire straits’, ‘VW (ISIN: DE0007664039) threatens to close plant’. This is just a small selection of the latest headlines about the German automotive industry. In fact, things are not looking good for Germany’s former flagship industry. The business climate surveyed by the Munich-based ifo Institute has recently deteriorated drastically. In particular, business expectations for the next six months have plummeted. “Companies in the German automotive industry are suffering from a lack of new orders – especially from abroad. This is now also being reflected in personnel planning,” says ifo industry expert Anita Wölfl.

Car manufacturers under pressure from three angles

Until the outbreak of the corona pandemic, an average of 1.1 million new cars were registered in the EU every month for 30 years. During crisis years it was 950,000, during boom times 1.3 million. However, the situation has changed drastically since 2020. In the last four years, only an average of 900,000 cars have been registered, which on average is significantly fewer compared to previous crisis years of the past.

This reluctance to buy new cars is understandable. German citizens are more insecure than they have been for a long time. And those who are afraid of the future simply do not buy consumer durables. But there is a glimmer of hope. Due to the low number of new registrations in the past, the average age of registered cars in Europe has increased significantly, according to the industry association ACEA. In Germany alone, it has risen from 9.6 to 10.3 years since 2022. Another important fact: the higher the average age of cars, the greater the need to replace them in the future.

Another point of criticism is aimed directly at the manufacturers: they have overslept the trend towards electric cars and are unable to offer volume models with electric motors at marketable prices. What is forgotten here is that innovations are always offered first in luxury class vehicles so that the higher margins cover the development costs. Only afterwards those innovations are offered in the volume products.

In addition, China plays a special role. Not only has the demand in China been weakening for some time. At the same time, Chinese overcapacity for electric cars is putting pressure on the global market and on prices. So pressure on car manufacturers is also coming from this side.

The key question – do share prices correctly reflect the fundamental situation?

Of course, none of these are good prospects. The DAXsector Automobile (ISIN: DE0009660084) has performed correspondingly poorly and is down more than 25% this year. The market capitalization of Volkswagen (DE0007664039) has even slumped by around 70% since May 2021. Many commentators see a long-term structural crisis from which the success-accustomed German carmakers can no longer free themselves. Why else would VW no longer extend the employment guarantee for almost 120,000 employees, which is valid until 2025?

It is interesting to note, however, that despite these three challenges, all three major German car manufacturers have not made a loss since the financial crisis in 2009, when the scrappage scheme had to be introduced at short notice (the only exception being VW’s result in 2015, which was affected by the diesel scandal).

As a mass manufacturer, Volkswagen had earned an operating margin of between 6% and 8% in the past. This was well in line with the results of its direct competitors Renault and Stellantis (Citroen, Fiat and Peugeot), albeit far below the results of premium manufacturers BMW (average 11%) and Mercedes (average 8%-10%).

The VW return on sales is currently at the lower end of the historical range. For 2024, securities analysts are now forecasting average earnings per share of €29. Although this is three euros per share less than in 2023, it is expected to be 34 euros again in 2025 and 35 euros in 2026.

Of course, securities analysts can be wrong. But we would also be completely satisfied with profits of around 20 euros. Then the price/earnings ratio would no longer be 3.5, but still at a moderate 5. The corresponding earnings yield – 20% per year – would be completely sufficient for us as investors to justify an investment. Even if there were no major profit growth rates in the future.

We start to invest in VW

The long-term comparison shows: Not only is the company far removed from the long-term trend (chart below), it is also cheaper than during the peak of the corona crisis. The entire VW Group currently costs 45 billion euros on the stock market. However, it should be noted that Volkswagen has around €40 billion in net liquidity in the automotive business (that is around €80 per share). If liquidity is included in the calculation, VW is only valued at an enterprise value of €5 billion.

What does the investor get in return? Around 330 billion in sales, 20 billion in earnings before interest and taxes and 4.5 billion euros in dividends.  Even if profit margins were to decline in the future, this data set would still be attractive.

Moreover, not everything is bad at VW. Parts of the Group are highly profitable. If you buy a Lamborghini Huracán, for example, you get an Audi A8 with a different chassis and pay a surcharge of 200,000 euros. Nevertheless, there is demand.

Such aspects are not being taken into account in the current, deeply negative perception of VW. It may be that this will not change so quickly and that the share price will remain under pressure. This is precisely why VW is currently a very interesting contrarian story. We have started our first investments and assume that we will continue to invest.

For our Contrarian Value Euroland Fund (ISIN: LU0370217092), we have been investing in undervalued companies with potential and a comprehensible business model for 25 years. In doing so, we act like an entrepreneur who wants to buy the entire company and deliberately swim against the prevailing market opinion. We remain true to this investment philosophy.

About the author: Hans Peter Schupp, is a managing partner of Fidecum AG and the portfolio manager of the Contrarian Value Euroland Fund.

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