This is an evolving topic and will gain in-depth over time. Discussions of risk factors will likely be visualized at one point.
Introduction
Volkswagen
Based on 2022 annual numbers and today’s share price of €123 Volkswagen’s valuation is extremely attractive with a PE of approx. 4. (Does not even account for profits in China).
Volkswagen reinvested most of its profits into its electric transformation and growing portfolio of fully collateralized loans to it’s customers and distributed a 7% dividend yield.
Volkswagen remaining 75% stake in Dr. Ing. h.c. F. Porsche AG is currently worth more than it’s entire market cap.
While Volkswagen management guides to a positive 2023, potential troubles from a slowing economy seem to be more than priced into the by now.
Acceptable scenarios: Given the above-described very attractive valuation the following scenarios are totally acceptable to me and I would use the opportunity in case of falling share prices to increase the position:
Multiple years (2-3) without profits. In case the automotive market deteriorates heavily it would be fine for me if Volkswagen does not generate any profits for a while if we have a clear sense that old profitability can be achieved again.
Slowing shrinking profits. If profits shrink a few % per year due to some troubles it would not change my investment thesis. Root causes could be e.g. the transformation to EVs or a growing share of self-driving cars.
Non-acceptable scenarios: If we think the following scenarios are likely I would reconsider my Volkswagen position:
Company threatening losses. In case Volkswagen gets into a position in which it suffers heavy company-threatening losses due to the macroenvironment or other factors.
Dramatically different revenue and profitability outlook. In case we think Volkswagen cannot maintain its current profitability due to long-term changes in competition or a different environment coming from regulation, the transformation to EVs or self-driving cars.
In the example of VW, your acceptable scenarios are based in the fact you think potential troubles are already priced in? and no much more downside in prices?
Answer: Acceptable scenarios are always based on valuations.
Volkswagen is a high-risk investment with a very low valuation. This basically means as long as none of the most dramatic risks materialize the stock is very cheap and the acceptable range of non-critical downside scenarios is way larger compared to other Investments.
(On the opposite end of the spectrum a growth company like Spotify has to grow in order to justify the investment - no growth over the long term in terms of revenue would be not acceptable for Spotify while a stable situation for VW would already be the best case scenario)
Given the risk profile and valuations what is acceptable?
As described on a fundamental level I would not care if the business gets less profitable for a number of years due to macro headwinds or a recession or even has no profits as long as it can emerge unscathed at the end. (In practice no profits would still be problematic because you never know that this is the button and it cannot get worse)
If it does emerge unscathed and macro clouds disappear the stock can easily double in my opinion.
Why does Volkswagen has an exceptionally low valuation?
See my first post on this topic for a very high-level explanation of the valuation.
Why is Volkswagen a high-risk investment?
As an automotive company, Volkswagen is cyclical and has relatively low margins.
(VW had an operating margin before special items of 8.1% in 2022)
That means in case a recession hits there is a heightened risk of the business not only losing profitability but potentially suffering enormous losses. (GM went bankrupt in 2009)
Therefore a good macro understanding both on an overall macro level as well as on an industry-specific level is paramount.
Are the current macro risks fully priced in?
That’s hard to tell. From all the data that I am seeing and my understanding, I believe that it is. (Otherwise, i would not invest)
Depending on the exact situation stock prices might still drop but it is hard for me to imagine that Volkswagen can fall below let’s say €90 unless there are deep troubles on macro and below €60 unless the company is in serious danger to survive.
If there is a recession, this recession is widely anticipated which helps a lot compared to a sudden shock like in 2008.
Which questions do we need to answer in order to gain more security?
I think we need to study how Volkswagen managed other situations of distress like recessions in the past.
From my brief research into the topic they always managed to navigate successfully through them.
They have a strong negotiation position with suppliers which helps them to preserve cash and they have some degree of flexibility in their production to react to demand shocks.
Moreover, they are prioritizing margins and profitability as of now, probably in anticipation of an adverse environment.
Nevertheless, we should gain an understanding of how severe different situations would be for them. Based on the past, how serve would be a drop in car sales of 20-30%? How serve a drop in prices by 10-15%?
I agree that macro will play a huge role in the company, but I think is more important to understand that the company can really survive an adverse scenario more than that. Do they have the same managers as in 2008?
I think even some manufacturers could come out winners if they have a strong position and management beforehand.
1 aspect I disagree is 2008 being a sudden shock. It was for the government and investors that continued to ignore the economic weakness that was very apparent long before the shock in September 2008, Bearn Stearns even failed since March, and the recession began end of 2007. Something really bad had to happen to make it obvious to them. And we see a similar pattern in other recessions. I think is similar to today’s environment, even if it’s extremely talked about, I don’t think investors are positioned in case of a “sudden” shock. Not saying we will have a similar shock btw than 2008, it could not even happen at all, but I don’t think it can be discarded either.
But I do agree VW still seems pretty undervalued, even with the rally and all. I would also not expect that large decline in prices compared to other positions.