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17 August 2021

VOLKSWAGEN TO VOLTSWAGEN - Yes, You Can Teach an Old Dog New Tricks

The shift away from internal combustion engine (ICE) vehicles towards electric vehicles (EVs) is intensifying, as hypothesised rules and regulations regarding emissions become reality. In November of last year, UK Prime Minister Boris Johnson announced a blanket ban from 2030 on the sale of new cars powered by petrol or diesel. Later this year, the European Union is expected to finalise plans for ‘Euro 7’ – regulation likely to make expensive emissions reducing technology mandatory for all ICE powered vehicles, potentially leaving them unviable to produce as early as 2026. It isn’t just government intervention that is driving the shift either; growing consumer demand for all-electric vehicles has led to financial markets pricing Elon Musk’s Tesla Inc as the world’s most valuable car company.
 
The race to capitalise on this shift and dominate electric vehicle production is far from over, and the world’s largest car manufacturer by revenue and second largest by production volume - Volkswagen Group - is poised to win. Earlier this year on 29th March, the Group found itself in a media storm over an April Fools prank, declaring it would be changing its name to ‘Voltswagen’ and insisting to media outlets that such plans were no joke.
 
The following day saw VW’s share price up by as much as 10% at one point as investors took the bait and saw the rebranding as a clear commitment to a renewed focus on electric vehicle production. Despite a reported SEC probe and many embarrassed journalists labelling the stunt a disaster, in an age of social media mania it was a modern masterclass. Celebrity influence on social media spearheaded by the likes of Donald Trump and Elon Musk has re-written the rulebook of public relations, and VW Chief Executive Herbert Diess understands this as well as anyone. A far cry from the typically staid German corporate, Diess is said to chair a weekly social media planning meeting to discuss how to steal some of Tesla’s internet sensationalism, has taunted Elon Musk on Twitter and posed wearing a batman mask on LinkedIn. A chief executive who understands the importance of tapping into this new era of brand populism is vital, and the firm’s supervisory board clearly agree, as it recently agreed to extend Mr Diess’ contract until 2025.

Volkswagen’s yearly revenue is nearly eight times that of Tesla’s, yet a share in Tesla currently costs investors over two and a half times more than a similar sized share of Volkswagen. Whether this is down to a market bubble or a genuine belief in Tesla’s growth prospects, many remain puzzled at just how Mr Musk has achieved such a sustained high valuation for his company, in spite of a more bearish trend this year.
 
Nevertheless, it has given Tesla extraordinarily easy access to funding, allowing it to remain head and shoulders above competitors in terms of technological advances. However, relying on share price for future funding is risky, especially when the US tech market is at continued risk of correction. Volkswagen’s far superior revenue means it can use a more sustainable approach to financing – utilising cash flow from traditional business activities to continue developing its electric technologies. German auto analyst Matt Schmidt argues that this could well explain disappointing EV sales in China, Volkswagen’s biggest market, suggesting that VW China’s strategy may be to continue driving profitable ICE sales for the next two years to organically finance the company’s shift towards EVs in the region. Another plaudit of this reliable funding approach is Arndt Ellinghorst, Bernstein analyst, who was impressed by VW’s revenue figures for the first half of this year and added “it is refreshing to see such huge numbers from a traditional manufacturer… it is certainly harder earned than some of the SPAC cash flying around these days”. This of course is a nod to the frenzy of special purpose acquisition companies (SPACs) or ‘blank cheque companies’ whereby a firm raises funds in an IPO with the aim to subsequently merge with a private company and take it public. Forbes recently reported that five separate EV start-ups financed through SPACs over the past year have since lost a collective US$40bn in market value, and all five are yet to produce a single car.
 
One potential hurdle for Volkswagen’s EVs is a lack of experience in the technology space. EVs are fast being seen as computers on wheels, and many argue that to truly make it as a dominant force in the industry, manufacturers must be technology companies first and vehicle companies second. Apple’s desire to bring an ‘iCar’ to market is no secret, while Sony has already produced its first concept vehicle, the Vision S. The success of Tesla has shown that the once impenetrable automobile market is not completely closed to newcomers, and the impeccable brand loyalty that big tech companies often possess would be a huge advantage in the car industry. Unfortunately, Volkswagen’s most famous technological accomplishment thus far is its ‘Dieselgate’ software, used in over 11 million vehicles to cheat emissions tests, a scandal which caused shares to more than halve in value throughout 2015. Volkswagen will pin its hopes on the remaining barriers to entry in the notoriously unprofitable automobile market keeping big tech away long enough to establish itself as number one.
 
A more clandestine example of Volkswagen’s increasing momentum in the EV race is its appreciation for how important recycling is for cost-cutting in vehicle production. At present, when a petrol or diesel car is destroyed, up to 95% of material is reusable; up to 70% of traditional ICE vehicles are comprised of raw ferrous metal. EVs are far more complex by material design, comprised from a multitude of components in circuits and battery packs, making the recycling process considerably less straightforward. To address the issue, Volkswagen recently opened a battery recycling plant in Salzgitter near Hanover, dedicated to working closely with battery experts to work out how to design EV parts with recyclability in mind from the beginning. This approach from the Group will not only please those investors with interests in environmental issues, but it shows a real confidence in the Group’s willingness to be a pioneer in the lifecycle processes of electric vehicles far into the future.
 
Casting our eye to the current fundamentals, June saw Volkswagen inform shareholders that deliveries between January and May were up 33% from the same period last year, and sales for traditional truck brands Man and Scania were up 68% and 61% respectively. This month, the company revealed that it expects to make €11bn in operating profits for the first half of 2021, which would be higher than the €10.6bn made in 2020 and the €9.6bn for the same period in 2019. Shares rallied almost 6% on the news, and the company is expected to publish full Q2 financials on 29th July. Looking exclusively at electric vehicles, Volkswagen has now overtaken Tesla to be the market leader in European EV sales, and its lead appears to be increasing. Recent growth is said to be driven by the Group’s premium brands, such as Porsche, which has seen deliveries for its all-electric Taycan rocket to 9,000 in Q1 of 2021, dwarfing the deliveries of Tesla’s equivalent Model S due to supply issues. At current growth rates, there is a possibility of the Group taking top spot in global EV sales before the end of the year.
 
For a while, Tesla deservedly occupied an untouchable throne in the electric vehicle market, as its sublime focus on battery innovation took the world by surprise. However, a puzzling share price in an unstable market threatens its financing ability, and an army of copycat start-ups do little but draw in over-excited investors with cash to burn. Founded in Berlin prior to the Second World War, Volkswagen Group is 87 years old, yet it still resembles the Turkish translation of its flagship Taycan: ‘lively young horse’. Some argue you can’t teach an old dog new tricks. In the case of Volkswagen and the electric vehicle revolution, perhaps that isn’t true.

This article was taken from Summer 2021 1875. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.

Please note that investments and income arising from them can fall as well as rise in value. This communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned.

 
VOLKSWAGEN TO VOLTSWAGEN - Yes, You Can Teach an Old Dog New Tricks
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