Volkswagen (OTCPK:VLKAF) is the leading global auto manufacturer, with strong, longer-term prospects on the back of its broad core product offerings, scale, and improved cost management. It comes as no surprise to me that Volkswagen has been resilient through COVID-19. However, an underappreciated aspect of VW is the fact that it is also the leading legacy auto manufacturer in the electric vehicle (EV) space.
A review of the EV Virtual Tour event strengthens my belief that the potential for VW’s EV volumes and contribution to ramp up is currently being ignored by the market. Valuing VW’s projected EBITDA contribution from EVs at a Tesla-like (NASDAQ:TSLA) multiple would yield upside of over 40% from current levels.
Closing the Product Gap
VW ambitiously highlighted its plan to reach a c. 3-4% EV share by 2020 and c. 6-8% by 2021 (up from the sub-1% level in 2019) at its EV Virtual Tour event. The target is underpinned by the following core products – VW ID.3, ID.4, Skoda Enyaq, CUPRA el-Born, and the Audi Q4 e-tron.
Interestingly, the ID.3 performs well against peers – according to an ADAC study (cited by VW as seen below), the ID.3 total cost of ownership over a five-year period is c. 12% below that of a Nissan Leaf (OTCPK:NSANY) and c. 21% below that of a Tesla Model 3. Meanwhile, the ID.4 is also expected to price at a c. 16% discount to the Tesla Model Y.
Importantly, VW’s first EV (the ID.3) to be built off its MEB platform represents the first of at least six MEB-based models to be launched in the upcoming year. It also means VW’s EV product cycle is without precedent and will grant VW the broadest portfolio of BEVs on the market. In other words, competition is coming for Tesla.
Targeting 1 million EVs by 2022/23 and c. 3 million EVs by 2025
In 2022, the goals get even more ambitious – VW is launching the Q5 e-tron, the electric Porsche Macan, and the VW Buzz, which will drive c. 1 million units by 2022 (or 2023 at the latest). If achieved, VW will likely have narrowed (or even closed) the volume gap relative to Tesla.
Looking further ahead to 2025, the company expects to sell up to 3 million EVs/year, which would make it the market leader by far. To achieve this target, VW will require over 150 GWh of batteries in Europe and North America and a similar capacity in Asia. In aggregate, c. 75-80% of EV sales will be contributed by Europe and Mainland China, with Europe set to be the main market at an over 50% share.
Tesla’s growth prospects can’t be ignored either, but by 2025, VW stands a solid chance of becoming a strong competitor to Tesla. The major strategic difference lies in their focus – Tesla is dependent on the North American market (car and pickup trucks), while VW is focused on selling in China and Europe.
Optimizing the Production Footprint
VW stands to gain from the production side as well – EV production represents an opportunity to streamline the production footprint and move towards multi-brand production plants. By optimizing its production footprint, VW stands to gain from economies of scale. Assuming execution proceeds as planned, VW’s Mosel plant could prove to be a major breakthrough in terms of scale, producing Audi, Seat, and VW electrics cars, and highlighting the flexibility in its MEB platform-based production strategy.
Source: VW Virtual Investors Meeting Slide (E-Mobility)
EVs Could be EPS Accretive
Also notable was VW’s confirmation that contribution margins on its EV products are already positive and on par with comparable internal combustion engine (ICE) vehicles. However, operating margins remain subdued due to the high fixed costs and relatively low volumes at present. This should change as VW scales – the ID.4 is expected to match ICE Golf profitability levels, while the Skoda Enyaq should match Octavia profitability, which translates into a c. 3-4% margin for the ID.3 and c. 5-6% for the Enyaq.
While the initial OP margin expectations are modest, I believe EVs can be EPS accretive as VW scales and gains market share going forward. Details are fuzzy at this point, but VW plans to confirm its long-term 2025 group profitability targets with the upcoming planning round. These numbers are crucial – while the quarterly disclosure of EV sales is a step in the right direction, further transparency is key in convincing the market to assign due credit to VW’s EV efforts.
Next Step – Closing the Valuation Gap
Like most other legacy auto manufacturers, VW shares are trading at a depressed c. 6x EBITDA multiple, which largely ignores its EV leadership. However, improved transparency and strong execution should eventually drive a re-rating. The opportunity is significant – if we were to value VW’s implied EBITDA contribution from the EV lineup at a Tesla-like multiple, for instance, VW shares could be worth upwards of €200/share (over 40% upside to current levels).
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.