Introduction
This report aims to assess the financial health of Volkswagen AG, a world-famous vehicle manufacturer. The automotive industry experienced a significant decline in 2020 due to the drop in sales associated with the COVID pandemic (Morgan Lewis, 2022). However, in 2021, the industry experienced a recovery and nearly returned to its pre-pandemic state (Morgan Lewis, 2022). This report illustrates the trends in the automotive industry, using Volkswagen AG as an example.
The report utilises ratio analysis to assess the company’s profitability, efficiency, liquidity, financial gearing, and investment performance, and compares it to one of its central competitors – BMW. Additionally, this paper analyzes a company’s cash flow and significant cash flow risks. This report utilises Volkswagen’s and BMW’s annual reports as the primary source of information. The report’s scope is limited, as it considers only two Europe-based automobile manufacturers. This implies that even though the analysis may reveal specific trends in the automotive industry, it fails to represent companies based in other regions, such as Asia or the Americas.
Background to the Industry
Brief History
Although the invention of the first car dates back to 1769, when French inventor Nicholas-Joseph Cugnot built a three-wheeled steam vehicle, the automotive industry’s history began with the establishment of the first car manufacturer, Mercedes-Benz, in 1896 (Logotech, 2022). The industry thrived in the early 1900s, as the Olds Motor Vehicle Company and Thomas B. Jeffrey Company developed mass-produced vehicles based on internal combustion engines (Logotech, 2022). The most famous success story in the automotive industry is Henry Ford’s invention of the assembly line, which reduced the cost of producing the Model T from 1912 to 1914 (Logotech, 2022). Today, the central trend in the automotive industry is to reduce the carbon footprint by transitioning to electric vehicles, and Volkswagen has committed to this trend (Volkswagen AG, 2021).
Porter’s Five Forces
Porter’s Five Forces is a widely used model for assessing an industry from five distinct perspectives (Scott, 2022). In particular, the model suggests that every industry can be assessed from the viewpoints of competitive rivalry, bargaining power of suppliers and buyers, threat of substitution, and threat of new entrants. The analysis of the industry using this framework is provided below.
Competitive Rivalry—High. The industry is characterized by a high number of competitors, including BMW, Volkswagen, Toyota, General Motors, Ford, Nissan, Honda, Geely, Suzuki, Tesla, and Renault (Haigh, 2022). Moreover, the industry is experiencing a rise in the market share of Chinese manufacturers (Morgan Lewis, 2022). Therefore, the industry is highly competitive.
Threat of New Entrants – Low. The entry barrier for the industry is very high due to the high cost of establishing a brand and significant investments to start manufacturing vehicles. Therefore, the threat of new entrants is low.
Threat of Substitution—Moderate. The threat of substitutes is moderate due to the combination of switching costs, availability, and convenience associated with using them. Even though the switching cost is low, substitutes such as public transportation, bicycles, and motorbikes offer limited convenience. Availability may also be limited in some areas.
Bargaining Power of Suppliers—High. While there are numerous suppliers of different parts, companies must maintain a complex supply chain that is highly sensitive to disruptions. Moreover, the industry is experiencing a semiconductor shortage (Volkswagen AG, 2021). Therefore, the bargaining power of suppliers is high.
Bargaining Power of Buyers – High. In the automotive industry, the threat that customers may switch from one firm to another is high due to low switching costs (Jothi & Kalaivani, 2015).
Company Background
Volkswagen AG is a multinational company operating in the automotive industry, with its primary operations centered on producing, marketing, and servicing vehicles (Volkswagen AG, n.d.). The company operates in four segments: Passenger Cars and Light Commercial Vehicles, Commercial Vehicles, Power Engineering, and Financial Services (Yahoo Finance, 2022). The company operates under ten brands, which are subdivided into volume brands (Volkswagen, Volkswagen Commercial Vehicles, Skoda, SEAT, and CUPRA), premium brands (Audi, Lamborghini, Bentley, and Ducati), and sports (Porsche).
The company was formally established on May 28, 1937, as the ‘Company for the Preparation of the German Volkswagen Ltd.’ (Volkswagen Newsroom, n.d.). In 1938, the name was changed to ‘Volkswagenwerk GmbH’, as the company built its first plant in Wolfsburg (Volkswagen Newsroom, n.d.). After the war, the British instructed the company to focus on producing two models of vehicles, including the Käfer and transporter, which became a symbol of the German economic miracle (Volkswagen Newsroom, n.d.). Furthermore, in the 1960s, the company became a joint-stock company and introduced the Passat, Scirocco, Golf, and Polo models to its production lineup in the 1970s (Volkswagen Newsroom, n.d.).
In 2015, the company experienced a significant crisis. The Environmental Protection Agency (EPA) revealed that Volkswagen used special software that detected when it was being tested and adjusted the engine’s performance to yield more environmentally friendly results (Hotten, 2015). The scandal had a profoundly devastating effect on the company’s reputation and financial performance (Volkswagen AG, 2016). To mitigate the scandal’s impact, the company has since made environmental sustainability a key component of its business strategy (Volkswagen AG, 2016, 2021, 2022).
Critical Success Factors
The company’s critical success factors are outlined below by category.
- Strategic:
- Outstanding leadership;
- An ambitious vision of switching to electric vehicle manufacturing (Volkswagen AG, 2022).
- Market segmentation:
- A potent brand mix that penetrates all segments.
- Successful penetration and performance in China.
- People:
- Valuable talents;
- Intense training and development programs for employees.
- Marketing
- Attracting new customers with the vision;
- Effective customer retention practices;
- Customer-centred corporate culture;
- Optimal marketing mix.
Financial Statements
Overview
This report is based on financial statements provided by Volkswagen AG for FY2021 and FY2020. Volkswagen AG consolidated the financial data and reviewed it by Deloitte for the relevant years between January 1 and December 31, as Volkswagen AG’s fiscal year ends on December 31. The statement included data from all segments, brands, and countries. The crucial financial data used for the analysis are provided in Appendix A.
Revenue and Profitability
In 2020, Volkswagen experienced a significant decline in revenues and profits due to the pandemic. In particular, net sales fell by 11.78% from €252.6 billion to €222.9 billion in 2020 compared to 2019 (Volkswagen AG, 2021). Net profit decreased by 37.55% from €13.3 billion in 2019 to €8.3 billion in 2020 (Volkswagen AG, 2021).
The primary reason for the decline was the implementation of lockdown measures and mobility restrictions, which reduced manufacturing capabilities and demand for the company’s products (Volkswagen AG, 2021). However, in 2021, Volkswagen experienced a recovery, with revenues growing by 12.26% from €222.9 billion in 2020 to €250.2 billion in 2021 (Volkswagen AG, 2022). Similarly, profits grew 78.1% from €8.3 billion in 2020 to € 14.8 billion in 2021 (Volkswagen AG, 2022). Horizontal analysis of the company’s performance is provided in Table 1 below.
The company’s trends in its profitability ratios compared to its competitor, BMW, are provided in Table 2 below. The analysis shows that Volkswagen’s margins increased in 2021 compared to 2020, indicating improved cost management (Volkswagen AG, 2021). However, it should be noted that while Volkswagen’s gross profit margin is comparable to BMW’s, Volkswagen’s net profit margin is significantly lower, which suggests that the company’s ability to manage selling, administrative, and general expenses is higher than that of BMW.
Return on Investment
Volkswagen’s attractiveness to investors was measured using dividend yield, earnings per share (EPS), and price-to-earnings (P/E) ratios. The analysis’s results are provided in Table 3 below.
The analysis demonstrates that, although the company’s EPS increased from €1.66 in 2020 to €2.96 in 2021, its share prices grew even faster, resulting in a rising P/E ratio. As a result, BMW’s P/E ratio was closer to the benchmark of 1, which makes Volkswagen’s shares significantly overvalued. At the same time, Volkswagen’s attractiveness in terms of dividends is also lower than that of BMW’s, as Volkswagen’s dividend yield ratio in 2021 was 1.78%, compared to BMW’s 4.25%.
Volkswagen’s return on capital employed (ROCE) and return on equity (ROE) were lower in 2021 than those of BMW, despite demonstrating a significant rise compared to 2020. Table 4 below compares these ratios.
Asset Management
The company operates 120 production plants across Europe, Asia, the Americas, and Africa, with 51.5% of these plants located in Europe (Volkswagen AG, n.d.). In 2021, Volkswagen’s non-current assets increased from €196,496 million in 2019 to €218,062 million. The increase was primarily attributed to the acquisition of Navistar and the establishment of Bugatti Rimac d.o.o. The effectiveness of the company’s non-current asset use in 2021 (0.76) was comparable to that of BMW’s (0.78).
Volkswagen demonstrated better performance in the receivables turnover ratio in 2021 (15.75) than BMW for the same year (1.27). At the same time, in 2021, the payables turnover ratio (8.77) and inventory turnover ratio (4.68) of Volkswagen were higher than the payables turnover ratio (11.36) and inventory turnover ratio (5.74) of BMW. The summary of efficiency analysis is provided in Table 5 below.
Liquidity
The ratios for Volkswagen and BMW are provided in Table 6 below.
Volkswagen’s current ratio increased from 1.18 in 2020 to 1.22 in 2021, indicating a slight improvement. The increase in the current ratio was due to a slight growth in current assets and a corresponding decrease in current liabilities, as shown in Table 1. Volkswagen’s current ratio in 2021 was also slightly higher than BMW’s, which was 1.13.
Volkswagen’s quick ratio of 0.95 in 2021 was also above BMW’s quick ratio for the same year and Volkswagen’s quick ratio in 2020. In summary, Volkswagen’s liquidity, as measured by the current and quick ratios, was close to the benchmark of 1 and comparable to BMW’s liquidity. This implies that Volkswagen’s liquidity performance was solid.
Solvency
Volkswagen’s solvency was assessed using two key ratios: the interest cover ratio and the debt ratio. The results are provided in Table 7 below.
The ratio analysis showed that Volkswagen’s financial leverage performance improved in 2021. The company’s debt ratio decreased from 0.74 in 2020 to 0.72 in 2021, demonstrating a lower reliance on debt. Moreover, the company’s ability to pay interest, measured in the interest cover ratio, increased from 4.39 in 2020 to 8.77 in 2021. While Volkswagen’s performance in terms of financial leverage improved, the company is still behind BMW, which had a debt ratio of 0.67 and an interest cover ratio of 57.01 in 2021. However, the analysis shows that Volkswagen makes enough money to cover interest.
The company’s debt increased from €113,556 in 2019 to €131,618. The growth in net debt was attributed to the company’s desire to use low interest rates during the pandemic (Volkswagen AG, 2022). While the company can take additional debt, it appears to have taken the course to decrease its dependence on debt to finance its assets.
Cash Flow
Volkswagen’s cash flow from operating activities was €38,633 million in 2021, an increase from €24,901 million in 2020 and €17,983 million in 2019. However, net cash flow in 2021, €5,691, was lower than that in 2020, €9,103. The company’s FCFE was €6,611 in 2021, almost €6,689 in 2020. The cash flow for investing activities was—€26,128 in 2021, lower than—€22,690 and—€21,146.
Sensitivity and Risk
Several risks can impact the revenue. In particular, the company acknowledges that the impact of the COVID-19 pandemic may lead to decreased demand and production ability (Volkswagen AG, 2021). Moreover, the company views the Russia-Ukraine conflict as the central revenue risk due to the possible need to stop selling cars in Russia and the decreased ability of Ukrainian customers to purchase vehicles (Volkswagen AG, 2021). Due to the conflict, Volkswagen may also experience problems with bad debt from Russian and Ukrainian partners and customers (Volkswagen AG, 2021). The company has high sensitivity to such risks, as the company’s sales in Russia and Ukraine are high, and the probability of the conflict impacting the revenue is also high.
The semiconductor shortage may be both a supply chain and a cost risk. On the other hand, a semiconductor shortage may lead to changing the suppliers, which may affect the stability of the supply chain. On the other hand, a shortage of semiconductors may lead to speculative prices and failure to deliver the parts in time, which may lead to increased inventory storage costs (Volkswagen AG, 2021). The company has medium sensitivity to such risk, as semiconductors are not the central parts of the vehicles, and the company employs some methods to decrease the dependence on semiconductors.
Moreover, the exchange rate volatility due to the war in Ukraine may also significantly impact the company (Volkswagen AG, 2021). Volkswagen is highly sensitive to these risks, as it is present in numerous countries and sells vehicles in different currencies.
Discussion
The company’s performance is likely to deteriorate in the near future. In particular, the company’s profitability is likely to fall due to decreased sales in the CIS region due to the conflict in Ukraine (Volkswagen AG, 2022). Moreover, the company may experience significant problems with investment performance, as the company’s stocks were significantly overvalued in 2021, which will likely lead to a decline in Volkswagen’s share prices. However, the company is likely to increase its cash to ensure liquidity for a quick reaction to the changing external environment.
However, the effect of the external factors will be mitigated by the company’s inner strengths. In particular, the company has strong leadership that has carried it through the difficult times of the pandemic. The same team is likely to help Volkswagen overcome the semiconductor shortage and the Russia-Ukraine conflict. Thus, profitability and efficiency are likely to change insignificantly.
Conclusion
The analysis of Volkswagen’s financial performance demonstrated a recovery from the crisis associated with the COVID-19 pandemic. Volkswagen’s profitability, efficiency, and financial leverage demonstrated a slight to moderate improvement, while the company’s liquidity remained roughly the same. The only primary concern associated with the company’s performance in 2021 was its attractiveness to the investors, as the share prices grew disproportionately compared with profits and dividends. At the same time, compared to the financial performance of BMW for the same year, Volkswagen has the potential to grow in profitability and financial leverage.
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