Volkswagen brand's turnaround plan “Transform 2025+” is not even a year old and yet next month the brand’s CEO, Herbert Diess, will likely find himself forced to revise already his targets – upwards.
Diess, a restructuring expert from his time at BMW, has so far over-delivered on his plans to boost profitability at VW Group's chronically low-margin core marque. However, investors see his 4 percent operating margin goal for 2020 as anything but a reach.
During VW brand's half-year results conference call in July, VW brand finance chief Arno Antlitz already had to fend off questions analysts wondering when VW would finally aim for truly ambitious targets.
It’s not hard to see why. In the first nine months the brand’s return on sales rose to 4.25 percent versus an unadjusted 1.6 percent a year ago.
Only about 30 basis points of that improvement resulted from its decision earlier this year to strip out revenue and earnings from the sale of cars from sister brands, VW Group CFO Frank Witter said during the group's third-quarter earnings call on Friday, meaning that VW just needs to tread water for the next three years. Witter's suggestion that with one financial quarter still to go the brand could moderately exceed its target range of 2.5 percent to 3.5 percent this year is not impressive.
Indeed this suggests a marked deterioration in performance during the fourth-quarter with an implied margin of just 3.0 percent – which would be the worst this year by far. Even ramped costs for the latest-generation Polo hatchback and new T-Roc crossover couldn’t have that big an effect, one executive conceded, saying there was no specific reason underlying the restrained Q4 outlook.
The 2020 goal hinges on pulling three main strategic levers:
- more lucrative SUV models
- higher productivity in Germany
- a turnaround in three money-losing regions.
These effects largely have yet to feed through to the brand’s profits, leaving plenty of further upside all things being equal.
Only a few months ago, VW launched with the Atlas as the first of several new SUVs that are seen as instrumental in improving return. The T-Roc is in the starting blocks for next month’s launch. Eventually the plan is to jump from just two SUVs at the start of this year – the Tiguan and Touareg - to 19 in total by the end of the decade, accounting for 40 percent of the brand’s volumes and no doubt a much higher proportion of earnings.
The second part of the plan is a more efficient German production network, with a cumulative 25 percent increase in productivity in the German plants over the four years through 2020, in part through thousands of job cuts. The bulk of those are in the pipeline, but won’t be earnings accretive until workers enter early retirement in 2018 and beyond.
No more U.S. losses
Perhaps the greatest progress has been made in the third pillar of the plan - putting an end to hundreds of millions of euros in losses in three regions of Russia, South America and the United States. After a solid turnaround in volumes — up 18 percent in the first nine months in Russia, 17 percent in Brazil and 9.2 percent in the USA — expectations may be getting ahead of themselves, but financial analysts already asked Witter on Friday whether the brand could break even in total across the three next year already. "No" was the clear answer from Witter.
All the premises and assumptions of the business plan will be revisited and stress tested come the group’s 66th investment planning round in a few weeks time. Executives are trying to buy themselves some breathing room for easier targets by cautioning that the plan is front loaded with heavy costs coming in 2019 and 2020 for the launch of the I.D. electric car family based on its 5 billion euro MEB electric architecture.
Given the progress seen so far, however, it will come as a huge disappointment if Diess does not raise his expectations next month. Even as the brand kept to its conservative 4.0 percent target for 2020 in a statement on Monday, Diess essentially admitted he should aim for a higher figure: “We’ve improved our operating profitability more quickly than expected,” he said.