Primary activity of the company
Volkswagen AG is the second largest automobile producers in the world, headquartered in Wolfsburg, Germany. The Volkswagen group includes twelve brands: Volkswagen Commercial Vehicles, Volkswagen Passenger Cars, Ducati, SEAT, Audi, Bentley, SKODA, Porsche, Lamborghini, Bugatti, Man and Scania. The Group is the largest car manufacturer in Europe: 25, 1 % of all new cars, made in Western Europe, produced by Volkswagen. The company is operating 119 plants in 20 European countries and 11 countries in Asia, Africa and Americas, occupying approximately 13 % share in the global market of passenger cars. The production of the Group is highly diversified: from motorcycles to luxury and low-consumption small cars. Moreover, the Group supplies diesel engines for marine, steam and gas turbines, chemical reactors and compressors, turbochargers.
The aim of this report is the analysis of the company’s financial statements and financial performance, including estimation of profitability, liquidity and solvency ratios, analysis of the earnings per share trend and ability of the company to generate free cash flows.
Volkswagen AG Financial Performance
Explanation for ratio analysis
Current ratio equals current assets divide current liabilities, this ratio shows the general ability of the company to pay current debts, such as payables, interest payments etc., using current assets, such as receivables and cash. Hence, this is desirable that current assets exceed current liabilities; the ratio should be more than 1. Current ratio of the company is slightly higher than 1, however since 2013 the ratio has decreased, that is unfavorable dynamic, because this means that the company’s liquidity has declined and probability not to meet its obligations in time has increased. Though the ratio is higher than 1, this is less than industry average, which is also might raise concerns regarding financial health of the company.
Inventory turnover is the ratio, measuring efficiency of using inventory, and comparing cost of goods sold with average level of inventories (COGS/Inventory). As efficient firms hold small level of inventories and turn them rapidly, the increase in the ratio likely means the improving efficiency of the company. Thus, the Volkswagen inventory turnover showed favorable dynamic – the ratio has increased during analyzed period from 5.63 to approximately 5.8. The last figure is close to the industry average; however, the company’s turnover ratio is still lower than average index.
Debt to equity ratio is another key measure of financial performance, indicating the company’s debt burden. The benchmark varies from industry to industry, and for car manufacturers it is usually 2,5 . However, the company’s ratio is higher than average. Furthermore, in recent two years it has increased from 2.7 to 2.9, which is unfavorable dynamic, showing increasing in debt burden and risk of the company insolvency.
Net profit margin is the ratio indicating which share of sales remains after paying all expenses, including interests, taxes etc. Therefore, the higher ratio is the better for the company financial health and investment attractiveness. Net profit margin of Volkswagen AG has shown positive dynamic during analyzed period, increasing from 4.6 % to 5.3 % and outperforming industry average, which is 3.6 %
Income for shareholders per each dollar invested, or return on equity (ROE) has also shown positive trend, and increased from 10.3 % in 2013 to 12 % in 2014, reaching the average ratio in the industry.
Price per earnings ratio (P/E) is crucial index for investors. The increase in ratio usually reflects positive expectations regarding the stock price. However, the company’s P/E ratio has slightly decreased, which is unfavorable dynamics, and the ratio is still lower than industry average.
Earnings per share dynamic
Figure 1. Dynamics of Earnings per share of Volkswagen AG, 2010-2014. Source: Volkswagen AG Annual Report, 2014
The analysis of the company’s EPS has shown that this ratio had increased almost triple during 2010-2012 years from 15.17 euros per common share, to 46.41 euros. However, EPS dramatically decreased in the following year – the ratio in 2013 was more than two times lower than in the previous year. During the last analyzed year dynamics has changed again indicating slight increase in EPS – 21.84 euros, that is almost 17 % higher than in 2013.
Financial performance assessment
Liquidity and debt situation
According to the ratio analysis, the company’s liquidity has decreased during analyzed period, indicated by decline in the current ratio. Though the inventory turnover has increased, this ratio is still lower than average and the growth was slight. Therefore, in general, company’s liquidity has worsened. Moreover, increased debt burden, indicated by the growth of debt to equity ratio, is raising concerns regarding the company’s ability to meet obligations entirely and in time.
Though liquidity of the company has worsened, the profitability ratios have shown positive dynamics, reflecting growth of both net profit margin and return on equity. However, the expectations of investors are not very positive: though EPS has increased, price to earnings ratio has declined, reflecting the relatively sharp decline in stock price.
Operating cash flow analysis
Analyzing cash flow statement is also crucial in assessing the company’s performance. The special attention should be paid to operating cash flow, which measures amount of cash generated by normal activities and therefore ability of the company to maintain and grow the business without external investments by generating positive cash flow.
The company’s ability to generate cash flow from operating activities has declined – net operating cash flow has decreased by 14,4 %, from 12595 million euros in 2013 to 10784 million euros in 2014. This decline has primarily occurred because of increase in inventories and leased assets.
Free cash flow was negative in both in 2013 and 2014; however, in the last year free cash flow has significantly decreased from 2811 to 5829 million euros, increasing the company’s need in external financing almost double. As the company’s debt to equity ratio is not quite favorable, and this situation is likely worsen in the next few years, because company will increase debt burden. Such growth will negatively affect the long-term solvency and liquidity.
Most recent financial articles are discussing the recent scandal connected with cheating emissions test in the US. For example, in the article “Sixty six investors to sue Volkswagen” published at January, 17, 2016 in the Financial Times by Mooney A., reports that 66 institutional investors are going to sue the company for these actions, resulting in suffering big loss by these investors. The cheating of tests was revealed by the Environmental Protection Agency of the US. Therefore, “billions of euros have been wiped off the value of Volkswagen” as a consequence. The European commission has also followed this initiative, demanding compensation for European customers, suffered from emission scandal. However, the financial liabilities occurred from paying penalties for the malfeasance, are going to be higher in the US than in the EU, as reported in The Star. Though Volkswagen’ s officials have not commented yet these claims, the legal actions are making additional pressure on the company’s financial performance, which recently reported about first in decade decrease in annual sales.
Therefore, the company’s financial performance has not favorable in the recent years, despite the increase in net profit margin. Much concerns raise from increasing debt burden and worsening liquidity of the company. Moreover, the analysis of the cash flow statement indicated that the company’s ability to generate free cash flows from operating activity has decrease, and in general, the need for additional financing has increased. Though earnings per share has increased in the last year, overall trend from 2012 is also negative. The recent emission scandal will make additional pressure on the company’s performance: firstly, company would have to pay huge penalties to investors and customers, and secondly, the demand for the company’s production might decrease, and consequently sales would decline. Moreover, stock price of the company might also decrease, reflecting the negative expectations of investors. Therefore, the worsening of company’s liquidity, debt situation and profitability is expected in the next year.
European industry commissioner demands action from VW: letter. (2016) The Star. Retrieved from: [http://www.thestar.com.my/tech/tech-news/2016/01/20/european-industry-commissioner-demands-action-from-vw-letter/]
Mooney, A. (2016). Sixty six investors to sue Volkswagen. Financial Times. Retrieved from: [http://www.ft.com/cms/s/0/185c4086-bb9f-11e5-bf7e-8a339b6f2164.html#axzz3y1it6JFn]
Moving Progress. Annual Report 2014. (2015). Volkswagen Aktiengesselschaft.
Appendix 1. Volkswagen AG Income Statement
Appendix 2. Balance sheet
Appendix 3. Cash flow statement