Our latest stock of the week poll gave our Twitter followers the choice of four undervalued companies from a wide range of industries. These 5-star stocks included voucher company Groupon, Canadian cannabis company Curaleaf and brewing conglomerate (and presenter’s nightmare) Anheuser-Busch Inbev. But German car giant Volkswagen (VOW3) emerged as the winner by a small margin.
Car makers are under pressure from all sides, not least from ESG investors, and rising raw material costs are also presenting serious challenges. But could VW emerge as one of the winners in the electric vehicle transition?
VW is not the only car manufacturer under Morningstar coverage to be considered undervalued at current levels: BMW (BMW) is rated as 4 stars, Japan’s Nissan (7201) is a 5-star stock, as is French carmaker Renault (RNO). Ultra-luxury brand and recent stock of the week Ferrari (RACE) is a conspicuous outlier, with a valuation to match the lofty price of its cars.
Let’s look in detail at the case for VW being significantly undervalued. Despite a mixed set of third-quarter results, which saw a drop in automotive operating profit, its fair value of €340 is being maintained, says Morningstar analyst Richard Hilgert. Shares have risen around 23% this year to around €180, but they are still below their fair value. Last time we wrote about Volkswagen, in March 2021, the fair value was €247, and the non-preference shares were considered to be fairly valued.
VW's valuation has yet to catch up with its potential to become a global leader in EVs. “Volkswagen is successfully executing a global automotive strategy and has one of the most aggressive plans to transition to battery electric vehicles (BEV) from internal combustion powertrains,” says Hilgert.
VW’s scale and diversification is also an advantage. With brands for most budgets, from the Up! to the Lamborghini, he adds that VW's own broad portfolio is a strength in a very competitive market.
“A broad array of brands, serving multiple segments, reduces reliance on any one vehicle category. As one of the world's leading volume producers, Volkswagen's economies of scale from common platforms across a number of models enable cost savings unattainable by smaller competitors.”
On the environment, the world automotive sector is not quite up there with the oil industry, but it is certainly one of the major producers of global carbon emissions. Unlike oil companies, car makers are perhaps quicker in addressing the problems their products have created. Currently, around 35% of vehicles made by VW are electric, and it plans to raise this to 70% by 2030. Tesla (TSLA) has become the poster child for EVs and is now 10 times the size of VW, but a company like Volkswagen can still grab market share in a sector that’s still growing significantly. Morningstar’s latest Electric Vehicle Observer estimates that electric and or hybrid vehicle sales are likely to speed up significantly towards the end of this decade.
Diesel Fumes Linger
Still, it’s not all open road ahead for VW. The reputational damage from the diesel emissions scandal in 2015 is still having an impact.
Morningstar-owned ratings agency Sustainalytics rates VW as “Medium Risk” in ESG terms, particularly as the diesel emissions scandal continues to attract regulatory scrutiny. It should be pointed out that this risk level has been downgraded, as earlier in the year VW was rated in the highest category of “Severe”.
“VW is still exposed to Dieselgate-related fines and compensation. The company’s reliance on diesel models and its relatively late entry to the EV race create challenges for VW to meet the EU emissions target for 2021, exposing it to considerable fines," Hilgert says.
"In addition to risks of defects and recalls, VW is exposed to other product safety issues.”
The shift to electric vehicles across the industry is not expected to be seamless. Rather than an emissions-free utopia, the future of travel could be scuppered by our over-reliance on technology.
Nor does that account for the moral, legal and technical issues raised by driverless cars.
“As cars become more connected, software malfunctions may delay production and delivery to customers or trigger recalls," Hilgert says.
Car recalls are serious business in particular, not just because of the safety implications and costs to the company, but because of the reputational damage, which can trigger consumers to shift to rival brands. Toyota and Honda, for example, had to recall 6 million cars in 2020 because of an issue with airbags, and VW had to recall 56,000 Golf cars early this year to fix software problems.
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