Volkswagen faces a perfect storm of challenges

Volkswagen is facing a critical juncture as it grapples with a perfect storm of challenges. The company's profitability is under immense pressure due to a combination of factors, including rising competition from Chinese automakers, increasing costs in Europe, and a slower-than-expected transition to electric vehicles.

In May, Volkswagen's finance chief, Arno Antlitz, issued a stark warning, stating that the company had approximately two to three years to prepare for intense competition from overseas, particularly from China. However, last week, he significantly shortened this timeframe to just one year, sending shockwaves through the global auto industry. The company even threatened to close plants in its home market for the first time, highlighting the severity of the situation.

Several key developments have exacerbated Volkswagen's challenges. One major concern is the potential acceleration of plans by Asian rivals, such as BYD, Chery, and Leapmotor, to establish production capacity in Europe. This is especially concerning given the European Union's proposed hefty import tariffs on China-made electric vehicles.

Furthermore, Volkswagen recently implemented price cuts for its VW brand cars to counter intensifying competition. While this move was intended to boost sales, it has come at a significant cost. According to Works Council boss Daniela Cavallo, these discounts have resulted in a loss of hundreds of millions of euros in profits.

The price cuts have not only been steeper than initially anticipated but have also highlighted the high-cost base in Germany, which is hindering Volkswagen's ability to compete with more agile rivals. A company source, who declined to be identified due to the sensitivity of the matter, confirmed that the discounts have significantly impacted the company's profitability. Volkswagen declined to comment on these specific details.

The price cuts, coupled with restructuring expenses, have undermined Volkswagen's efforts to reduce costs by more than EUR 10 billion (USD 11 billion) by 2026. As a result, the VW passenger car brand's profit margin plummeted to a mere 0.9% in the second quarter, down from a meagre 4% in the first. In contrast, Renault and Stellantis, the other two major European volume carmakers, achieved profit margins of 8.1% and 10%, respectively, in the first half of the year.

Volkswagen's squeezed margins, combined with the increased imports of Chinese vehicles into Europe, have raised serious concerns about the company's future prospects. As Chinese automakers establish a local presence in Europe, they will be competing for a smaller market share, further intensifying the competition.

DZ Bank analyst Michael Punzet has expressed his expectation that Volkswagen will once again lower its full-year group margin target when it publishes its third-quarter results. This follows a previous reduction to 6.5-7.0% in July due to provisions related to the potential closure of a Brussels factory owned by its luxury subsidiary, Audi.

The shrinking demand for mass-market cars has transformed the industry into a fierce battle over cost competitiveness. Volkswagen's finance chief, Arno Antlitz, has acknowledged that the VW brand has been spending more money than it earns for some time, emphasising that the company cannot sustain this trend and remain competitive.

In the first half of 2024, Volkswagen's automotive cash flow turned negative, reaching minus EUR 100 million. This stark contrast to the positive EUR 2.5 billion recorded in the same period last year underscores the company's financial challenges.

Beyond Europe, Volkswagen is also facing headwinds in its largest market, China. Profits from China have nearly halved over the past decade, and while they are expected to recover slightly, they will remain significantly below their peak levels.

Additionally, the high energy and labour costs in Germany, which rank among the highest in Europe, are further straining Volkswagen's profitability. These costs have also become a major concern for other sectors in Germany, such as chemicals and steel.

Analysts from Citi have highlighted the perfect storm of challenges facing Volkswagen, including new cheaper competition, higher energy prices, and high labour costs. These factors, combined with the intensifying competition from Chinese automakers, paint a difficult outlook for European mass brands, including Volkswagen.