Volkswagen (VLKAY) - A No-Brainer Contrarian Investment

by Ryan Fitzwater, Senior Research Analyst

Investors can’t turn on the television, jump online, or open a newspaper today without being pounded with headlines about the Eurozone Crisis. Greece’s unmanageable debt, Spain’s unbelievably high unemployment, Ireland’s banking woes – the list goes on.

The crisis created extremely volatile market conditions the individual investor is having a hard time stomaching. The media paints a gloomy future, and it’s no surprise that billions of dollars have moved out of equities. Investors are losing their confidence.

But contrarian investors like myself will tell you this is the perfect time to going shopping for discounts in the market, especially strong businesses located inside the Eurozone. And I’ve found one German automaker that fits the bill.

“Das Auto”

Headquartered in Wolfsburg, Germany, and founded in 1937, Volkswagen (OTC: VLKAY.PK) provides automobiles to drivers around the world.

You’re probably familiar with Volkswagen’s popular models such as the Jetta, Beetle and Passat. But the company also provides vehicles under Bentley, Audi, Bugatti and Lamborghini, to name a few.

So why is Volkswagen showing up on the value stock radar?

In large part, because investors don’t want to touch European companies with a 20-foot poll. Even the financially fit businesses operating in Europe’s strongest economy, Germany.

Trading At a Discount

In general, a company with a low price-to-book ratio signals a stock is undervalued. Of course, things are never that simple. If they were, all investors would need to do is buy any stock trading below its book value and call it a day.

Currently, Volkswagen’s price-to-book is 0.90, meaning the company is trading at a 10% discount.

Volkswagen shares currently trade around $30. The current book value per share is $32.28.

This means if the company was liquidated today, each shareholder would, in theory, get $32.28 per share for their ownership of the company’s hard assets. (And this doesn’t include the separate value of patents, etc. that could further boost book value.)

Who wouldn’t want to buy a stock today, have the company (worst-case scenario) fail tomorrow and still make over a $2 per share profit the next day? Like I said before, it’s not that simple.

Many stocks that start trading below book value hint that there might be something fundamentally wrong with the company. So let’s break down some of Volkswagen’s financials to ensure this isn’t the case.

Fundamental Breakdown

Investors should check the return on equity (ROE) and return on assets (ROA) for any stock trading at a discount.

ROE measures how well a company is using reinvested earnings to produce additional earnings for shareholders. Currently Volkswagen’s ROE is a healthy 30.84%, which is well above the industry average that sits at 21.81%.

ROA indicates how efficient management is at using the company’s assets to generate earnings. And many stocks begin to trade at a discount because investors believe the company’s assets are overstated. Looking at ROA can help you determine if a company is properly converting money it has invested into profits.

Volkswagen ROA is 7.10% - more than double the industry average of 3.17%.

Comparison is always key when analyzing a company’s metrics, so let’s see how Volkswagen stacks up against an American competitor like Ford Motor (NYSE: F).

Volkswagen (VLKAY)

As you can see in the chart above, Volkswagen dominated every category. Value investors should be salivating right now. Ford’s price to book is currently 2.39, close to three times higher than Volkswagen.

Now let’s look at some more industry averages the company is torching.

Volkswagen’s current P/E is an attractive 3.23; the industry average is over six times higher at 22.37.

The company’s recent quarterly operating margins are well above the industry average of 4.52%, sitting at 6.78%. And their 6.69% quarterly profit margins more than doubled the industry average of 2.81%.

And their revenue growth over the past few quarters has been excellent.

A No-Brainer Contrarian Investment

The company’s most recent quarter saw sales grow 26.30% compared to the same period last year. In comparison, the industry average was 18.81%. And Ford had negative sales growth of -2.02% in their most recent quarter.

The only metric you could be nervous about is Volkswagen’s 152.3% debt to equity. But don’t worry too much…

Auto manufacturing is capital-intensive industry and always carries a high debt-to-equity ratio.

Currently the industry average is 153.31%, so Volkswagen is right on par here. I would be more worried about Ford’s 603.54% debt to equity that’s almost four times higher.

Volkswagen’s dividend yield of 2.70% is just icing on the cake; the industry average is only 1.73%.

Going Against the Crowd

When investors are fleeing a particular sector or economy out of fear, contrarian investors stand by ready to put their money to work.

The fact that Volkswagen has exposure to markets outside the Eurozone, including North America, South America and the Asia-Pacific, gives the company an advantage over other European businesses that are less fortunate in global reach.

Over 54% of Volkswagen’s cars are sold outside the Eurozone. And Germany makes up 44% of vehicles sold inside Europe.

Better to have almost half your European sales inside the country with the strongest economy in the region. Not to mention, Germany is the one most likely to be left standing should the Eurozone completely fall apart.

Investors should consider Volkswagen as a true value play right now. Fundamentals are strong and the stock is trading at a nice discount. Though, if you’re still wary about the Eurozone crisis, you might consider waiting a bit for Greece to possibly exit. A Greek exit could send prices down even further, giving an even better discount on shares.

Good Investing,

Ryan Fitzwater

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