Porsche Holding (Volkswagen)

I decided to invest in this carmaker holding. Depressed valuation and double holding discount are the two main factors for my decision.

Since I've been looking a bit more into cyclicals in the last month as a way to mitigate the interest rate cycle effect in equities and have even done some minor investments in BMW and Daimler I necessarily had to end up looking into Volkswagen (VW).

We all know that VW cheated on emissions and that it even adjusted the software, with, in my opinion necessary, participation of the top management, to disguise its lie in front of the emissions testers. This has made a traditionally blue-chip/cyclical company to be looked as a non-investment case for the majority, if not the totality, of the institutional investment community.

VW has set aside €18.2bn for the emissions scandal, after admitting in Sep2015 to equipping 11m cars worldwide with software to cheat tests, but for the shareholders the results of this management adventure have been worse.

Until Sep2015 the company was trading at c. €150 per share, coming from a peak in in Apr2015 of €244. With the news of the scandal the share price dropped to as minimum of €102 in the beginning of Oct2015 and has been trading since them in the range of €110 to 140 per share. Shareholders of ordinary and preferred shares lost c. €30bn of their market cap in a matter of days despite the "fraud" had been brewed well before and along many years.

There are other lies in corporate history, but this one makes it indeed to the top of the board in terms of cost and stupidity. I wouldn't discard the possibility that VW was not alone and that probably they were only the less cautious or the most brave of the bunch.

Having said all of this it is a fact that the company is trading at very interesting levels, only based on past performance of course. If history counts for anything, we have to admit that VW is, or at least has been, a sound performer. In my historic summary, which format I've used in other analysis, I only have information since 1990 until 2013, so I'm missing two years of financial statements, which I have reviewed separately.  In any case it is more than enough for the required purpose right now.

In the last 10 years (2003-2013):

• Revenues have grown at CAGR of 8.3% and margin which is even more impressive at a CAGR of 12%.
• Assets have grown at a CAGR of 10% and EPS at 20.8%. Equity in the books, after dividend payment, has grown at a CAGR of 11.5%.
• The average  of the net income vs. total assets (proxy for ROA) has been 3.1%. If we take in account the whole period (since 1993) the average goes down to 2% with a range that goes from the -0.7% to the 6%. This does not look spectacular but it is quite positive for any industrial company like a car maker.
• VW has only lost money in one year (1993) since 1990.
• Current leverage is on the low part of the historic range. As of 2013 leverage was at 3.8x assets to equity vs. an historic average for the whole 23 years period of 5.5x and a range of 4 to 8x leverage.

Looking into the current valuation fo the automaker we can see that:

• In the whole period (1993 to 2013) PERs have had a range of 58x to 3x with an average of 18.2x. If we applied that average of 18 times to the trailing 10 years average EPS (€15) the average valuation for the company would be c. €270 vs. the current €128.
• Of course we don't want to apply average valuation but a conservative 10x one, that would lead to a reference value of €150, or 17% above current share price. This value might be too conservative because it uses average historic EPS and does not take in account the compounding effect of ROE.
• If we apply last 10 years average ROA (3.1%) to the current leverage (3.8x) the resulting ROE (11.9%) applied to last BV per share (€188.6) yields a normalized EPS of €22.4 that valued at a normal 10x earnings provides a standardized reference valuation of €223.8 per share. This value is also a useful reference and it represents a "safety margin", in the words of Graham of 75% with the current share price in mind.

VW market cap is divided into ordinary shares and preferred shares as you can see in the table:

Now the added angle with VW comes with the fact that 30.8% of its market cap (52.2% of its ordinary shares) is held by a holding company named Porsche Automobil Holding SE (or PAH), a German public company traded in Frankfurt with a market cap of €14.2bn. In this company the Porsche family holds its stake in VW as well as the other brands under VW group (namely Audi, Seat, Skoda, Porsche, Ducati, Bentley, Bugatti, Lamborghini, Scania and MAN). This holding company has little more than the shares of VW and almost no debt at all. Well, the question is if this family holding trades for less than its value (quite frequent for holdings) or not.

The indirect market cap of VW owned by PAH is €19.83bn (154.9Mn shares of VW at €128) and other assets and debts in PAH amount to €1,631Mn and €391Mn, which imply a net asset value (NAV) of €21bn, equivalent to a share price of €68.8 which compares with the current price of €44.16 of the preferred shares and €48 of the ordinary shares of PAH (the number of ordinary and preference share in PAH is the same - 153.1Mn shares). That is, the shares of PAH trade at a 30% discount to the already "safe" market price of VW when compared to its potential value.

Looking at the same figures upside down, buying PAH instead of VW, you get equivalent shares of VW at a price of €83 equivalent to a 35.1% discount to the VW share price (that implies a 54% potential hedge price adjustment). Of course nothing guarantees that this differential disappears, continues or even increases over time, but it just feels safer because intrinsic value of this investment is objectively better regardless of what the market thinks now or in the future.

In summary, I think that the market may have discounted most, if not all, of the emissions scandal effect and that the remaining value belongs to a company with a sound past performance at a safe valuation of anything between 150 and 220 euros per share that can be bought through PAH at an implied cost of 83 euros per share which is a safety margin of anything between 45 and 62%. If and when the company returns to a standard €15 EPS the implied return for the investment will be a very interesting 18% annual return.

I will invest my predefined ticket size for a value investment. In the Peter Lynch categories I'd define VW-PAH as an Recovery play.