One would think carmakers would be out of vogue. They’re struggling with calls to reduce emissions, trying to get consumers to buy (more expensive) electric vehicles, and trying to source critical inputs (such as scarce microchips). But these difficulties haven’t put PSG off taking a closer look at two German behemoths, Volkswagen (VW) and BMW.
“In the current environment, consumer discretionary [stocks] are not a great place to be,” Vaughan Henkel, head of equity research at PSG Wealth, tells the FM. “But we think there are some nice opportunities in European vehicle manufacturers — mainly VW and BMW.”
The first reason Henkel is casting his eyes towards Europe has to do with the extremely cheap valuations of these two stocks.
VW, based in Wolfsburg, trades at a trailing p:e of 3.6 and a dividend yield of 5.8%. Munich-based BMW trades even cheaper, at a p:e of 2.44 and dividend yield of almost 8%. Compare these valuations with Ford (p:e of almost 4), General Motors (p:e of 5.3), Toyota (p:e of 10.3) and Hyundai (p:e of 8.8).
A second reason for Henkel’s enthusiasm involves the so-called reopening trade — the expected boom in new-vehicle sales once the global microchip shortage eases. Currently, second-hand car prices are fuelling inflation, in the US especially.
You discount at a higher rate and it reduces the size of the deficit. And therefore you can start to take a pension fund holiday
— Vaughan Henkel
The price of used cars and trucks in the world’s largest economy surged 16% year on year in June. In the UK, the figure is estimated at 28%. This allowed car dealerships to push through higher prices for new vehicles.
Yet, despite the higher prices obtained, new-vehicle registrations slumped across the largest markets in the first quarter of the year, data from BMW shows — from a 5% decline in China to a 24% drop in Italy.
Supply chain disruptions due to Covid lockdowns in China, tight merchant ship availability and overwhelmed international ports, coupled with the microchip shortage, have disrupted production by the world’s large carmakers.
But for Henkel, probably the most important reason to tilt towards VW and BMW is pension fund deficits. German companies must, by law, provide defined-benefit pensions to employees. This is in contrast to SA’s defined-contribution pension funds, where an employee’s ultimate retirement pot is left to the sway of markets over time.
“European companies have large pension fund deficits,” says Henkel. “When you’ve got a large deficit [and] when you hike interest rates, you obviously discount at a higher rate and it reduces the size of the deficit. And therefore you can start to take a pension fund holiday.”
At end-December, BMW’s pension fund obligations totalled €24.9bn — a €1.6bn reduction from a year earlier — with €25.01bn of assets covering them. These pension fund assets rose €2.1bn from the previous year, according to the carmaker’s annual report. Thus, BMW’s pension fund obligations went from a deficit to a surplus within 12 months.
VW’s pension fund obligations also took a dive as the company used a significantly higher discount rate in 2021, at 1.21% from 0.7% a year earlier. The company’s pension fund obligations shrank from €45bn at the beginning of 2021 to €41.4bn at end-December. Henkel reckons this can go even lower.
“VW is a particular poster child of [pension fund deficits],” he says. “About 50% of its enterprise value is sitting in a pension fund deficit.” When VW discounts its obligations at a higher rate, the company can take a pension fund holiday, which benefits shareholders, Henkel explains.
The European Central Bank will most likely raise the eurozone’s interest rate this month, for the first time since 2016. Investors forecast the rate will jump from 0% to 0.25%.
The yield on German bunds with a 20-year maturity has moved significantly over the past six months, from 0.006% to the 1.556%.
These rates are critical in determining the discount rate of pension fund obligations.
“We expect in the next quarter or two that these companies will speak about [their] pension fund deficits,” says Henkel.
VW’s share price has slid 38% over the past 12 months, whereas BMW’s has declined 15%. By comparison, Toyota has gained 8%, Ford has fallen 24% and Hyundai has slumped 25%.
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