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If I had to name a stock market myth that has lasted the longest on Twitter, YouTube, etc., it would certainly be the excessive debt of VW, Ford, BMW and all other long-established car manufacturers and their imminent bankruptcy. Taking Volkswagens debt on the balance sheet as an argument that the company will go bust in the foreseeable future is problematic to say the least. Partly I get the feeling that people don't know any better and partly that they don't 'want' to know any better. For the first group, I dove back into Volkswagen's balance sheet to highlight the difference between traditional automakers and the majority of all other companies. Don't worry, you need virtually no prior knowledge to understand the facts.
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Car manufacturers as the most indebted companies in the world - A widespread myth
I am not exaggerating when I say that every other day I read on Twitter about the "zombie company" Volkswagen, which is supposedly the most indebted in the world. Some time ago, I had already written a long thread on Twitter, which I am using as a basis here, but which I am expanding again significantly in order to refute further arguments.
I have collected some opinions from Twitter in the following picture and I can promise you that I do not have to search long to meet these opinions. I have blackened the tweet authors out of consideration accordingly, because it is not about me to make fun of the people, but to clarify how widespread this opinion is.
But it's not just on social media that people are writing about the high debt levels of these companies. Also at Car-Motor-and-Sport, T-Online.com, faz.net, boerse-online.de and many other well-known media, we come across the headline of the mainly German, highly indebted carmakers. If one is then one of the 8 people who have read an article in 2022 not only as far as the headline, the sentence "however, this is due to the financing division" can be read from time to time, but this is not explained further in all the examples mentioned. In addition, there are also always Articlewhich disregard the financing segment altogether. Consequently, anyone who has never dealt with the subject has little chance of understanding the difference between this and other companies.
A look at Volkswagen's balance sheet
First of all, I'm referring to Volkswagen's 2021 annual report in the following, as I wanted to take an entire year into consideration. However, you can also easily transfer the statements to the quarterly reports.
If you look at Volkswagen's balance sheet (AR 2021), you might initially think that the assumption of massive debt is correct. However, this assumption does not take into account how Volkswagen and other car manufacturers are structured financially.
In addition to the operational part of the business, i.e. building and selling cars, they usually have 100% subsidiaries that act like banks. The assets of these subsidiaries are mainly of a financial nature, i.e. receivables and loans, and are mostly shown with their own balance sheets in the filings, while the assets are nevertheless integrated in the 'main' balance sheet. For example, Volkswagen's Financial Services segment. These subsidiaries are usually very highly leveraged, i.e. they increase their return on equity by taking on debt.
A look at the Financial Services segment reveals that liabilities of 192.4 billion euros are offset by assets worth 235.6 billion euros. These are largely receivables from loan or lease agreements with customers and bank deposits. Anyone who makes the mistake of including only the liabilities and not the outstanding receivables in their analysis of VW will arrive at considerably distorted results, as the liabilities are more than offset by the assets.
To clarify again: Would we value banks based on their liabilities, but not on the claims against them? Yes? Then I have bad news for all JP Morgan shareholders. Your company has liabilities amounting to 3.5 trillion (No, that's not a typo), including over $300 billion in debt, and just $290 billion in equity.
VW's Financial Services operate on the same principle. Among other things, they issue bonds, take out loans and receive bank customer deposits with which they then finance the cars, which customers in turn finance or lease from VW's distributors or from VW directly. Each bank basically acts on the same principle. The debts are not a burden 'for' VW's business model, they 'are' the business model. In relation Cheap borrowing and profitable lending of the capital. By the way, this has allowed VW to make an operating profit of about 6 billion euros in 2021. Doesn't seem too bad a business model, does it?
The Automotive Segment and the Financial Segment should therefore be considered and evaluated separately from each other in order to arrive at meaningful results. Fortunately, VW makes it easy for us and lists the assets separately in its balance sheet. This then shows which liabilities are attributable to the financing arm and which to the automotive segment. Here, it is the 'real' debts that should be looked at, the majority of which are attributable to Financial Services. This is something that also often gets mixed up. We usually only consider interest-bearing liabilities as debt, i.e. loans, bonds, leases and, depending on the interpretation, also pension obligations, which I always include because of their structure.
How valuable are the assets?
From endlessly long Twitter discussions, which I usually only follow as an observer, I know that after the argument of the over-indebtedness of the carmakers, there is usually another one: It may well be that VW has to be regarded partly as a bank and that the assets more than cover the liabilities, but how valuable are the car fleets, which for the most part still consist of combustion engines, in view of the global switch to electric cars? Doesn't this give rise to a financial risk that could come to bear in the future? This is an idea that is not so far-fetched in principle, although I disagree with the conclusion drawn from it about the value of the assets for a number of reasons.
Let's take a look at the receivables reported in the Financial Services segment. As you have already seen in the previous overview from Volkswagen's annual report, the "Financial services receivables" (receivables from the Financial Services segment) fall in part into the "current liabilities" (short-term receivables) and "noncurrent liabilities" (long-term receivables). The former are receivables that are due within one year and accrue to VW, the latter are all receivables that accrue after more than one year and thus theoretically become cash.
The current portion of the receivables alone amounts to 56.5 billion euros, i.e. payments that VW will receive in the near future. The non-current portion amounts to just under 85 billion euros. This part consists of 50 billion "Receivables from financing" and 34 billion "Receivables from finance leases".
As Volkswagen itself indicates under this point, the receivables are covered by the respective vehicles or liens. The vehicle value is also irrelevant for these payments. In the case of financing, the customer has the residual value risk either way, but also in the case of finance leasing, i.e. leasing as we know and call it in this country, the main opportunities and risks are transferred to the customer. He just often doesn't notice it. The vehicle is derecognized from Volkswagen's assets and a receivable in the amount of the "net investment" is booked. As you can see, the non-guaranteed residual value is added to this calculation, while the interest not yet collected and an estimated value for expected credit defaults are deducted. The "net investment" is therefore ultimately an amount that has been calculated 'worse'.
Volkswagen also lists when the payments will be made. Most of the payments are made over the next few years, which corresponds to the standard leasing period of 24 to 36 months.
Well-informed critics, even after these points, would make one more point: What about lease assets for operating leases? Briefly to distinguish: Finance leases are more long-term leases, as you can see in the chart above. Operating leases, on the other hand, are more short-term and more like a pool from which vehicles are leased on an ongoing basis. There are many more distinctions, but they are not relevant for us here.
Looking at the operating leases, it then becomes clear that there is an imbalance between the vehicle assets of 59.6 billion and the expected lease payments. However, this is the very nature of these short-term contracts.
Vehicles leased out under these terms are capitalized at cost and then depreciated on a straight-line basis over the term of the contract to the previously calculated residual value. If it were the case that the market value of the vehicles in question were to fall rapidly to below the carrying amount because, contrary to expectations, we suddenly have an oversupply of electric cars, Volkswagen would have to carry out an impairment test in accordance with the IFRS accounting standards (IAS 36), which would then lead to an impairment loss and have a corresponding negative impact on the asset in the balance sheet and the income statement.
The underlying calculations of market value take these aspects into account, i.e. vehicle supply, vehicle demand and price trends, and are calculated by external experts. If the value of the vehicle or asset were to fall massively, this would also be reflected successively in Volkswagen's balance sheet.
Even if you disregard all the accounting details, there is another way of arriving at the point that Volkswagen and other carmakers tend not to be threatened by a massive loss in value. As many of you have probably already noticed, either positively or negatively, falling used car prices are not really an issue at the moment, but skyrocketing prices are. In addition, combustion engines are now gradually being replaced by electric cars.
To assume that VW's vehicle assets will no longer have any value in the foreseeable future therefore seems far-fetched to me, but it is also not my main point.
Anyone who still has concerns about the recoverability of the receivables is welcome to take a look at the corresponding classification of the loans on the part of VW as well as the ratings of S&P and Moody's. The latter also rate VW's financial services separately. By the way, these also rate VW's Financial Services separately.
How should automaker debt be valued?
If you want to look at and evaluate the key figures of VW or other carmakers, you should basically make two evaluations. One for the financial division and one for the automotive division. Fortunately, the car manufacturers list the assets separately, so that you can view the divisions very well.
If you now want to look at the debt of the individual divisions, for example, you will see that the bulk of the debt, just under 200 billion euros, is accounted for by VW Bank. This compares with 257 billion in assets, 37 billion of which are covered by equity.
If we then look at the Automotive sector's debt, we see that it has cash and cash equivalents of around 43 billion euros and financial liabilities of 14.4 billion. The negative figure for current liabilities is mainly due to loans between Automotive and Financial Services. Taking this into account, we would then have a net cash position of 28.6 billion euros. If we include pension obligations, as I believe would be correct, the cash position is -12.2 billion euros, and even that is no cause for concern in my opinion.
Conclusion
I want to make one thing clear again. Just because I don't consider debt to be a concern doesn't mean I consider automakers to be a good investment. In fact, in my portfolio, the automotive sector has a place only through detours, if at all. For example, through a battery manufacturer. I am generally not a fan of cyclical companies, and the upheavals in the automotive sector, both political and technological, make me even more wary.
My only concern here was the frequently misinterpreted or misrepresented debt. In any case, I do not see an imminent demise due to debt. Volkswagen's example can also be transferred almost completely to other car manufacturers, but also to companies like John Deere. Of course, you should look at each company individually to understand its financial condition.
If one of your companies has a similar financing division, you should definitely not make the mistake of comparing the debt one-to-one with other companies, as they are the drivers for the business model of these divisions. This is also the reason why I don't like to rely on the numbers of many finance sites, as they usually recognize the difference in banks, but not in these hybrid companies. Therefore, I always recommend to make the effort and go through the annual reports of your companies yourself and make your own thoughts. What initially takes a long time will eventually become routine.
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