Volkswagen AG ADR (VWAGY) Management on Q2 2019 Results – Earnings Call Transcript

Volkswagen AG ADR (OTCPK:VWAGY) Q2 2019 Earnings Conference Call July 25, 2019 8:00 AM ET

Company Participants

Oliver Larkin – Head of Group Investor Relations

Frank Witter – Member of the Board of Management, Finance and IT

Jens Effenberger – Head of Group Sales Steering

Conference Call Participants

Stephen Reitman – Societe Generale

Patrick Hummel – UBS

Tim Rokossa – Deutsche Bank

Arndt Ellinghorst – Evercore

José Asumendi – JPMorgan

Angus Tweedie – Citigroup

Jürgen Pieper – Metzler

Kai Mueller – Bank of America Merrill Lynch

Tom Narayan – RBC Capital Markets

Christian Ludwig – Lampe

Daniel Schwarz – Crédit Suisse

Operator

Good day, ladies and gentlemen, and welcome to the Volkswagen AG Live Audio Webcast and Conference Call on the Half Year Financial Results 2019. For your information, today’s conference is being recorded.

At this time, I would like to turn the conference over to Mr. Oliver Larkin, Head of Group Investor Relations for Volkswagen AG. Please go ahead, sir.

Oliver Larkin

Thank you, operator. Ladies and gentlemen, welcome to Volkswagen’s conference call for investors and analysts on the results for the period January to June 2019 based on the half yearly report we published early this morning.

For today’s conference call, I’m delighted to be joined by Frank Witter, Member of the Board of Management, Volkswagen AG responsible for Finance and IT; and I’m also pleased to welcome Head of Group Sales Steering, Dr. Jens Effenberger to his first call as he fills in for Christian Dahlheim currently on vacation.

Most of you will have followed the webcast from this morning’s press conference. Our focus now is to add a little more color relating to your specific needs as investors and analysts. Following the presentations we look forward to taking your questions. To — so Frank, it’s over to you.

Frank Witter

Thank you very much, Oliver and a warm welcome at a very, very warm day to all participants of this call. The Volkswagen Group has performed well in the first 6 months in a challenging global environment and a pretty tough sector.

At €10 billion the underlying operating result before special items was a touch ahead of the already strong result in H1 2018. This lead to an operating margin of a solid 8%. After the €1 billion special items already booked in the first quarter of this year, the operating result came in at €9 billion.

Deliveries for the first half at 5.4 million were 3% below the prior year. It is important to note that there are — that there is a base effect from H1 2018 as sales were boosted by the pre-buy push ahead of the WLTP switchover. And of course, China has been weaker this year too as have Argentina and Turkey in particular. Jens will give you more color in a few moments.

Despite the lower number of units sold sales revenue rose 4.9% to around €125 billion reflecting mainly the strong model mix. At €0.6 billion the financial result is down about a third versus last year. The decline is mainly related to higher interest costs.

The equity income mainly driven by our Chinese joint ventures came in just a notch below last year. Profit before tax at €9.6 billion was up €0.6 billion compared to the prior year. Profit after tax for the first 6 months was €7.2 billion.

Automotive net cash flow before diesel outflows and M&A came in at €6.9 billion. We all realize fully how important this position is and we will go into the details following the sales update from Jens.

Automotive net liquidity at €15.9 billion remained more or less at the same level as the end of Q1 and we will deep — dive deeper into the drivers in a few moments.

As you probably heard me confirm this morning, we stick to our full year guidance of a return on sales for the group certainly before special items of between 6.5% and 7.5%.

Let me now hand over to Jens.

Jens Effenberger

Ladies and gentlemen, I would also like to extend a warm welcome to this conference call and present the sales results of the first half of this year. Since the beginning of the year, the Volkswagen Group delivered a total of 5.4 million vehicles to customers worldwide.

After the last year’s strong first half year for many of our brands, this represents a solid result being only 2.5% — 2.8% sorry, below 2018 on a year-to-date basis and gaining market share as the overall market declined stronger.

The brand Volkswagen experienced a decline of 3.9% compared to last year resulting in 3 million vehicles delivered to customers. Then the new models such as T-Roc and T-Cross in Europe, Atlas in the U.S. as well as Tharu and Tayron and China performed well. The brand could further expand its market shares despite predominantly shrinking of all markets.

ŠKODA delivered around 621,000 vehicles to customers since the beginning of the year, representing a decline of 4.9%. This decline is mainly caused by difficult market conditions in the Chinese market, but partly offset by a favorable performance in Europe and Russia. The brand had its worldwide market share stable. The new models Karoq and Scala were especially well-received among our customers.

SEAT concluded the first half year with over 314,000 cars deliveries achieving a new record. Year-to-date this equates to an increase of 8.4% compared to last year. The performance was particular favorable in the stagnating or even decreasing markets in Western Europe led by the performance in Germany, France and Italy. On the model side, the gain was mainly driven by three SUV models Ateca, Arona and Tarraco.

With 260,000 deliveries to customers Volkswagen Commercial Vehicles remains on the level of last year. A strong performance in Poland and Spain was dampened by market-related downturns in Turkey and Argentina. Model-wise particular the Crafter showed a very satisfying performance.

Year-to-date Audi delivered 906,000 vehicles to customers a minus of 4.5% compared to last year. The first half year of this year was still dominated by numerous change — challenges such as model changeovers with value models and the delayed effects of the WLTP switchover.

On the model side, the recently launched SUV models such as Q2, Q8 and as well in Q3 in Europe show a strong performance. Additionally, 10,000 vehicles of the group’s first purely electric SUV, the Audi e-tron have already been delivered to customers around the world.

Porsche delivered 133,000 vehicles to customers from January until June 2.2% more than in the prior year period. Again, the repercussions of WLTP could be observed in Europe. After a difficult first quarter, the brand performed exceptionally well in China in the second quarter benefiting from a reduced VAT rate since April and a change in registration requirements.

Worldwide the Cayenne registered the highest model growth with a rise of 45%. The model has been available in all markets since this year while the coupe version arrived at dealerships only in May.

Bentley delivered 4,800 vehicles an increase of 8% mainly due to the new Continental GT. The truck and bus division continued its positive development with both brands Scania and MAN posting further growth. While MAN deliveries increased by 9.9% to a total of 72,000 year-to-date, Scania recorded an even higher growth of 10.1% resulting in 52,000 deliveries this year so far. Both brands recorded their highest growth in Western Europe.

Let us now take a look to the — at the performance of our deliveries to customers whereas the car market development on a regional basis. The North American market decreased as the U.S. remained slightly behind its high levels of last year and economic difficulties in Mexico continued. Additional economic conditions in Canada are worsening. Year-to-date, our deliveries declined by 0.9%, however, we increased deliveries in the U.S. by 2%, especially driven by a strong performance of Volkswagen Brand and increased market share as well.

Total demand in Western Europe shrank in the first half year, among others due to the repercussion of the WLTP changeover, the continued uncertainties around Brexit as well as declines in Sweden due to currency devaluation. Despite unfavorable circumstances, deliveries of the Volkswagen Group declined only slightly as some of the losses in Sweden and the U.K. were compensated by positive development in France driven by both SEAT and Volkswagen Brand.

The total market in Central and Eastern Europe remained on the level of last year. Our deliveries decreased moderately as the group’s positive performance in Russia was dampened by a market-related downturn in Czech Republic, which affects us given our high market share there.

While the recovery in Brazil continued a double-digit growth rate the drastic market slump in Argentina further dampened the South American market. As the increase of our deliveries in Brazil could not fully compensate the strong market-related decline in Argentina deliveries in the region decreased slightly by 1.1%.

Demand in the Asia Pacific region decreased by 6.2%. Again, this was impacted mainly by China. The ongoing trade conflict with the U.S. was a driver of the reluctance to buy. The positive development of the Chinese market in the month of June was driven by artificial effect of a change in registrations requirements.

For the remainder of the year, we do not expect a further positive impact on the market. Deliveries of the Volkswagen Group were affected by this environment recording a decrease of 4.8% in Asia Pacific and 3.9% in China in the first half year of this year. However, we again increased our market share in China.

To sum-up, the group’s performance in the first half year of the year. In a challenging environment, our brands were able to deliver total volume of 5.4 million vehicles to customers, which is just 2.8% below the prior year period. Main drivers of this volume reduction were the market downturns in China, Argentina and Turkey.

On the positive side, our performance in France, Algeria and Brazil was significantly better than the respective market and could partly compensate these losses. In light of the macroeconomic conditions, we expect a slight increase in our deliveries to customers for the full year 2019. The following products will help us in reaching this target.

The A4 from Audi represents the core of Audi’s product portfolio. Its exterior is embedded in the brand’s new design language. Additionally, with the launch of facelifts of the popular model ŠKODA Superb and Volkswagen Passat, we fully renew our product offering in this important high-volume segment.

The Kamiq ŠKODA’s third SUV model for the European market convinces with modern assistant and infotainment systems emotional design and numerous simply clever solutions. Thanks to efficient engines and state-of-the-art connectivity solutions, it is perfectly tailored to the requirements of a younger urban target group.

The all-new Jetta VS5 will be launched in one of the most attractive and fastest-growing segments in China, the A economy segment, accounting for about one-third of the Chinese market. The car is equipped with a large modern touch screen and offered at an attractive entry price to appeal in particular to young first-time buyers in China.

Taking the first step towards electrification, Bentley creates the group’s first luxury hybrid. The new plug-in hybrid model combines an advanced electric engine with a powerful and new generation V6 petrol engine and will be most efficient – will be the group’s – will be Bentley’s most efficient model ever.

Now, I would like to hand back to Frank.

Frank Witter

Thank you very much, Jens. Moving on with the group operating result performance for the first half in more detail. Let me start by apologizing to Arndt since he cares about cash flow only and has to wait a very little bit longer. The position volume/mix prices in the Passenger Cars segment reported a plus of €0.8 billion. Strong product mix reflecting the ongoing growth in our higher-margin SUV portfolio, and strong pricing were able to more than compensate for the decline in volume.

Exchange rate was negative with around €0.3 billion. This effect is mainly driven by negative hedging FX effects and the negative development in fair value valuation of commodities. This position is highly volatile as we already saw in Q1. This volatility shows us again that it doesn’t make much sense to speculate now on where this position might end up at year end.

Product cost savings continued to improve with a plus of €0.3 billion year-to-date. Fixed costs have risen by €0.9 billion over the first six months. Within fixed costs ramp-up costs increased as product momentum gathers. This combined with higher depreciation on CapEx dragged on fixed cost by €0.6 billion.

Furthermore, R&D costs was a P&L impact were about €0.4 billion higher. We know that the continued high level of investments are necessary for the further electrification of our product range getting up to speed on digital transformation and the expansion and overhaul of certain factories.

To compensate for this, it is a must that the focus on cost is to be sharpened even more. The brand’s efficiency programs will have to measure up to at least secure the respective margin targets. And you can rest assured that each brand is being closely monitored. I will comment in a few moments on both our Commercial Vehicles and our Financial Services results when I take you through all brands in details.

To wrap-up on this chart, we booked special items of almost €1 billion already in Q1 with nothing further added in Q2. This compares to €1.6 billion booked in the second quarter of 2018.

Turning now as promised to our brands, it should be noted that three of our core brands once again contributed over €2 billion to our operating results in the first six months. The €2.3 billion Volkswagen Passenger Cars achieved an operating result before special items of more than 7% above the result of the first half 2018. This was achieved despite slightly lower sales. It corresponds to an RoS of 5.2% compared to 5% last year.

Product mix, pricing and cost reductions were the key drivers which more than overcompensated the lower volume and negative exchange rate impacts. Audi reported an operating profit of €2.3 billion compared to €2.8 billion in the prior year. Lower volume higher ramp-up and run-out costs and negative currency impact dampened the result. On the other hand, mix improvements and effects from the efficiency program contributed positively.

As we saw earlier this year with the Q1 results, the lack of availability of certain models caused by WLTP homologation issues remained a burden. Audi is predicting stronger sales in the second half and is working hard to close the gap — close in on the gap to last year, sorry.

ŠKODA came in with operating earnings of around €0.8 billion. Negative FX effects and costs for new products and technologies were key headwinds. On the other hand, the volume and pricing measures were positive.

At €0.2 billion earnings at SEAT were also flat. Growing SUV volume and mix effects more than offset the costs relating to new products.

Bentley is showing an operating result of €57 million. Increased volume due to the availability of additional models, mix improvements and the success of the turnaround program, have been key here.

Porsche delivered an excellent operating profit before special items of €2.1 billion. The positive drivers were mainly volume, combined with lower product cost, while currency was negative.

At just over €0.5 billion, the margin of Volkswagen Commercial Vehicles was 7.8%. Higher volume and improved product costs couldn’t compensate for higher fixed and development costs.

Supported by the new truck family, Scania increased volumes and had also positive FX impacts that more than compensated for cost increases. This resulted in an operating profit of €0.8 billion, with the benchmark margin of 11.6%.

MAN Commercial Vehicles delivered a positive result of €0.2 billion, as higher volume was offset by costs relating to the new truck changeover.

To round up, our comments on our industrial brands, Power Engineering came in at €42 million. Moving on, Volkswagen Financial Services has continued to perform well with an operating result of €1.3 billion for the first six months of the year, up slightly on the prior year. This was very much in line with the increase in earnings for the full Volkswagen Financial Services division, which reported higher earnings at €1.4 billion.

At around, minus €700 million the other line normalized to a more typical year-to-date result. As you know, this position consists of the elimination of intercompany profits as well as the earnings from non-brand companies, such as Porsche Holding Salzburg and PPA cost allocation.

Please be aware, the swing related to commodity hedging is also reflected in this line. There’s no change in the principle, volatility in this line is and will be very difficult to forecast and reflects the global nature of our business as well as the cross supply of components and vehicles between our brands.

Let’s now take a closer look at the underlying Automotive net cash flow. As a start, our strong operating result in H1, gave us a good base for further cash flow generation. Cash outflows for diesel amounted to €0.7 billion in the quarter, bringing the year-to-date diesel cash outflows to €0.9 billion. H1 prior year was €2.6 billion just to remind us.

The cash paid out for M&A activities of €0.5 billion relates mainly to our state — stake in WirelessCar that were already acquired in Q1 as well as the announced acquisition of shares in Northvolt, as part of our long-term battery cell strategy. Focusing on our — on the underlying net cash generation, this came to €6.9 billion, around €0.9 billion ahead of where we were this time last year.

All-in-all, this is a decent result and puts us well on course to meet our target of at least €9 billion of underlying Automotive net cash flow for the full calendar year. On the face of it, our working capital management shows signs of improvements. However, this is not enough and we have to talk about the elephant in the room.

The core message here is that our inventories are still too high relative to ideal stock levels. By that, I refer to those stocks held in our factories and our fully consolidated national sales companies.

The key lever to correct this issue clearly is our production. For that reason, we have already taken more than 400,000 cars out of our production planning compared to where our planning was at the start of the year.

The fact that most core markets are trending downwards, overall also warrants reducing production even more if needed. Just this week, I had a call with all CFOs of the individual brands and companies, who have been clearly targeted to adjust production where needed, and we also addressed the subject again in our Board of Management meeting.

In relation to receivables, the declaration of dividends for FAW-VW for calendar year 2018 is still outstanding therefore the corresponding receivable has not been booked. We expect the declaration and receipt of dividends towards the end of the year.

Moving on to CapEx and R&D. CapEx is at €5.2 billion, corresponding to a CapEx ratio for the first half of 4.9%. Despite this increase, we strive to stay within our 6.5% to 7% full year guidance. Total research and development costs or call it cash spend, came in at €7 billion more or less in line with prior year.

Capitalized development costs came in at €2.3 billion versus €2.5 billion last year. The capitalization rate in H1 was around 33% versus around 37% in the prior year. As we have consistently commented this year, strict discipline in our investment and development processes is vital. We are not there yet, and 2019 is a crucial year to bring improved engines and new bests to market to meet our CO2 goals.

Automotive net liquidity ended at €15.9 billion, more or less on the level of end of Q1. As mentioned, diesel-related cash outflows were €0.9 billion so far this year. Within the position M&A, the acquisition of our stakes in Wireless and Northvolt were the key elements. In the first half, we received Chinese dividends of €1.1 billion, and as mentioned the outstanding amount is expected in Q4.

For the full year, we expect more or less the same level of dividend compared to prior year. As already communicated in Q1, the change in accounting for leasing was an effect of €5.1 billion negatively impacted our net liquidity. In relation to MAN minorities, the end of the domination agreement led to further payments of close to €1.1 billion shown in the first quarter.

And moving on to one of the most relevant positions for you guys, we paid out dividends of €2.4 billion to our shareholders in Q2. In case, you were expecting to see the cash inflow from the partial IPO of TRATON, this will be included in the third quarter as the proceeds only arrived earlier this month.

We guided for a net Automotive liquidity of at least €15 billion by year-end 2019 and remain firmly on course. Going forward our minimum target of 10% of group turnover remains a clear focus.

Now let’s get to our final chart. Q2 was also an important strategic quarter for the Volkswagen Group. We took important steps with our long-term battery strategy and the TRATON IPO. Furthermore, the announcement together with Ford two weeks ago advanced our position in autonomous vehicles and light commercial vehicles. The MEB platform supply agreement is a further step in tapping into scale potential.

There will also be a lot happening for us in the second half too. We are, of course, ramping up for e-mobility and gearing up to face the CO2 challenge. We will shortly introduce the Porsche Taycan, the new Golf and of course the first wave of our MEB vehicles the ID.3 at the Frankfurt show in September.

Production of these cars is albeit shortly get underway. These are challenging, but exciting times and our robust results at H1 give us a solid foundation as we go into the second half. However, of course, there are also risks and we need to ensure that they are considered.

We learned some hard lessons from the first wave of WLTP in H2 of calendar year 2018. Although, we are much better prepared for the WLTP second act EVAP and RDE it is — it will still be a challenge as we go through the next two quarters.

The unsettling global economic framework conditions have certainly not gone away. Global markets cooling down, Brexit uncertainty, risks of U.S. tariffs with China and Europe, as well as significant foreign currency swings and volatility of raw material prices are some of the key issues to look out for.

From where we are now, we continue to expect a solid robust full year in terms of volume, operating result and cash even if we were seeing a somewhat downward trend in markets. I trust you know us by now. For us delivering consistently is a clear priority. This involves mitigating risk by using realistic assumptions. That is why we are sticking to our guidance for deliveries to slightly exceed the prior year for revenues to grow as much as 5% and for the operating margin to be in the range of 6.5% to 7.5% before special items. And for our Automotive net cash flow, we are striving to come in above our €9 billion target.

To wrap up, our overall path remains the same and we continue to push as hard as we can. Thank you and now back to Oliver.

Oliver Larkin

Thank you, Frank. Thank you Jens as well. We will now take questions from investors and analysts, so operator, it’s over to you.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] We will now take our first question from Stephen Reitman from Societe Generale. Please go ahead.

Stephen Reitman

Hi. Yes, good afternoon. Thank you, couple of questions. I’d like to also try to get my hands around this elephant in the room that you mentioned about inventories. Obviously, we saw a substantial increase in inventories and in the cash flow although that was quite similar to last year where you were building up, I guess, before the WLTP. How big do you think the issue is? Or what is the potential you feel that you can actually reduce inventories by — and the impact that would have then on cash flow? Thank you very much

Frank Witter

Yeah. Stephen, I think you are absolutely right with the elephant. If I go through our report, I think if I look at the overall numbers, I think in stock until year-end we have to bring it down by a number north of 200,000 units. If I go through the Volkswagen universe, we obviously have differences in the current stock levels by brands and by regions.

If I look at the SEAT or Bentley or Lamborghini, they are definitely at ideal. We know ŠKODA is doing well, except China, so that’s the only complain. We knew that Porsche going into the year would be higher. That was totally planned, but we have a lot of sales momentum going on.

So we have detailed plans for each and every brand. Obviously, if I go through the markets, there’s almost in all markets something to be done, but we have a clear vision of what we need to do. We have high degrees of details. And I think we can be assured that all our folks will and have — are paying a lot of attention. This is certainly important to make the progress, which I indicated in order to exceed our minimum target of €9 billion.

From where we are today, if you manage inventories as described, I think the floor can be exceeded. But we also all know and we shouldn’t forget Q4 given the normal trends is most often cash negative. We know that obviously WLTP’s second act EVAP, RDE, you know that we will have higher levels of CapEx and R&D. A lot of that goes — is obviously all cash relevant.

So on the positive, I think from you heard me saying about China more dividends. That’s certainly helping. So if you add all of that together, we will push as hard as we can to exceed the €9 billion.

Oliver Larkin

Okay. Thank you, Stephen. Have you got a second question Stephen?

Stephen Reitman

Yes. So I was going to ask about the active measures that you’re taking be better positioned for the second phase of WLTP.

Frank Witter

Yeah. I mean, I referred to the hard lessons. Learnings are — we obviously took a hard look at our processes. We obviously had — we tested them the hardest way possible last year. So we improved our processes and the collaboration amongst the people responsible.

We increased our capacity. We added a significant number of dedicated people. But we also secured a higher level of testing capacity. So, we furthermore reduced significantly the engine-gearbox combinations, in some cases by around 30%.

So, I think that’s all together, giving us a comfort that we should do significantly better. But as you know, EVAP, RDE and WLTP’s second act also means a lot of work. But, I think we are definitely better prepared in these sorts of measures.

Stephen Reitman

Thanks very much.

Oliver Larkin

Okay. Thank you. We will take the next question please, Operator.

Operator

We will now take our next question from Patrick Hummel from UBS. Please go ahead.

Patrick Hummel

Yeah, thanks. Good afternoon, Patrick from UBS. My two questions, first one, relates to the mix effect which has been a strong positive driver also in the second quarter. I think your SUV share is now up to 35% from 25% last year.

So my question is simply for how long do you think that positive mix effect will continue? Is that something that we can expect to continue also into 2020? And I’m not asking to give an explicit 2020 guidance. I’m just wondering how much of a tailwind that can be in spite of already having reached 35%, SUV share in the mix. And my second question, can you just give us an update on, where we are from a VW perspective in China as far as the China six changeover is concerned? Are you still having some inventory that’s not China six in the provinces, that haven’t switched over yet?

What do you expect in terms of sales expectations? What’s the pricing and inventory management that yes you need to do over the next few months in China? Thank you.

Frank Witter

Yeah. Hi. Patrick. Let me start with the overall mix effect. And Jens is then adding up to it in Auto particularly on the China situation. The 35% is the number which I gave this morning also we gear towards to the end of the year. So roughly by the end of the year, 35% will be the mix.

So we are building up deposits to that number, and might then add another 5% in the overall share in 2020. So we have the strongest momentum of tapping new segments certainly this year, but I can’t personally imagine that it will abruptly end.

So volume/mix/price in our EBIT bridge look also next year to be an important part of the overall occasion. I hope that answers your question. China’s — overall China development Jens will take up.

I’m positively not aware of any major issues on the changeover to China 6. But Jens is more closely aligned with the overall situation in China and the sales trend.

Jens Effenberger

Okay. Just let me add some comments to the SUV segment development. I think we will see a strong — or we will see a stronger further development of the SUV segment in total.

And of course our share will increase there as well as we are launching a lot of new products, now this year and also next year. And don’t forget that a lot of electric SUVs will come in the future as well, which accounts of course in the SUV segment. And then of course will bring the share up again — further again I think.

So, I think this is more or less the explanation about why what to — how do we see the development of the SUV segment. If we look into China we have had this, China six emission regulations now.

And it starts — it has started this year in — from June — or from July onwards. In approximately 70% of all cities in China you are not allowed to register cars with old emission standards.

I think we did a great stock clearance. That was exactly the effect I’ve mentioned in my speech that we had an artificial effect in June, due to this. And we cleared the stock with old emission standards and have produced new ones now, so that we can continue.

But of course customers were waiting for these kinds of actions which we were undertaking and also the competition was undertaking in China at that stage. So at the end that is also my comment about the Chinese market in July and August.

So this was a one-off effect in June. And we will not see an increase now in the Chinese total market for the second half of this year.

Patrick Hummel

Can I just follow-up on that? Obviously, there was a bit of pre-buying in June as well because of very high discounts available in the market. So, how do you specifically think about the next few months? Do you think we’ll fall back substantially into negative territory, so that third quarter will be very weak for you again?

Jens Effenberger

No. I think — and to be very honest I think — I don’t believe that — it has not been weak first half year in China for us — or the first quarter. I think we’ve gained market share or we added — where we increased our market share in China.

And our plan is to increase further market share in China whereas we have new products coming along. And also second half year in China is always a stronger half year than the first half year. So I think, we will see, still see good sales in third and fourth quarter. But of course some pre-buying effects we have seen there in June.

Patrick Hummel

Okay, thank you very much.

Oliver Larkin

Okay. Thank you. Let’s move on to the next question please.

Operator

We will now take our next question from Tim Rokossa from Deutsche Bank. Please go ahead.

Tim Rokossa

Yeah. Good afternoon, everyone. It’s Tim Rokossa from Deutsche Bank. I’d like to do two follow-ups please. The first one is on the free cash flow. And the second one then again on the mix effect.

Frank, we already got you much further by saying that you are trying to over exceed the €9 billion target. And I actually thought we would get you. I thought you would say you want be conservative. And we know you that you want to be cautious. But let’s maybe not miss any of the details.

And you left the target unchanged so you will have some thinking behind this.

If we do like at the close to €7 billion in the first half underlying free cash flow, you do get the China dividend that already makes you exceed the €9 billion. Is there chance that you generate zero or negative free cash flow in the second half on an underlying basis?

Or is that really just being overly cautious, because you do not know what’s going on specifically keeping in mind that you also said you’re quite optimistic on sales. And that you still have the inventory situation?

And then secondly, just on the mix effect. Can you maybe help us quantifying this a little bit? It’s always kind of difficult to see with all your Chinese numbers also consolidated.

What’s the average selling price increase for the group? Are we talking about a few hundred euros? Are we talking about €1000? Or is the magnitude smaller than that? Thank you.

Frank Witter

Hi, Tim. No — I mean I try to be clear that we consider the €9 billion as the minimum or call it floor. And certainly, the objective is to exceed. But the point I made earlier are certainly valid. We shouldn’t forget that we will have in absolute numbers higher CapEx and R&D. Particularly on the CapEx side, a lot of that is coming soon in the second half. You know that very often leads to a cash-negative Q4. And we have the described homologation subject. So, I don’t want to be too conservative, but we are forecasting in a market, in an environment, which is clearly difficult. You’ve seen a lot of other companies not only in our industry taking full year forecast down and you know from the discussions we had at the end of 2018 and also at Q1. I took — in all honesty; I took the miss in — for 2018 on our net cash flow target personal, the €3.4 billion. And if there’s an opportunity to catch up at least on some of that amount that is certainly what we are striving for. But for the very moment, I think also in the context of what you see left and right committing to a floor of €9 billion is okay. And you know us with the explanation I gave that, we certainly will strive to come in better, but we also need to deliver on the inventory development which I described related to Stephen’s questions.

Tim Rokossa

So really just very clearly reflecting the uncertainties and what happened last year also rather than any planned major cash outflow for anything that you foresee right now.

Frank Witter

I think that’s a fair description.

Tim Rokossa

Thank you.

Frank Witter

I think you know the subjects, also the strategic ones we are working on. But you know how the €9nine billion are calculated and what has been taken out, so based on that calculation, your assessment is right.

Tim Rokossa

Thank you.

Oliver Larkin

Shall we take the question on the pricing?

Jens Effenberger

Yes. I think generally speaking of course, we do consistent pricing in all regions. It’s depending a little bit of the reason if you — or the region. I mean, if you take for example Argentina of course, the pricing is due to inflation much higher than in Europe. Nevertheless, I think we do consistent pricing and we do that also even at the market you have mentioned in China. So, we have done that, but further pricing steps for this year are not scheduled yet.

Tim Rokossa

My question was then probably a bit misphrased, but I’m much more talking about quantifying the mix impact that we’re seeing. So, don’t really necessarily assume price increases, but just the fact that you are SUV-ing your portfolio primarily, what is the mix impact of that on the average selling price? Are we talking about a few hundred Euros on average? Are we talking about €1000?

Frank Witter

I think if you — think — I obviously could do the Math. But I think, it’s just a number which you should think of is in the range of €1 billion.

Tim Rokossa

Great. Thank you very much.

Frank Witter

Thank you.

Oliver Larkin

Okay. Let’s take the next questioner please?

Operator

We will now take our next question comes from Arndt Ellinghorst from Evercore. Please go ahead.

Arndt Ellinghorst

Hi and good afternoon everyone. It’s Arndt from Evercore. Well Frank, thanks for the shout-out on the cash flow. It’s obviously what we all appreciate most from the company nowadays. Stock seems to go up when companies burn cash. But ultimately that’s what matters. Let me try to get a bit closer to cash flow for the full year by a different way. Just asking you, you still had this €2.4 billion working capital outflow in the first half. Second quarter was better. Would you dare to say that you can finish the year with a balanced working capital when you look at all the different parts of it? That’s the first question.

And then the second, a huge elephant in the room is really CO2 next year. You’re selling about 3.6 million cars in Europe. Your footprint is about 120 gram CO2 per kilometer and your target is about 95 gram. So all companies tell us, we won’t pay fines. We’re going to get there. We’re going to close the target, which I guess is probably true probably not for all of them.

But when you look at your high level really planning for next year and I know you haven’t done your budget yet, is there a really significant fundamental earnings risk that you see for the VW group coming from CO2 compliance? And not from paying fines, but from having to force technology into the market whether it’s EVs or PHEVs or mild hybrids that consumers would simply either not want or will not be willing to pay for. Is that really the big earnings risk that you see realistically when you look into the next two years? Thank you.

Frank Witter

It’s a very interesting and loaded question. I mean, first of all, you know that from the different venues, we have been on together. We work under the mandate and the clear target that we want to be CO2 compliant in the respective jurisdictions. This is our plan. That’s why we invest a lot of money.

But there’s one very big unknown and that is the customer. What we are definitely 110% fully convinced of is the product. And I mean, many of you already got into the Taycan or the C-BEV and some of you also got a snapshot view on the ID.3 and other vehicles of the ID family. We are fully convinced and I’m not car guy so to speak, but more and more over the last couple of years, the comfort has grown on me that these products have a distinctive design. Interior is different. It’s new. It’s modern. It’s fresh. Connectivity is state of the art.

And it reminds me of the splash of the Prius made in the United States at the time being something people want to get to. They wanted to get their hands on it. And I think we are entering a new era. We still will be dominated by ICEs, but this new segment has based on the strong product momentum, the potential to make inroads with a lot of customers, certainly not a black-and-white discussion. We are talking — making inroads into a stronger share of the total fleet being fully electrified over a decade. But the product momentum is what gives us the comfort.

At the end of the day, certainly avoiding fines is the mandate, but selling those electric vehicles orderly is certainly key. We all together in the industry needs to be disciplined. And if I look at the volumes, we have to get to in 2021 just to talk about the next two years. I think those volumes can be done in an orderly manner, so, certainly legitimate concerns that volume will be pushed, but I think it can be done. What we also shouldn’t forget particularly related to Europe, more than 50% of the market in the top EU5 countries is corporate fleet business. This is good business and a lot of those customers have their own CO2 fleet targets, which naturally supports our ambition to sell more electric vehicles. So, it will be a combination of all those facts, but the very big unknown remains to be the customer. But to say it with my own words, we have a lot to offer and that’s the way I would look at it.

In terms of working capital, I mean the key question Arndt is that, we will be much more efficient as it comes to inventories and stock. So, totally balanced I think is probably a bit too much, but definitely a huge step towards to year end and maybe at a level of 2018.

Arndt Ellinghorst

Okay, which would imply a positive working capital in the second half.

Frank Witter

Yes.

Arndt Ellinghorst

Thank you, Frank.

Oliver Larkin

Okay. Okay, Arndt, thank you. We’ll take the next question please.

Operator

We will now take our next question from José Asumendi from JPMorgan. Please go ahead.

José Asumendi

Thank you. José, JPMorgan. Two questions please Hi Frank. The first one on CapEx. I mean you’re keeping a strong control over this CapEx-to-sales ratio. Can you talk a bit about the absolute increase you saw in the first half? And then also, can you comment a bit on the — there’s this press rumor that you could be potentially opening a plant in Turkey or in Eastern Europe as a multibrand plant. What’s your thinking behind this? Do you need another plant?

Second question would be around Audi. Can you maybe outline a little bit or give a bit of color around their recently announced efficiency plan that Mr. Bram Schot wants to tackle in the next six months and year to improve the profitability of Audi? And would you agree that Audi is probably the largest contributor in terms of improving the working capital in the second half? Thank you.

Oliver Larkin

Okay. Okay, José, thank you. I counted that at three questions, but we’ll take that anyway. And we’ll start off with your questions on CapEx.

Frank Witter

Yes, hi José. Yes, I mean, we guided you folks that this is an important year for CapEx and R&D in order to be CO2-compliant. So, we still strive for both ratios to be within the corridor of 6.5% to 7% as indicated. But we obviously expected H1, 2019 to be higher than H1, 2018. But for the full year, we will push and work hard. And just after this call, I am having a video conference with one of my CFO colleagues from a brand located in the South of Germany, who is probably bitterly complaining that our top-down targets are too ambitious. So we are working on it jointly and we will push to be where we need to be.

New plant. Let’s be very clear and precise. There is no final decision yet. There is a potential decision to be made. The rationale is obviously not only looking at today’s markets, but looking from a longer-term perspective, the idea behind a possible decision as a multibrand location. And the — one of the ideas is to — for a new generation of product to have an optimized production setup for multibrand cars being on the same technical platform potentially. But this is a decision which is — which has not been made. But it needs to be seen in the greater scheme of obviously a low-cost location would help us with the averaging out our production cost and factory cost, but nevertheless can only be done if the respective volume for cars do support it in the medium and long term.

You mentioned Audi. I think, we knew from the get-go and I think we guided you guys that Audi on the back of a difficult H2 in 2018 would have a slower first half of 2019. That’s exactly the way Audi started. There was a lack of availability of engine-gearbox combinations.

In terms of sales, Audi is more comfortable for the second half given the better availability. But obviously in a difficult market environment, we are confirming the operating margin target of 7% to 8.5%, which clearly has to be backed by the effective efficiency program. The Audi team is working on. And I have no reason to assume that the program will not deliver as desired.

It is a combination of cost measures, but also look don’t — not forgetting the revenue side because just with cost measures, you can’t work against headwinds the ones we are talking about general terms. And if I look at frankly direct competitors of Audi, I think there’s a clear indication that even for those fine luxury brands, the markets are quite difficult. And Audi is right on track on pushing hard for their program.

José Asumendi

Thank you.

Oliver Larkin

Okay. Thank you, Frank. Thank you for your three questions José and we’ll move on to the next one please.

Operator

We will now take our next question from Angus Tweedie from Citigroup. Please go ahead.

Angus Tweedie

Brilliant. Thank you. Just a couple of questions. Firstly, could you discuss capital allocation a bit? You’ve obviously invested in Northvolt Argo more recently. And I was wondering, how you sort of measure the hurdle rates for those sort of investments and the returns that you need to generate from them? And sort of connected with that, I just wondered if you could give us an update on your investment in Gett you made a couple of years ago on the mobility side of things.

Then secondly, on the EBIT bridge for this year, could you help us think about the FX drag for the remainder of the year as you see it? And given the movements we’ve seen in product costs and fixed costs in the first half, can you sort of scale the impacts of efficiency that you’ve seen within those numbers? Thank you.

Oliver Larkin

Okay Angus. I guess you were talking about our investments that we reported in Northvolt. I think Argo is still to come. But as you know, we obviously made progress there with Ford. Gett, we’ll touch on. And I think it was FX for the second half.

Frank Witter

Yeah, bunch of subjects. Yeah, Northvolt, I think key issue is that needs to be seen in the context of our overall strategic setting for battery, battery supply, battery cell technology. That is a strategic investment in Northvolt AB, but clearly aligned worth €900 million, clearly with the idea of potentially making a decision on a joint venture with a potential facility here in Germany, if the conditions are being met necessary to make such an investment and step.

You know how the current footprint of battery cell suppliers is. And I think a greater level of diversification, but also potentially European alternative is certainly something in the general interest. And that’s the way we look at it. But at the end of the day, you can rest assured it needs to pencil, and this is certainly behind the capital allocation we were referring to.

Second point was related to the EBIT bridge. Yeah, exchange rate with the volatility, you know that there’s a derivative evaluation and purely FX included. The — difficult to forecast, but I think we indicated all year long that in the EBIT bridge for the full calendar year, we expected to be a negative number even though we seen a great level of volatility in those — in that line item from the first to the second quarter. But for the full year, we continue to expect a negative number.

On the fixed cost side, obviously we invested over the last couple of years significant amounts, particularly in product and related technologies. So, growing depreciation is clearly main driver, and higher R&D costs together with HR cost increases are probably the main drivers. If our efficiency programs wouldn’t work, the fixed cost increases would be even greater. That’s the way I would describe it. But certainly, the investments over the last couple of years, the heavy investments need to be amortized. So fixed cost increases for the next years and also quarters are a given.

I think then the other one, Argo and I think you mentioned also Gett, if I’m not mistaken. Autonomous vehicles, it’s for sure a costly endeavor and nobody can be absolutely certain when technology will be ready. I think the very first optimist revised forecasts that it will probably not as early as some folks assumed. Some of them already thought next year or at latest 2021. So might be a little later. But for sure, it will be costly.

But the idea is and the logic is to share the cost with Ford to develop that important strategic technology, and then independently use it down the road in the respective regions. That is the logic. And for us we deem it to be strategically important. We believe that we can’t afford not to invest. And we felt similar to Ford obviously that to share those costs is — makes good business sense. That is obviously a multi-billion investment decision over time, but definitely a lower bill to be paid compared to doing it all on our own grounds.

Gett, new mobility services are clearly something we are all excited about. Our investment in Gett is a strategic one. We wanted to participate in ride-hailing. You know from all the other folks being in that business too, it’s difficult to make money and it needs to be seen in the strategic context. But at the end of the day, all those companies may it be Gett, Uber, they all have to prove that it’s a business which pencils. And we all know what are the key drivers of their respective P&L is. So, we are supporting Gett to the extent a financial investor does.

Oliver Larkin

Okay. Thank you very much. Let’s move on to the next question please.

Operator

We will now take our next question from Jürgen Pieper from Metzler. Please go ahead.

Jürgen Pieper

Yes, it’s Jürgen from Metzler. I’m asking for some more details on the pricing, if possible. So if I calculate it rightly from what you said could it be that the pricing — the positive pricing effect is a little smaller than the mix effect for the first half?

Secondly, is pricing positive presently for all your brands? Or is maybe for Volkswagen Commercial Vehicles not benefiting from higher pricing? Just it sounded a bit like that.

And thirdly, so to understand your pricing strategies, I guess it’s principally one price step somewhere in spring time and it’s not some kind of steady process. Is that correct?

Jens Effenberger

I can start with — I think I can start with the pricing, with the last pricing question. Whether it’s a steady process or not? Yes, it’s a steady process. We normally price once a year in regions where we have stable inflation. But in regions where we do not have stable inflation, we are going to have several price steps. In some countries, even we have steps month-per-month. For example, in Argentina, we had that for a long while. And even in Brazil, we did a couple of price steps. And also we look into our competitors of course what kind of price steps they do and want to be — of course want to be ahead of them, and do the pricing first. So I think I hope this answers the first part of the question.

Jürgen Pieper

Yeah, that’s good. Thanks.

Frank Witter

Okay. I pick up on the other part. I think your assessment generally speaking is right. The net mix affect is higher than the pricing, because obviously you’re also in some areas and some models have higher incentives. So if you — if I net it, the net mix effect versus the net pricing effect is higher. You asked about more specifics by brands. We have to come back to you directly because I don’t have my hands on the specific details of all brands. This is obviously a consolidated statement for all our passenger car brands.

Jürgen Pieper

Okay. Thanks.

Oliver Larkin

Okay, Jürgen. Thank you. We will take the next question now.

Operator

We will now take our next question from Kai Mueller from Bank of America Merrill Lynch. Please go ahead.

Kai Mueller

Thank you very much for taking my question. Just to come back a little bit on the point that Arndt made earlier. When you think of your model ramp-up in the second half, you obviously have your Golf as well as your ID models and the EV models. How do you see that mix over time changing? Do you have more people switching possibly to a T-Roc from the Golf version and ID going either into the SUV space or full electric? And how are Golf orders shaping up? And also can you give us an update possibly if you have already numbers for the ID orders so far? And if any color on the Taycan order intake so far.

Jens Effenberger

If you look at the segment development, of course, especially in Europe now for Golf and ID, I think the A segment is a little bit shrinking of course, due to the SUV segment. And of course, we also see some customers going from a Golf and into an ID. So this is the way we see it. But nevertheless, we believe there’s place for two cars for the Golf and ID, three in A segment. And of course we will see some customers going from a Golf into an ID. But nevertheless, I think, there’s place for both cars in the same segment even if it is a little bit a shrinking segment. If we then asked the question on — we have pre-orders for Volkswagen ID and I think we are there on track. Mr. Stackmann has announced that 30,000 preorders should be up to the launch of the car in the system and we are on good way to 30,000 there.

Kai Mueller

And on the Taycan?

Jens Effenberger

Sorry, on the Taycan?

Kai Mueller

On the Taycan?

Jens Effenberger

On the Taycan, it’s more or less the same story as on the ID. We are there on track as well. I think we have approximately 27,000 preorders in the system so far.

Kai Mueller

Thank you very much.

Jens Effenberger

Thanks, Kai.

Oliver Larkin

Let’s take the next question please.

Operator

We will now take our next question from Tom Narayan from RBC Capital Markets. Please go ahead.

Tom Narayan

Yes, thanks for taking the question. Tom Narayan, RBC. Real quick housekeeping question. What’s the new target for special items for year end? It appears that you’ve increased that amount in your new guidance today. I get the sense that it’s probably not that big. And then a little bigger question you’re already selling MEB kits to Ford potentially could sell to other OEMs. Given the CO2 targets everyone in Europe has to electrify at varying degrees.

Do you envision a scenario were the European OEMs may be not as aggressive on BEVs could wind up buying MEB kits from you? I’m trying to ask basically could this be a new business windfall for you guys as the kind of lone large electrifying OEM in Europe that’s really going about it in this route? Thanks.

Frank Witter

Yes. Let me start with the MEB. We always said that we are open for discussions with others. And obviously, Ford took us up on that statement. But there’s not anything else to be announced other than to confirm that we continue to be open. And I think for example it was indicated that with Ford might come to grips on a second model, but this is still to be defined. So I wouldn’t rule it out. But at this very moment this is what we have agreed upon and what is publicly already known.

Yes, special items. We are — diesel-related that’s 30 billion in total and we obviously had to book another 1 billion. The clear point is and you know that from the past we present only material extraordinary and not projectable topics as special items. So we don’t have a target. The key fact is and has been since diesel started, it is due to the multitude and complexity of the risks which have been the result of the diesel issue which we unfortunately created.

And there are certainly uncertainties with the ongoing and expected legal cases. It can’t be excluded that future risk assessments could be different. And this is the statement I made that many occasions. And unfortunately if you look the way we had to step-up to the 30 billion in total now that has been the case and we can’t exclude that things are going to happen in the future.

You know from the descriptions in the Annual Report where we present all those different particular legal risk not only related to diesel but many of them. And we closed a lot of those potential risks, but we still have critical subjects being open. So no target but obviously to be assessed regularly whether the current level of provisions is satisfactory or not.

Oliver Larkin

Okay. Thank you. We’ll take our last question now please.

Operator

We’ll take our next question from Christian Ludwig from Lampe. Please go ahead.

Christian Ludwig

Yes. Good afternoon. Thank you very much for taking my questions. Just a quick housekeeping question, in your guidance you have kept your target of increasing the volume of unit sales slightly for the full year which means a significant pickup in H2 despite all the weakening global markets. What has built on the confidence that you actually outsell last year’s second half?

Jens Effenberger

Yes. Let me try to answer this question to you. I think first of all, yes we have — we are seeing a decrease slightly decreasing markets all over the world. Nevertheless I think we have gained market share in all regions. So I think this is a very positive signal which we have had in the first half year. And we of course are going to continue with that.

And I’ve shown also some new models which are coming in the fourth quarter. And you have other new models will come to the marketplaces. And significant volume significant models will come to market. And I think that’s just one of the reasons that we say, we can be slightly above previous year with our total sales in 2019.

Oliver Larkin

Okay.

Christian Ludwig

Okay, okay.

Oliver Larkin

I — looks like I jumped ahead of the gun, we have one more call on the phone please.

Operator

We will now take our last question from Daniel Schwarz from Crédit Suisse. Please go ahead.

Daniel Schwarz

Yes. Thank you for taking my question. I have a follow-up question on the Ford partnership. From a ROCE perspective could you give an indication what’s the incremental investment that’s needed for Volkswagen to produce 100,000 MEB platforms for Ford?

And then secondly in that context, as you also supply the battery to Ford within that contract, if there would be a shortage in battery cells at some point in the future, would you need to prioritize Ford over Volkswagen or is that completely different cell supplier that go into the Ford contract than compared to your contracts?

Frank Witter

I think it’s fair to assume that, we only made offers for toolkits, where we have supply secured. So I think in that respect, we assume to be able to deliver whatever finally will be delivered.

And with respect to the current deal size is 600,000 at best. Obviously including the battery packs. And we need to ask for your understanding that particularly for competitive reasons we can’t disclose any more details of transaction and behind the subject.

Daniel Schwarz

Okay, okay. Thank you.

Oliver Larkin

Okay. Frank, thank you very much. Before we close the call today, just a couple of the save the dates I’d like to mention for your diary. On Monday, September 9, ahead of the ERR in Frankfurt we’re planning to host an event to give you some more information.

At the moment the focus is expected to be around our EVs, but will come back to you with a few more details. But if could save the date for Monday, September 9 ahead of our Group Night that will be very good.

Following that as well on September 20, we will be hosting our second sustainability forum in Berlin with Hiltrud Werner our member of the Board of Management for Integrity and Legal Affairs. She will be joined by Ralf Pfitzner our Head of Sustainability. And we’re also expected to confirm a member of the ID team to join.

You’ll remember that — the forum we held last year. And the second event will give you an update as to where we are going. And this time we will also provide a webcast if you cannot attend in person.

And then finally, from my side, perhaps a more personal note. Some of you know already that after 15 years in the Investor Relations team this is my last conference call, as I move to a new position at Volkswagen Group U.K. in August as the Head of Group Corporate and Public Relations.

I’m pleased to let you know that Helen Brachman will take over as Interim Head of the IR team to provide continuity. Although, it was initially planned for me to be here for four years somehow this moved into 15 years. And during this time, of course a lot of water has flowed under the bridge.

In those early days our share price was in the low 30s, and we focused on the ordinary and not the preferred share. Today we sit at around €160 although the movement today has been a bit surprising I have to say. And we are very different truly global company albeit with deep German roots.

We have exposure to trucks. Additional brands have joined such as Porsche and not to mention Lamborghini or Bentley. And who can forget our capital increase back in February 2010 at the Royal Opera House where we had our Capital Markets Day.

So for me personally, please allow me to thank you our investors and analysts for your engagement. It’s not always been easy. We’ve had some difficult issues to communicate along the way. I trust you found us open and informative but most importantly available during these times.

To Frank and the team here in Wolfsburg from my side thank you for your support and willingness to put up with my limited German, even if you didn’t always get my jokes in English.

And to the Investor Relations team of course my deep thanks not least for these last 3.5 years. It’s not always been easy but we made it. So having worked for four CEOs and two CFOs, it’s now time for me to pass on the baton, this is Larkin, out.

Operator

This concludes today’s call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.