In the wake of a tough market and a poor reception for its new-look Golf, German carmaker Volkswagen has revealed a downbeat outlook for 2004 and announced plans to cut expenditure by 10%. Yet, it seems, analysts are still sceptical. Geraldine Lambe reports.

Volkswagen’s run of bad news continues in the first quarter of 2004. Against the backdrop of the new Golf’s underwhelming reception, being put on negative watch by Standard & Poor’s last month (joining Moody’s one-notch downgrade to A2 in December 2003), dollar weakness and an ongoing difficult market environment, the company’s management stated that it expected a “lousy” first quarter and not much joy throughout the rest of the year either.

Georg Grodzki, global head of credit research at Royal Bank of Canada, says: “The slow initial sales performance of its all-new Golf, coupled with heavy balance sheet charges, has alarmed the agencies and the company’s credit ratings are drifting towards the lower end of the single-A range. Credit spreads have underperformed its European peers in the car sector, despite the traditionally strong retail following for the name. Further widening on negative rating actions and poor first-quarter results are likely.”

In its 2003 annual report, released last month, Volkswagen (VW) said that it wants to cut its capital expenditure budget by more than 10% in the “next years”. This is not huge, but many analysts believe that achievement of this goal is, anyway, questionable if VW’s management remains committed to expanding in the luxury segment.

Luxury brands

US-based analyst house CreditSights says: “The new management under Mr Pitschestreider needs to make a decision for how long the company will keep burning money for the sake of bringing the Volkswagen brand upmarket, and developing super luxury cars like the 1001 hp Bugatti. We have long been critics of this brand strategy, which completely neglected Audi’s strengths and VW’s limitations, and would much rather see a shift to a more focused brand and model strategy with a better brand differentiation and market coverage.”

Cost-cutting efforts

VW’s cost-cutting plan aims to double savings to €4bn in two years. It is seen as a step in the right direction, though in view of the negative pricing trend in the European market, some analysts question how savings will be maintained. “We maintain our negative view on VW despite its cost-cutting efforts, which we believe will have limited impact on its cash flow metrics in the absence of a substantial cut in its high capex budget and streamlining its model strategy,” says CreditSights.

Data from Credit Market Analysis (CMA), shows that both VW’s credit default swap and its asset swap spreads are continuing on an outward path.

There are some positives, says Mr Grodzki. “The company has had some success in China and VW continues to benefit from good financial flexibility. Its financial services business looks set for further earnings growth and its operating performance should improve in the second half of the year,” he says. “That said, ongoing headline negativity suggests a cautious stance.”

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