Beetle Juice

The Daily Reckoning Presents: a unique opportunity to enjoy cash-rich dividends of 11.3%…on accelerating revenues… even as the global economy grinds to a halt.


With its subcompact New Beetle turning other small cars into bland econoboxes – and its shiny Bentley, Lamborghini and Bugatti’s redefining the superluxury space – it’s no wonder Volkswagen AG is on a roll.

Especially when you consider that between those eye- catching opposites lies an impressive middle fleet of retro Audi TT roadsters, chiseled Passat sedans and even hot-rod Skodas that make Czech housewives dream of racing at Le Mans.

But even better than a new set of wheels, we think, are VW’s deeply discounted and often overlooked preferred shares.

Unlike most U.S. preferreds, the VW brand offers an upside potential nearly identical to the ordinary shares but are cheaper and pay a richer dividend. It sounds to us a bit like buying a Bentley for the price of a Bug.

Indeed, with Volkswagen’s margins increasing and its revenues impressively on the rise – even as questions arise about the health of the global economy – the preferreds currently offer low-priced participation in one of the world’s best-positioned automakers.

So just what are these preferreds?

Let’s take a look. They pay higher dividends than the ordinary shares, and they take precedence over the ordinaries in the payment of dividends. The preferred shareholder also has a senior claim on company assets over the holder of ordinary shares in the unlikely case of a Volkswagen liquidation.

What’s not to like? The preferred shares do not have voting rights. Nor do these ‘preferreds’ carry a fixed dividend. The VW board adjusts the dividends on the preferred just as it does with the ordinary shares.

But an analysis of the past 10 years shows roughly identical year-to-year percentage changes, implying that the preferred and ordinary dividends are equally influenced by annual earnings. What’s more, over the same 10-year period, the payout on the preferreds has, on average, exceeded that on the ordinaries by about 11.3%.

The ‘preferreds’ currently trade at 33.4 euros per share with a dividend of 5.4%, vs. 51.5 euros and a 3.3% dividend for the ordinaries. They have a price-to- earnings ratio of 5.7, while the P/E for the ordinaries is 8.8. If you don’t care about voting rights – and with this deal, why should you? – the preferred stock is definitely the better bargain.

What’s more, the ‘preferreds’ are gaining more notice, thanks to a brouhaha over the so-called Volkswagen Law in the German state of Lower Saxony – home to VW’s headquarters.

The law prohibits any single shareholder from controlling more than 20% of VW’s, or any other native company’s, voting power. It’s a handy little law for Lower Saxony, which, with about 19% of the vote, is itself VW’s largest shareholder. And it can work to your advantage…

The preferred stock issue aside, VW is an attractive investment on its own terms. Its balance sheet has steadily improved, thanks to Ferdinand Piech, Volkswagen’s patrician chairman and chief executive, who has emphasized cost-cutting.

At the same time, overall sales are growing at a steady pace despite the uncertainty in global markets. Trailing 12-month revenue totaled 87.6 billion euros as of March 31, and the five-year compounded annual growth rate averaged 13.6% at year-end 2000.

Moreover, the company had its strongest U.S. sales month in 28 years this June. Last year, its overall world market share rose to 12.2%, and its North American market share rose nearly two points, to 6%. Volkswagen’s collection of car brands – from Seat in Spain to Skoda in Eastern Europe – surpassed the five million-delivery mark for the first time last year. The company has a commanding presence across Europe, Asia and South America.

Volkswagen runs with an efficiency that is the envy of the automobile world. The entire company’s offerings, with the exception of niche products like the Bentley and the Lamborghini, are built off of just four platforms.

Sharing parts and platforms has helped keep costs down, and Volkswagen’s margins continue to rise. Gross margins rose to 12.64% in 2000 from 11.34% in 1999, while EBIT margins accelerated to 3.8% from 2.5%. Hendrik Emrich, an auto analyst at Berenberg Bank in Germany, estimates the company’s platform strategy will save about one billion euros next year, or about 1.4% of the cost of sales in 2000.

All the more reason why individual shareholders shouldn’t give a hoot whether or not their shares have voting power.

“Volkswagen’s one of the few truly global automakers; it sells just about everywhere. And it has an incredibly strong brand portfolio,” observes David Moorcroft, an auto analyst with Commerzbank. “Buying the preferreds is a cheap way of getting into an automaker that has, for starters, 20% of the Western European auto market.”

Our sentiments exactly.


Jay Akasie,
July 30, 2001

For The Daily Reckoning

Jay Akasie is a staff writer for As a reader of The Daily Reckoning you are cordially invited to join, “a new destination for thoughtful investors,” for a 30-day free-trial.

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*** Bonjour, Addison here…Bill and la famille have headed south to Nicaragua for a couple of weeks of much deserved vacation… Eric, too, is enjoying a little R&R, so today it’s just us chickens…

*** “Slowdown is all in consumers’ heads,” a Journal of Commerce headline tells its readers…

*** I wonder if Tom Ahrens, the Canadian soybean farmer we mentioned in Friday’s Daily Reckoning is delusional. You’ll recall Mr. Ahrens retirement fund, formerly brimming with $210,000 in Nortel, has shrunk to $40,000… and he now owes his broker $30,000.

*** Or what about “Poor John Teeples?”

*** According to a report in the New York Times, “Mr. Teeples, age 45, worked for six years as a software salesman with Microsoft. He saved his money. He bought stock options from a pair of brokers who persuaded him to put his money – all of it – with them. He had amassed $700,000 in his retirement account by putting in 80-hour weeks. He was with the right company at the right time: Microsoft.

*** “Today, his retirement funds are down to $400. Not $400,000 – $400.

*** “Of the 23 stocks that the brokers bought for Teeples and his wife,” says the Times story:

“12 were companies that Morgan Stanley had brought public or provided with other investment-banking services. Ten were rated buys by Morgan Stanley analysts when they were bought. Three of these rose slightly, but seven fell, generating $85,000 in losses. By the time Teeples sold all his shares in those seven, they had lost, on average, half their value.

“Teeples and his wife have taken out a second mortgage on their home to pay their bills, and he went back to work in November at a wireless-data company in Baltimore that he would not identify.”

*** Notes Dan Denning: “Mr. Teeples, at age 45, is unlikely ever to recover his former wealth. He was with Microsoft when it paid to be, and he was in Cisco options when it didn’t. Most people don’t get one opportunity like this in a lifetime, let alone two.”

*** Microsoft, Cisco, Nortel…Sun Microsystems, Lucent, Oracle… On average, second quarter profits at US computer-related companies dropped 66%, a report declares. Intel reports profits fell 94%. JDSUniphase’s $50 billion year-end loss made US economic history.

*** “It was a brutal quarter,” a research analyst told Bloomberg. “The third quarter is going to be even worse, and fourth-quarter estimates are still too optimistic.”

*** Neither consumers with the desire to “max out” their Visa cards – nor businesses wishing to take the Fed up on its inducements to ‘easy money’ – can keep pace with overcapacity in the industry.

*** Layoffs by tech companies totaled 31,000 last week alone. Alas, workers dreams of exploiting the capitalists’ may well have to be postponed until the next boom hits Wall Street. When will that be? Well… at the Daily Reckoning we do not presume to be able to predict the future, but we’re willing to hazard a guess: not this year. Not even next.

*** The S&P 500 is experiencing its worst slowdown since 1958. “The rat-a-tat-tat of newspaper headlines announcing ‘plunges,’ ‘drops’ and ‘declines’ in second- quarter results adds up to this rather startling fact,” reports “Not since the days of poodle skirts and the Big Bopper have corporate operating earnings declined to such a degree.”

*** Well at least we can all be thankful that this slowdown is “all in consumers’ heads.”

*** The indexes were a mixed bag on Friday. The Dow dropped down 38 to close the week at 10,416. The S&P 500 index gained a couple to 1205; the Nasdaq added 6 to 2029. Year to date… the Dow has lost 3.5%; the S&P is off nearly 9% and the Nasdaq is down 18%… the Nasdaq 100 – home to the largest techs – is off 28%.

*** But here’s some good news… at least for some. Lance Armstrong, the American cyclist who overcame testicular cancer in 1995, won the Tour de France for the third straight time here in Paris yesterday.

*** “Pandemonium,” says Becky Kramer, the newest addition to the DR intern squad. Becky was on the Champs Elysees when the race finished. “One guy was parading around with such an enormous American flag, I thought he was going to get beat up.”

*** “This American guy comes over here and wins three Tour de France’s in a row,” said one of our French colleagues this morning, “it’s really quite annoying.”

Addison Wiggin

Paris, France

The Daily Reckoning