Porsche's Success Riding on $15,000 Hatchbacks

Porsche AG's 911, a $72,400 sports car, helped make the carmaker the world's most profitable last year. Chief Executive Officer Wendelin Wiedeking says earnings will grow even more thanks to models such as Volkswagen AG's Golf, a $15,000 hatchback.

Having silenced critics who ridiculed Porsche for buying a stake in Volkswagen two years ago, Wiedeking, 54, may extend the luxury car company's share-price gains by raising the stake and using Porsche's influence to transform Europe's biggest carmaker. Porsche's experience in lean production will boost Volkswagen's profitability, while the companies will save by sharing development costs, analysts and investors said.

Sales and profit at Volkswagen, now 31 percent owned by Stuttgart, Germany-based Porsche, have already risen since the initial tie-up, helping Porsche's shares more than double.

``Porsche knows how to take care of itself and stands to gain significantly from its ownership in Volkswagen,'' said Peter Braendle, who helps manage about 63 billion Swiss francs ($52 billion) in assets at Swisscanto Asset Management in Zurich, including shares in both car companies.

Porsche's profit may grow to more than 3 billion euros ($4.1 billion) in five years from 1.39 billion euros in the 12 months ended July 2006, according to Adam Jonas, an analyst at Morgan Stanley in London. He expects the company's shares to reach 1,650 euros within a year, compared with Thursday's closing price of 1,330 euros.

``The collaboration between Porsche and VW is extremely vital to Porsche,'' said Juergen Meyer, who helps manage about 1.3 billion euros of assets at SEB Asset Management in Frankfurt, including Volkswagen and Porsche shares.

Lagging Profitability

Concern that Volkswagen's lagging profitability would crimp Porsche's growth sent the luxury carmaker's shares plunging 10 percent on Sept. 26, 2005, a day after Porsche said it would buy a stake in the larger automaker. Wolfsburg, Germany-based Volkswagen's operating margin was 3 percent in 2005, compared with 19 percent at Porsche in the 12 months ended July that year.

Last year, Volkswagen's margin widened to 4.3 percent as new models including the Eos and the Audi Q7 helped boost sales 10 percent to 5.72 million vehicles. Net income more than doubled.

Cost cutting already begun at Volkswagen by former Chief Executive Bernd Pischetsrieder has included shedding 20,000 jobs.

``Volkswagen has become leaner,'' said Andreas Dittmer, who helps manage about 3.5 billion euros in assets at Apo Asset Management in Cologne, Germany, including Volkswagen shares.

Porsche is entitled to almost a third of Volkswagen's dividend, which was 497 million euros last year. Porsche's profit will rise ``significantly -- and I mean significantly'' this year because of Volkswagen, Wiedeking said on June 26.

Shared History

The two companies' shared history dates back to the 1930s, when Ferdinand Porsche designed the original Volkswagen. Porsche founded the company that shares his name after World War II, and its first model, the 356, was built mainly using Volkswagen parts.

Ferdinand Piech, a grandson of Porsche's founder, and his family control all of Porsche's voting shares. Piech sits on both companies' boards and is chairman at Volkswagen, while Wiedeking and Porsche Chief Financial Officer Holger Haerter also sit on Volkswagen's board. That is enough to help Porsche exercise its influence at Volkswagen, said Swisscanto's Braendle.

Porsche has a loan from a group of banks worth 10 billion euros to increase its stake to 50 percent and can do so without making a public announcement.

Tightening Grip

As Porsche tightens its grip on Volkswagen, the biggest savings may come from sharing technology and development costs.

Since 2002, Volkswagen has built the body of Porsche's Cayenne sport-utility vehicle, which shares a platform with the VW Touareg and the Audi Q7. Volkswagen, now Porsche's largest supplier, will also build the body of the Panamera sports car, to go on sale in 2009.

``Research and development is the biggest cash drain for car companies,'' said Thomas Aney, an analyst at Dresdner Kleinwort in Frankfurt. ``Porsche is going to save a ton of money piggy- backing on Volkswagen.''

The companies are working on gasoline-electric versions of their SUVs, and Porsche may begin offering diesel engines in its vehicles, a technology Volkswagen specializes in, Aney said.

Quality, Efficiency

Porsche also aims to improve Volkswagen's quality and efficiency.

Porsche topped J.D. Power's 2007 initial quality survey, while Volkswagen was fifth from the bottom. Lean production methods helped Porsche's operating margin widen to 26.5 percent in the 12 months ended July 2006, compared with 8 percent at Munich-based Bayerische Motoren Werke AG, the maker of BMW-brand cars, for the year ended December.

In addition to gains from Volkswagen, Porsche plans to sell more of its own models. The carmaker aims to sell 20,000 Panameras a year and to increase sales in China and Russia.

``Growth in emerging markets is the key driver behind the longer-term growth story at Porsche,'' said Christian Breitsprecher, an analyst at BHF-Bank in Frankfurt.

Even as Volkswagen's profit has grown, many analysts are skeptical it will continue to boost Porsche. Volkswagen has excess capacity at German factories and is losing money in the U.S. as the euro has strengthened against the dollar. A dearth of models that appeal to U.S. buyers has also crimped sales in the world's largest car market.

``Risks for VW include ongoing difficulties in restoring North America to profitability,'' said Nathan Kohlhoff, an analyst at HVB Group in Munich.

Analysts' Views

Of 36 analysts surveyed by Bloomberg, 17 including Kohlhoff recommend selling Volkswagen's shares. Thirteen rate the shares ``hold'' and six rate them ``buy.''

Analysts and investors with a more optimistic view say Porsche's track record, including 13 straight years of rising profit, shows that one of the world's smallest carmakers has what it takes to transform one of the largest.

``The influence of Porsche management at VW could prove significant,'' said Avaneesh Acquilla, an analyst at UBS Ltd. in London. ``Volkswagen is increasingly the dominant share-price driver'' for Porsche.

source:bloomberg.com