Why Volkswagen Is Systematically Important For Germany And Europe

It is no secret that with the rest of the US economy, and especially housing, sputtering the one bright spot for US production and manufacturing has been the automotive sector. Whether the recent strength has been a function of money-losing leases, extremely generous terms on auto loans including a new rise in subprime debt issuance is up for debate, but whatever the reason carmakers have had a few years of relative stability (with China rolling over this won’t last, but that’s a different topic).

But if in the US automakers have been the solitary silver lining to an economy that is once again rolling over (as the Fed lack of a rate hike just confirmed), in Europe carmakers are absolutely critical, while for export powerhouse Germany, one can say the local auto industry is nothing short of systemic.

Here are the latest facts on Germany’s automotive industry from GTAI.de

• German automobile manufacturers produced almost 13 million vehicles in 2013 – equivalent to more than 17 percent of total global production.  Twenty-one of the world’s 100 top automotive suppliers are German companies.
• The automotive industry is the largest industry sector in Germany. In 2014, the auto sector listed a turnover of EUR 384 billion, around 20 percent of total German industry revenue. Source: VDA 2015
• The auto industry is the largest industrial sector in Germany, contributing about 2.7% to gross domestic product.
• Some 20% of Germany’s exports are made up of vehicles and parts.
• Germany is Europe’s number one automotive market; accounting for over 30 percent of all passenger cars manufactured (5.6 million) and almost 20 percent of all new car registrations (3.04 million). Source: ACEA 2015
• Germany is home to 43 automobile assembly and engine production plants with a capacity of over one third of total automobile production in Europe. Source: ACEA 2015
• One in every five cars worldwide carries a German brand. Source: VDA 2015
• In 2014, automotive industry R&D expenditure reached EUR 17.6 billion, equivalent to one third of Germany’s total R&D expenditure. Source: VDA 2015
• 21 of the world’s top 100 automotive suppliers are German companies. Source: PWC 2013
• Around 77 percent of cars produced in Germany in 2014 were ultimately destined for international markets – a new record. Source: VDA 2015
• R&D personnel within the German automobile industry reached a level of just over 93,000 in 2014. Around 775,000 are employed in the industry as a whole. Source: VDA 2015

Then there is the value-chain, i.e., the suppliers and the providers of R&D for Germany’s automotive industry.

• Germany boasts 21 of the world’s top 100 automotive OEM suppliers. Of these 21 companies, 18 belong to the top 50 automotive suppliers in Europe. Breaking the figures down further still, six belong to the top 25 global suppliers by size.
• Exports account for almost 37 percent of 2013 revenue generated by German OEM suppliers

As for why Volkswagen is the benchmark? Because not only is the Volkswagen Group the largest automaker in Germany, it is also the largest German company by revenue according to Forbes (Daimler is #3, BMW is #7). Some other facts:

• The Volkswagen group accounts for roughly one in 10 vehicles sold globally.
• Most German auto sales came from the Volkswagen group, which reported just over 202 billion euros in revenue in 2014.
• Roughly 70% of Volkswagen vehicles are sold outside German borders.
• Volkswagen employs nearly 600,000 people around the world, and more than a third of the 775,000 people who work in the auto industry in Germany.

In short, while banking may be the most important sector to the hyper-financialized US economy, for the export-driven German economy – whose exports account for over 40% of GDP – it is all about the car companies and their massive supply chains.

So what happened over the past 48 hours to Volkswagen, which has lost over a third of its market cap, or more than the market cap of Tesla, is nothing short of an earthshattering cataclysm to an economy where all the cogs and gears and running in a smooth, undisturbed ensemble… until everything changed overnight.

What happens next to Volkswagen is unknown: as noted earlier a Credit Suisse laid out what may be the worst case scenario: “the balance sheet is at significant risk to deteriorate beyond the impact of the €6.5bn provision the company has announced so far. With group free cash flow generation largely dependent on China (we estimate 94% of industrial free cash flow – 78% dividend from JV), there could be increasingly risk to dividend payments.”

But it is not so much concerns about Volkswagen as fears the entire German auto industry may be at risk.

The best case scenario: “Even a heavy drop in diesel car production and exports would probably not subtract more than 0.2% from German GDP,” said Berenberg economist Holger Schmieding. “Demand for non-diesel cars may rise and partly offset the drop in demand for diesel-powered cars.”

The worst? Quote Theo Vermaelen, a finance professor at INSEAD: “If nobody else has done it, the damage would be limited. If it looks like it’s more companies, not just Volkswagen, it would be a major problem for the German car industry, and the German economy overall.”

And that’s the question German investors are wrestling with: was it just one cockroach. If it was more, the ultimate outcome will (not may) be more QE from the ECB because with Europe tentative recovery also sputtering after 6 months of ECB QE, a steak through the heart of Germany’s most important industry, will be just the black swan that sends Europe into a recession.

So the question becomes: will Mario Draghi wait to see the fallout of the rapidly escalating Volkwsagen scandal, or will he preempt and ratchet up the bondbuying even more? Find out in the next few weeks.