VW's Secret Additive

Volkswagen is riding more smoothly from quarter to quarter, now that management has rammed through some tough cost-reduction measures in Germany. Operating profit for the first half of 2007 (before exceptional items)soared 44.5% to $3.8 billion, despite heavy losses in the US market. That catapulted VW’s first half operating margin from 1.8% a year ago to respectable 5.1%.

The gains may look impressive, but they are not all powered by Golfs, Jettas and Passats. The real thrust behind VW’s earnings is Volkswagen’s premium unit Audi. It has only half the sales of VW brand unit, yet Audi brings home more bacon. It’s $1.38 billion operating profit in the first half of 2007 makes up more than 50% of total automotive earnings — and has done so for several years running.

In the past, Audi’s profit machine kept the VW group out of the red. Now with VW on the mend, it’s really revving group margins. Analysts forecast a stellar 7% operating margin at Audi this year, versus 2.5% for VW, and a group margin (includes financial services) to 5.2%.

The real intriguing question is whether fast-growing Audi is going to become the next BMW — a boutique luxury brand turned global primus. Morgan Stanley analyst Adam Jonas believes Audi will grow three times as fast as BMW over the next five years and could overtake BMW in profitability by 2010. Already Audi is the jewel in the crown of the VW group, accounting for 80% of group market cap. Now management needs to apply a bit of Audi magic to VW.

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