Sunday Edition: When Buying Luxury Isn’t So Illogical

April 30, 2017

Sunday Edition: When Buying Luxury Isn’t So Illogical

Sven wrote an interesting article a couple of weeks ago on Ferrari (NYSE: RACE), and how investing in it is dangerous as doing so is investing purely in sentiment. If you didn’t have a chance to read it at the time, you’ll find the article here.

I agree wholeheartedly with Sven on Ferrari. The brand is synonymous with exclusivity, and when a brand’s market is meant to remain small—Ferrari produces only about 8,000 vehicles per year—it’s hard to imagine how the company intends to grow sales, and if sales and revenue won’t grow significantly over time, I have to wonder what the real point is in investing in the company.

Not only that, but the instant sentiment for the company changes or the market begins to decline, Ferrari’s stock price will undoubtedly fall significantly and any gains made will be wiped out.

However, I also believe that there are ways to invest in luxury that do make sense.

In his article, Sven states: “For the rational human being, it’s difficult to understand the concept of luxury as the utility of such things is questionable. What’s even more difficult to understand is how investing in luxury can be logical or ever profitable…”

I have to disagree with Sven here as I do believe that a rational person can understand the utility of luxury products, and I also know that it is possible to profit on luxury.

One way to do so—and I’ll stick with the car theme here—is to invest directly in a luxury item that’s value is certain to appreciate.

As a personal example, I along with my significant other—a “car guy” by anyone’s measure who likes to build race cars and who writes about cars for a living—recently purchased a mid-1990s air cooled Porsche race car. The car runs beautifully, and though it isn’t a “daily driver,” the car’s utility as a sports car is intact.

Rather than purchase a new vehicle that would have depreciated significantly the moment we drove it off the lot, we purchased this car for a fantastic price after it had already depreciated and then began to appreciate as a rare “collector” vehicle, and promises to continue to appreciate for years to come.

In investing terms, we bought an excellent brand at a very good price, and our investment has already began to appreciate substantially, which is a classic value investor play. Considering this, I think Warren Buffett would be proud and Sven might even concede that in this case, investing in luxury wasn’t so irrational after all.

Now, in this article, Sven was talking about the futility of investing in the stocks of luxury brands, not specifically in the luxury products these brands produce, which brings me to the other way I believe investors can profit on luxury.

What Sven’s article inspired me to think about was how the rational investor can invest in luxury in a way that isn’t as illogical as investing in a stock like Ferrari. The conclusion I ultimately came to was that it makes the most sense to me to invest in luxury by way of investing in a conglomerate that owns luxury brands.

A good example of this is Volkswagen AG.

Volkswagen AG (OTC: VLKAY) is the world’s largest automotive manufacturer—it overtook Toyota for this title in 2016—and its owned brands include Volkswagen, European brands Skoda and SEAT, Porsche, Audi, Bugatti, Bentley, and Lamborghini. Its line-up includes vehicles for every type of driver in any price range.

Five of the names listed above represent some of the world’s most luxurious car brands. But the beauty of Volkswagen AG is that it isn’t only comprised of luxury brands, unlike Ferrari, and the majority of the company’s profit comes from its non-luxury brands. This gives investors an opportunity to invest in luxury brands with a certain margin of safety, something Sven has discussed at length, as if the sales of any one of these luxury brands declines, it will only represent a small portion of Volkswagen AG’s total revenue.

Now, you may be thinking about Volkswagen’s dieselgate scandal from 2015 – 2016 where the company was found to have been intentionally programming its turbocharged diesel engines to evade emissions standards by only activating certain emissions controls during formal emissions testings and thus allowing their cars to spew higher than legal levels of pollutants into the air while on the roads.

What this scandal provides us with is an excellent opportunity to make a long-term investment at a point of maximum pessimism, a concept you’ve undoubtedly read about in several Investiv Daily articles.

Since the scandal broke in mid-September 2015, the price of VLKAY has been depressed and I’d imagine that’s largely because the scandal continued to unfold throughout the entirety of 2016 and investor uncertainty about the company still remains.

Today, Volkswagen AG is still dealing with some of the heavy fines that came out of dieselgate, though the company thankfully had a substantial cash hoard that has covered the fines.

Once the legal problems subside, the market will once again focus on the company’s brands and earnings power and the price will rise, and I imagine that day will come sooner rather than later and here’s why.

One would have thought that dieselgate would have significantly impacted consumer sales of Volkswagen vehicles and that the other brands in the Auto Group would have suffered as well, but that didn’t turn out to be the case.

Volkswagen’s 2016 U.S. sales were down only 7.6%, and in the last two months of 2016 and first month of 2017, sales were up 21%. This is because while Volkswagen did lose all of its U.S. diesel sales for 2016, or 20% of its total sales, just over two thirds of Volkswagen’s diesel owners that were effected by the recall of its vehicles simply purchased a non-diesel Volkswagen vehicle rather than abandon the brand. Not only that, but sales for 2017 look strong as well as Volkswagen is set to release its new Touareg model, its best selling model in the U.S., later this year.

As for the other brands in the Auto Group, Audi’s sales for 2016 were up 4% in the U.S., Porsche’s were up 4.9% in the U.S., Bentley’s sales were up 9% globally… It appears that the Group’s other brands’ sales were largely unscathed.

Bottom line, the company has survived its dieselgate doomsday legal scenario quite well.

From a business perspective, there’s a good margin of safety with VLKAY. The company boasts a diverse group of brands, and while Volkswagen makes up a majority of the sales, the other brands continue to grow. The company’s presence as a global brand reduces its reliance on any one market, and as it manufactures everything from economy to ultra-luxury vehicles, it also isn’t dependent on any one segment. Add all of this to the fact that the company, as I mentioned earlier, has a substantial cash hoard, and we’ve got a pretty financially flexible company.

From a fundamental perspective, VLKAY is pretty cheap trading at 0.8 price to book, and with a forward P/E of 1.2. It also has a solid earnings track record and a secure balance sheet.

Now, let’s look at things from a technical angle.

Source: Trading View.

What we can see in the chart above is a clear bottom in September 2015 which was precipitated by an exhaustion gap (blue bracket). We can see here that volume—as marked by the light green bars along the bottom of the chart—spiked at the exact same time and formed the exhaustion gap.

It’s also clear that the price has been trading below a resistance line (pink line) since the bottom, keeping the price low.

Now what’s also interesting to me here is that if we look at the volume before and after the exhaustion gap—the bar and area graphs running along the bottom of our chart—we can see that the volume on VLKAY has been far higher since the bottom than it was before it. This tells me that it’s likely smart buyers are accumulating the stock and expecting it to move higher, as I do.

Once the price breaks out above the resistance line, which I expect it will do soon, the price should rise to around the price where the exhaustion gap started, or around $36, then retest the new support line (the old pink resistance line) before continuing its uptrend which I think we could see the price in the mid-$50s in the coming couple of years.

Aggressive traders should buy now and then add to their positions when the support line is retested. More conservative traders could wait until this retest occurs before buying in to the uptrend.

As we’ve seen, the good news with VLKAY is that the company has survived a devastating scandal, and it’s only a matter of time before the market realizes how great this company is. The great news about VLKAY is that I believe it presents investors with a fantastic opportunity to make a long term investment in a solid company that just so happens to own several of the world’s biggest luxury car makers.

As always, do your due diligence before investing in VLKAY. If you like how the books look for the world’s largest auto manufacturer, it’s presenting a great opportunity now to buy on the cheap.