No, Tesla Isn’t Bigger Than Volkswagen

In the market for cars, big is beautiful these days. In the market for car stocks, things are more complicated.

Tesla’s market value raced past the $100 billion mark this week. While it’s still less than half of Toyota’s , it overtook Volkswagen’s and reached twice that of U.S. market-share leader General Motors. VW is still bigger by enterprise value-a better measure of relative weight as it accounts for different capital structures-but whichever way it is calculated the valuation gap relative to fundamental measures such as revenue is staggering.

Some might conclude that investors are valuing scale less highly as electric vehicles replace conventional ones, largely for reasons of regulation in Europe and China. The reality is messier: Scale will be both a benefit and a burden for incumbent auto makers in the industry’s technological transition. The inherent uncertainty is one reason investors are so reluctant to buy the stocks.

VW will likely become the official global industry leader by sales for 2019 when Toyota publishes its full-year sales and production next week. The two giants were neck and neck for most of last year, but VW pulled ahead in the final months, with growth of 12,5% in December deliveries compared with the same month in 2018.

The company isn’t celebrating. Chief Executive Herbert Diess explicitly urged his executives to focus on profit rather than sales in a speech at VW’s Wolfsburg headquarters earlier this month. He praised the Mexican business, where the company culled some unprofitable vehicles, sacrificing market share for the sake of narrower losses.

VW’s late-year growth spurt was for all the wrong reasons. New European Union emissions rules that took effect this month make gas-guzzlers more expensive for auto makers to sell in the region. Incentives for dealers and consumers to buy ahead of the change seem to have turbocharged sales-possibly at the expense of margins. Sales were also weak at the end of 2018, exaggerating the recovery.

Auto-industry leadership has proven something of a curse ever since a near-bankrupt GM, after 77 years at the top, ceded it to Toyota in 2008. Former VW boss Martin Winterkorn finally achieved his longtime goal to be No. 1 in the first half of 2015, just months before resigning amid the diesel scandal. Carlos Ghosn made much of the fact that his alliance of Nissan, Renault and Mitsubishi made more cars than its peers in 2017, only to wind up in a Japanese detention center.

Toyota is the one company that has achieved industry leadership without seeming to accumulate big problems. With one dominant brand and similarly engineered products across the world, it is the “only globally scaled auto maker,” says Philippe Houchois, an analyst at brokerage Jefferies. Toyota’s market value is $238 billion.

For others, global reach has often seemed a problem to fix rather than an advantage. GM under Mary Barra addressed this head on, retreating from big markets including Europe and India. The largest U.S. auto manufacturer has tumbled down global sales rankings but improved profitability.

Yet GM’s transformation also underlines how scale still matters at the regional level. Peugeot owner PSA was able to transform the finances of Opel Vauxhall, GM’s subscale European business, by bringing its vehicles onto shared production platforms. Investors are hopeful Chief Executive Carlos Tavares can achieve something of the same magic in PSA’s merger with Fiat Chrysler, which is due to complete in early 2021.

Scale could matter even more in electric-vehicle production. One reason is already clear: Research and development costs have escalated as auto makers have electrified their lineups. As PSA and Fiat Chrysler detailed in their merger agreement last month, the larger the production base over which these can be spread, the better. Smaller players, like Tata Motors’ Jaguar Land Rover, are struggling to keep up.

The other reason will only be properly tested as production ramps up. Battery technology is still too expensive. High-volume assembly and negotiating power over suppliers may offer car makers their best chance of making it more affordable. This helps explain why investors are broadly bullish on VW. The auto maker’s big, early bet on a dedicated electric-vehicle platform puts it in a stronger position than most to earn acceptable margins.

The big risk for VW-and for the entire industry except Tesla-is that it ends up with more factories and workers than it needs. Battery-electric vehicles are less complex and labor-intensive to assemble. GM’s battle with the United Auto Workers union last fall illustrated how costly the process of winding down factories can be for companies. The largest players could end up with the most stranded assets, even as they face the most political pressure to maintain jobs.

VW and Tesla have one big challenge in common over the coming years: scaling up electric-vehicle production profitably. Given its superior resources and experience, VW may well prove better at the job. Tesla’s valuation will doubtless remain bumpy. When a story stock meets a red-hot momentum trade, as seems to be the case now, investors tend to get burned.

Yet Tesla is also in the almost unique position of having nothing to lose in the auto industry’s journey to a greener future. All told, the enormous valuation gap between Elon Musk’s company and its peers isn’t quite as outlandish as it seems.

By Stephen Wilmot