Report on Expected Developments

After presenting the significant risks to the Volkswagen Group’s operating activities in the previous chapter, in the following we will explain the opportunities arising from expected future developments. The potential identified by the Group is quickly incorporated into its plans so that market opportunities can best be leveraged as they arise. These emerge mainly as a result of our moving into new markets, developing additional products and implementing technical innovations.

 

 

 

Our plans assume that global economic growth in 2008 will be lower than in 2007. Growth will continue to be slowed by persistently high commodity prices, particularly oil prices. The effects of the crisis in the US property market also pose a major threat. The fall in US property prices and the resulting credit risks could damage the North American economy and – as a result – other economies worldwide. We expect the strongest growth to be recorded in Asia, especially in China and India, in South America and in the countries of Central and Eastern Europe.

 

 

US economic growth will continue to slow in 2008. Although this trend will also impact negatively on the economy in Canada and Mexico, high oil prices will have a positive effect here.

 

 

We are predicting lower growth than in 2007 for Brazil and a sharper fall in GDP growth in Argentina. Growth will also slow in South Africa.

 

 

The Chinese economy is likely to experience double-digit growth again in 2008, while the Japanese economy will continue to weaken. India will maintain a fast pace of growth.

 

 

GDP growth in Western Europe is expected to be lower than in 2007. The Central and Eastern Europe economies will expand at an above average rate, but the growth rates will weaken compared with the previous year.

 

Real GDP growth in Germany is likely to drop below 2% in 2008 due to weakening exports and only moderate growth in domestic demand.

 

 

 

The main automotive markets are likely to record mixed trends in 2008. While we expect double-digit increases in demand in Brazil, India and China, we anticipate a slight decline in new registrations in Western Europe and North America.

 

 

In the USA, we expect the economic climate to cool, partly because of the crisis in the mortgage market. This, combined with high fuel prices, will impact negatively on demand for new vehicles. In the Canadian and Mexican markets for passenger cars and light commercial vehicles, we expect to see moderate growth.

 

The South American markets will continue to benefit from the positive economic trend. We expect strong growth rates here in 2008. The South African passenger car market has been affected by a sharp downturn since mid-2007 after the government imposed tighter restrictions on lending. We expect automotive demand to stagnate in 2008.

 

 

In the markets in the Asia-Pacific region, we expect demand to continue growing in 2008, particularly in China and India. In Japan, the market as a whole is likely to remain on a level with the previous year.

 

 

In Western Europe (excluding Germany), we assume that demand for passenger cars will be slightly lower than in 2007 since none of the main markets is expected to grow. In Central and Eastern Europe, particularly in Russia, it is likely that new registrations will continue to rise.

 

 

Following a weak year in 2007, demand for passenger cars is expected to pick up slightly in Germany in 2008, although high fuel prices and economic uncertainty may have a negative impact.

 

 

 

Our planning for fiscal year 2008 regarding unit sales and factory capacity utilization is based on the estimates of economic institutes and capital market players regarding the development of exchange rates worldwide. The majority of them expect the US dollar and sterling to continue to weaken against the euro. The Russian rouble and the Chinese renminbi will strengthen against the euro, however.

 

In the euro zone, we expect minor fluctuations in interest rates in 2008. In the USA, interest rates are likely to continue falling.

 

 

 

We expect prices for commodities and steel to remain at a high level but fluctuate sharply in 2008. The supply situation will not ease very much. It will take several more years to build up new capacity in this sector.

 

 

 

As part of our research work, we dedicate a considerable amount of time and energy to traffic-related megatrends that will affect our products and processes in the future. These include not only the increasing importance of environmental and climate protection aspects, but also the strong growth of megacities in some markets, which presents new challenges for infrastructure. At the same time, micromarkets will grow up alongside existing mass markets. A further point of focus is demographic change and the constant increase in the proportion of over-60s, who show a high degree of quality awareness, for example.

 

In addition, customer requirements are diverging across society as a whole due to growing differences in income levels. And tomorrow’s world of work will be more flexible than is the case today with regard to the tasks performed, the way in which work is organized, working hours and places of work. As a result of all these trends, our products will be shaped to an even greater extent by intelligent and networked technology and ease of use by people. Driver assistance systems will bring increasing improvements in safety, while new vehicle materials will offer enhanced functionality and comfort.

 

 

 

A number of highlights will selectively complement the Volkswagen Group’s model range in 2008.

 

The Volkswagen passenger cars brand will expand its range to include a dynamic coupé based on the Passat series. This vehicle boasts a sporty body line and delivers an appropriate level of performance without sacrificing the functionality typical of Volkswagen. The new Scirocco will also be available in 2008. This compact coupé offers above-average performance and emotional design at an attractive price. In the spring, Volkswagen will launch its model rollout for the US market by unveiling the Routan, its first model for the country’s important minivan segment. The second half of the year will be dominated by the new Golf. Its unique combination of attributes, such as extremely economical engines, outstanding quality and excellent value for money, will enable the Golf to continue setting standards and extending its lead over others in its class.

 

Audi will launch three new models in the spring. In addition to the new Audi RS 6 Avant*, which combines comfort with a very sporty profile, the A4 series will be complemented by the new Audi A4 Avant. The Audi A3 Cabrio, which sets standards for compact convertibles with a traditional soft top, will also be presented to the public. A further highlight in the course of the year will be the presentation of the Audi Q5, which pushes the boundaries of driving dynamics and off-road capability.

 

Škoda will unveil the successor to the Superb, a hatch-back with a roof-hinged lift gate.

 

In the small car segment, SEAT will present the new Ibiza series. Available in a family-friendly five-door version and a sporty three-door version, the new Ibiza will impress its customers with a number of innovations.

 

The Bentley brand will present the luxury Brooklands coupé*. The third Arnage model is a captivating vehicle offering the ultimate in sportiness and luxurious comfort.

 

The successful BlueMotion eco-label of the Volkswagen Passenger Cars brand is to be extended to the Volkswagen Commercial Vehicles brand. The Caddy, for example, will also be available in a BlueMotion version in 2008.

 

* Consumption and emission data.

 

 

 

After we delivered more than 6 million vehicles to customers last year, we will continue to pursue our strategic objectives in 2008. Thanks to our successful model policy, we are well placed to achieve another year-on-year increase in deliveries to customers.

 

We intend to further increase our global market share by moving into additional segments and extending our presence in expanding markets. In Germany and the other Western European markets, we expect moderate increases in our market share despite the advanced stage of market saturation.

 

 

 

In addition to scaling back activities within the dealership system that do not add value, we will take measures in the European markets to enable us to respond to the changes to the Block Exemption Regulation expected in 2010. With its brands, the Volkswagen Group is preparing to exploit possible opportunities resulting from further European single market liberalization and to promptly identify and avert possible risks. In addition, the joint marketing activities of the Automotive and Financial Services Divisions will be more tightly interwoven and integrated so that we can continue to develop attractive and innovative products for our customers.

 

 

Our future strategic focus will also include making greater use of opportunities in emerging markets. India, Russia and the ASEAN region harbor the greatest growth potential in the global automotive market.

 

India is one of the most important emerging markets worldwide. Unit sales of vehicles (passenger cars and light commercial vehicles) will rise from around 1.3 million units a year at present to an estimated 3 million units in 2015. In less than ten years' time, therefore, India will become one of the five most important automotive markets, after the USA, China, Japan and Germany.

 

This presents particular growth opportunities for the Volkswagen Group since Škoda is so far the only brand to have established a foothold in the Indian market and further brands will be able to target additional customer segments. In 2007, the sales company Volkswagen Group Sales India P.L. was established with this in mind. We also started to expand the dealer network and to assemble semi-knocked down Volkswagen Passenger Cars and Audi models at Škoda’s Aurangabad plant, where the Audi brand is assembling Audi A6 models in an exclusive area. By 2009, we will build a production plant in Pune with a view to producing a vehicle specially designed for the needs of Indian customers.

 

In Russia, unit sales of vehicles (passenger cars and light commercial vehicles) will rise from around 1.6 million units a year at present to over 3 million units in 2015, making it one of the ten most important automotive markets. Volkswagen AG is already importing and distributing all Group brands successfully via its own sales company. On November 28, 2007, the Volkswagen Group opened a plant in the town of Kaluga, 160 kilometers south west of Moscow, with a view to even better exploiting growth opportunities in the Russian market. At present, semi-knocked down Volkswagen Passenger Car and Škoda models are being assembled there. Parallel to this, a full production line for Volkswagen Passenger Car and Škoda models, including body shell production, painting and assembly facilities, is being installed at the same location and will become operational in the first half of 2009.

 

We also see substantial opportunities for significant additional sales volumes in the ASEAN region, whose countries impose import duties and other non-tariff trade barriers. Volkswagen aims to gain a sustained foothold in this economic area. With deliveries expected to reach around 2.4 million vehicles in 2015, the automotive markets in this region – in which the Volkswagen Group has hardly been represented so far – harbor enormous growth potential. The largest passenger car market in the ASEAN economic area is Malaysia. We therefore established a sales company in the capital, Kuala Lumpur, at the end of 2005. Due to the legal framework there, which may change at any time, it is only possible to gain a sustained foothold in the automotive market via a local assembly line for semi-knocked down vehicles. The situation is similar in the other large markets of Thailand and Indonesia. In this context, we are currently investigating how we can enter these markets without making substantial additional investments.

 

The growth markets mentioned above are undergoing a process of mass mobilization that has long since ended in saturated markets such as Europe, the USA and Japan. Over the coming years, hundreds of millions of people will try to gain the mobility provided by a car. Due to the low purchasing power per household in these countries, there will be a demand for basic mobility at extremely favorable prices. Automotive manufacturers able to offer fully functioning vehicles at prices of between €3,000 and €6,000, depending on size, will meet with very strong demand. This provides the opportunity to produce and sell in high volumes. However, entering a low-cost segment of the market also poses considerable risks, as a brand’s positioning may suffer as a result.

 

Significant changes will be seen in the lower-cost market segments over the coming years. One thing is already apparent: it is impossible for any company with its sights on a leading role in the global automotive market to ignore these trends.

 

 

in € billion

 

 

 

 

Our investments in the Automotive Division will be €28.9 billion in the period 2008 to 2010. As well as investments in property, plant and equipment, this total amount also includes additions to capitalized development costs and investments in financial assets.

 

€20.9 billion is attributable to property, plant and equipment, of which more than half will be invested in Germany. Following the relatively low figure achieved in recent years, the ratio of investments in property, plant and equipment to sales revenue (capex) will rise to a competitive level averaging around 6% over the next three years as a result of upfront expenditures on new products, powertrains and production sites.

 

Most of the total amount invested in property, plant and equipment in the Automotive Division during the planning period (€13.8 billion) will be spent on modernizing and extending the product range. The main focus will be on new vehicles, successor models and derivatives in virtually all vehicle classes. Over the next three years, the Volkswagen Group will develop and launch a number of additional new models, thereby continuing its new model rollout and tapping other markets and segments. In powertrain production, the Group will launch new generations of petrol engines with improved performance, fuel efficiency and emission levels. In future, we will use common rail technology for our diesel engines. Capacity for automatic gearboxes will be adapted to meet the rising demand.

 

In addition, cross-product investments of €7.1 billion will be made over the next three years. Due to our challenging quality and cost targets, manufacturing the new products will require adjustments at the press shops, painting and assembly facilities. Apart from production, we will invest mainly in the areas of development, quality assurance, genuine parts supply and information technology. Planning also includes the construction of the new plants in Russia and India. It will thus be possible to supply the growing markets from local production.

 

Our aim is to finance investments within the Automotive Division using internally generated funds. For the planning period, we forecast cash flows from operating activities of €37.3 billion. The funds generated will thus exceed investment requirements for the Automotive Division by €8.4 billion and continue to improve the financial situation.

 

The joint venture companies in China are not consolidated and therefore not included in the figures given above. They will invest a total of €2.1 billion in the period 2008 to 2010, to be financed using the joint venture companies’ own funds.

 

Investments in the amount of €21.4 billion are planned in the Financial Services Division for the period 2008 to 2010, with investments in leasing and rental assets (net of disposals) accounting for €9.7 billion, and the increase in receivables from leasing, customer and dealer financing accounting for €11.4 billion. As is common in the industry, the planned cash flows from operating activities of €8.6 billion will not be sufficient to finance these investments in full. The additional capital requirement of €12.8 billion will be financed mainly by debt issuance programs in the money and capital markets and by customer deposits from the direct banking business.

 

 

 

Based on long-term interest rates derived from the capital market and the target capital structure (fair value of equity to debt = 2:1), the minimum required rate of return on invested assets defined for the Automotive Division remains unchanged at 9%.

 

Having achieved our target of generating at least the cost of capital and exceeded the minimum required rate of return of 9% in 2007, we are aiming for a return on investment of more than 10% over the medium term based on current planning.

 

 

Thanks to optimized cost structures and improved processes, we were able to further increase the Volkswagen Group’s competitiveness and earnings power in 2007. We will systematically drive forward this development in 2008. Because we are adding new products to our model range and moving into new markets, we believe that we will exceed the previous year’s key performance indicators in 2008.

 

 

 

This report contains forward-looking statements on the business development of the Volkswagen Group. These statements are based on assumptions relating to the development of the economic and legal environment in individual countries and economic regions, and in particular for the automotive industry, which we have made on the basis of the information available to us and which we consider to be realistic at the time of going to press. The estimates given entail a degree of risk, and the actual developments may differ from those forecast.

 

Consequently, any unexpected fall in demand or economic stagnation in our key sales markets, such as Western Europe (and especially Germany) or in the USA, Brazil, China, or Russia will have a corresponding impact on the development of our business. The same applies in the event of a significant shift in current exchange rates relative to the US dollar, sterling, yen, Brazilian real, Chinese renminbi and Czech koruna. In addition, expected business development may vary if this report’s assessments of value-enhancing factors and risks develop in a way other than we are currently expecting.

 

 

Global economic growth in 2008 is likely to be lower than in the previous year. Global automotive markets will also expand at a slower pace compared with 2007. We expect growth to be slowed primarily by further rises in the price of energy and commodities, particularly oil, as well as the current CO₂ debate. The repercussions of the crisis in the US property market will also impact negatively. We expect trends in the most important automotive markets to vary from region to region, with markets in Asia, particularly in China and India, expanding at the previous year’s strong rates. Growth in South American markets will slow. The number of new registrations in Western Europe is likely to be lower year-on-year, while the Eastern European markets may record sharp increases again. We expect the situation in the North American market to remain difficult.

 

Its diverse range of brands gives the Volkswagen Group a critical competitive advantage. In 2008, almost all brands will again present attractive new models, enabling us to selectively complement the Group’s product portfolio and move into further market segments. We therefore expect deliveries to customers to exceed the record set in 2007, with sales figures rising in the Asia-Pacific and Central and Eastern Europe regions in particular.

 

As a result of the expected increase in unit sales, the Volkswagen Group's sales revenue in 2008 will be higher year-on-year. The further optimization of our processes and continued systematic cost discipline will also have a positive impact on earnings development. As a result of upfront expenditures on new products, powertrains and locations, the ratio of investments in property, plant and equipment to sales revenue (capex) will be at a competitive level of around 6%.

 

Overall, we expect the Volkswagen Group’s 2008 operating profit to exceed the 2007 level.

 

We also anticipate a positive net cash flow, which will further improve the Automotive Division’s liquidity situation.

 

 

 

Wolfsburg, February 18, 2008

The Board of Management

 

 

 

 

 

 

The Board of Management of Volkswagen AG is responsible for preparing the consolidated financial statements and the Group management report. Reporting is governed by International Financial Reporting Standards (IFRSs) as adopted by the EU and the Interpretations of the International Financial Reporting Interpretations Committee (IFRIC). The Group management report was prepared in compliance with the provisions of the German Commercial Code (HGB). Volkswagen AG is required by section 315a of the HGB to prepare its consolidated financial statements in accordance with the standards issued by the International Accounting Standards Board (IASB).

 

The accuracy of the consolidated financial statements and of the Group management report is safeguarded by internal control systems, the implementation of uniform Group-wide directives and by employee training and continuing education measures. Compliance with legal requirements and internal Group directives, and the reliability and proper functioning of the control systems, are continuously reviewed across the Group.

 

The early-warning function stipulated by law is implemented by a Group-wide risk management system that enables the Board of Management to identify potential risks at an early stage and to initiate appropriate countermeasures where necessary.

 

In accordance with the resolution adopted by the Annual General Meeting, the independent auditors PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, Hanover, have audited the consolidated financial statements and the Group management report, and have issued their unqualified auditors' report reproduced following the notes to the financial statements.

 

The consolidated financial statements, the Group management report, the audit report and the measures to be taken by the Board of Management to ensure early identification of going concern risks have been reviewed in detail by the Supervisory Board Audit Committee and by the Supervisory Board of Volkswagen AG in the presence of the auditors. The result of this review is presented in the report of the Supervisory Board.