Dieselgate, China, and sleeping software. Where the crisis of European automakers came from

I wrote a longer analysis on Volkswagen $VOW3.DE today. Here I’d like to put it into a broader context, because it didn’t start with one weak quarter.

For the second quarter, Volkswagen reported an operating profit of 3.5 billion euros, about a tenth lower than last year and well below the estimate of 4.3 billion. It reversed its revenue outlook from growth to a 3% decline. According to June reports, there is also the possibility of cutting up to 100,000 jobs and closing four plants, but the company has not yet officially confirmed it and the unions are fiercely opposing it.

The roots of this problem go much deeper. In 2015, Dieselgate hit, and it wasn’t just about fines. In my opinion, German automakers lost their negotiating position in Brussels, and European regulation turned against combustion engines faster than would have happened otherwise. Companies then invested hundreds of billions in electromobility according to a timetable they didn’t set themselves, and demand lagged behind. When subsidies for electric cars ended in Germany, unused capacity and written-off projects remained.

The second thing is China. It was the main profit engine for twenty years. Volkswagen sold over 4 million cars there annually in its best years, and Chinese money subsidized European plants and development. Automakers therefore continued to invest there even when it was already clear that local brands were catching up. Now German manufacturers have seen their Chinese sales plunge by 30% to 41% in a single quarter.

The third thing is software. While Europe debated whether to build an electric car on a new or modified platform, a whole chain emerged in China from lithium to batteries and infotainment. Volkswagen racked up operating losses of over $7 billion at its own software division Cariad between 2022 and 2024 and still ended up having to look for partners elsewhere.

And then came the energy crisis in 2022. Gas and electricity prices in Germany have calmed down but remain well above US and Chinese levels. Add to that high wages and excess production capacity.

For me, one figure sums it all up best. New car registrations in the EU in the first half of the year rose by 5.7%, yet BMW $BMW.DE slashed its operating margin outlook in June from 4–6% to 1–3%, and profits are also tumbling at Mercedes. So demand is there. But European automakers have stopped making money from it.

In my view, the market has shifted from manufacturers that made money on brand and mechanics to those who can manage costs, software and fast model turnover. Chinese manufacturers have an estimated 30% cost advantage and build a new model in about half the time. Tariffs won’t fix this, especially when BYD $BYDDY , MG and Chery are building factories directly in Europe.

But this doesn’t apply to all of Europe. Ferrari $RACE just posted a quarter with an EBIT margin of 29.7% and confirmed its full-year outlook. It produces around 14,000 cars a year, with orders covered well in advance, and has simply passed on some of the US tariffs into prices, hiking some models by up to 10%. The stock, however, is roughly a quarter below last year’s peak, so the market has stopped paying for those margins, even though the business itself is still doing well. Škoda is also in good shape; it exceeded one million deliveries for the first time last year and added another 9.1% in the first half of this year. It is the second best-selling brand in Europe and also moved into second place in Germany. So the healthiest part of the group, which is otherwise facing the elimination of tens of thousands of jobs.

But I definitely wouldn’t conclude from this that premium-ness alone protects. Porsche $P911.DE shows this best. Last year its group operating profit fell by 92.7% and the automotive division’s margin dropped from 14.5% to 0.3%, mainly due to extraordinary costs of around 3.9 billion euros after backing away from its electric strategy. The dividend was slashed by 56%, and on top of the earlier 3,900 job cuts it added another 4,000 in Zuffenhausen this July. The difference compared to Ferrari, in my opinion, isn’t the price of the cars but the volumes. Ferrari sells 14,000 and demand is consistently higher than supply; Porsche delivered 279,449 last year and even that was a tenth less than the year before. It needs China for that, where its sales dropped by 26%, and it had to pay for electric platforms.

In my view, the pattern is that companies that don’t have to compete on volume are surviving. Either because they make very few and have a waiting list, or because they know how to manage costs like Škoda. The worst off are brands that built their premium margins on China and are now losing both.

From a valuation perspective, Volkswagen is probably cheap. It trades well below the consensus analyst target and the dividend yield is above 6%. In this situation, though, I’m more interested in whether that cost gap can be closed at all. Restructuring in Germany is slow and expensive, and the unions are not used to backing down.

How do you see it? Is Volkswagen at this level a turnaround story that will one day reward the patient, or a value trap where cheap keeps getting cheaper for years?