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Even Volkswagen Now Feels the Weight of Europe’s Economic Troubles

Adam Jeffery | CNBC

The troubled European car market is now dragging down even Volkswagen, the region's leading automaker, as vehicle sales on the Continent have declined to their lowest levels in decades.

Until now, Volkswagen, the German auto company, had been buffered a bit more than other auto companies doing business in Europe because of its size and strong sales in North America and China.

But its shrinking profit margins reflect both the industry's steep sales decline in Europe as well as intense price competition in the biggest vehicle segments.

Volkswagen joins a growing roster of foreign and United States automakers that are struggling in Europe, where car sales dropped 10 percent during the first quarter, including double-digit decreases in France, Germany and Spain.

Most automakers are banking on surging sales in the United States to offset some of these losses.

(Watch Now: Stay Cautious on European Car-Makers: Pro)

And VW's chairman, Martin Winterkorn, cautioned that the company expected little improvement any time soon in Europe.

"The coming months will be anything but easy," Mr. Winterkorn said in a statement. "The current environment is definitely a tough challenge for the entire industry."

Volkswagen on Monday that its after-tax profit fell 38 percent, to 1.95 billion euros ($2.5 billion) in the first quarter, even though revenue slipped just 1 percent, to 46.6 billion euros.

The Italian automaker Fiat also reported a drop, reporting that its net profits plunged 88 percent during the three-month period, to 31 million euros ($40 million), and that revenue fell 2 percent, to 19.76 billion euros.

Fiat's chief executive, Sergio Marchionne, said that the combination of pricing pressure and weak demand was likely to depress profits in Europe for some time. "It is unfortunate the European market is in this state," Mr. Marchionne said Monday in a conference call with reporters and analysts.

He added that some automakers had considered themselves immune to the downturn, but no longer. "Those who have claimed a Teflon approach are getting that coat taken off," he said.

(Read More: Has Volkswagen Discovered the Holy Grail of Carmakers?)

Last week, the American automaker Ford reported a pretax loss of $462 million in Europe, and projected a full-year loss of $2 billion in the region. And the French carmaker Peugeot Citroën said it expected losses to force new labor talks to cut costs and increase competitiveness.

With the European market in such a dismal state, most auto companies are counting on surging sales in the United States to generate the bulk of their future profits.

At Volkswagen, the company's Audi luxury brand is the bright spot in its lineup. Audi, which has posted a 16 percent sales increase in the United States this year, contributed more than two-thirds of overall profits that VW earned in the first quarter.

Fiat has been getting virtually all of its profits from its Chrysler subsidiary in the United States.

Fiat took control of Chrysler after the American company's government bailout and bankruptcy in 2009. Since then, the Italian automaker has accumulated a 58.5 percent stake in Chrysler, and they have begun developing vehicles together.

In the first quarter, however, Chrysler's comeback stalled somewhat, as it spent heavily on new versions of two core products, the Jeep Grand Cherokee sport utility vehicle and a heavy-duty Ram pickup truck.

Chrysler said Monday that its net income fell 65 percent during the quarter, to $166 million, and revenue dropped 6 percent, to $15.4 billion.

Yet Chrysler still managed to help Fiat post a profit. Without Chrysler's contribution to the bottom line, Fiat said it would have lost money during the period.

Mr. Marchionne, who is also chief executive of Chrysler, said he expected the American company to reach its full-year target of $2.2 billion in net income and revenue of $72 billion or more.

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He said that the coming introduction of the new Jeep Cherokee S.U.V. this summer was "crucial" to hitting those goals.

"We need to do everything we can between now and then to make it happen," Mr. Marchionne said.

He added that given the strength of the United States market, Chrysler should regain momentum with its new models. "The onus is on us," he said.

Analysts said that Chrysler's performance remained Fiat's best hedge against the turmoil in Europe.

"Who would've guessed five years ago when Fiat rode to the rescue of a then-bankrupt Chrysler, that Chrysler would be viewed as the savior of Fiat?" asked Jack R. Nerad, an analyst with the auto research service Kelley Blue Book.

Mr. Marchionne also updated analysts Monday on the potential for Fiat to take full ownership of Chrysler.

"I have always seen Fiat and Chrysler being one entity at some point in time," he said. "How we get there is a story that's going to be written."

Fiat hopes to buy the 41.5 percent stake in Chrysler owned by a health care trust for United Automobile Workers union retirees in the United States. But Fiat and the U.A.W. trust remain far apart on a price for the shares.

(Read More: Carlos Ghosn: Europe's Car Market Is Collapsing)

A federal judge in Delaware is considering different valuations proposed for the stock, and is expected to make a ruling on a fair price this summer.

Until the court case is resolved, Mr. Marchionne said a potential Fiat-Chrysler merger was temporarily delayed.

"I remain hopeful that we can find a solution that meets their objectives and ours," he said.

If Fiat is successful in acquiring the shares owned by the U.A.W. trust, it could consolidate its balance sheet with Chrysler. Fiat could then gain access to Chrysler's cash reserves to bolster its product lineup in Europe and elsewhere.

Once a Fiat-Chrysler merger is completed, Mr. Marchionne said the combined company would restructure itself and issue new shares to raise capital.

Fiat shares, like most Italian companies, are currently traded on the stock exchange in Milan. But Mr. Marchionne said new shares in Fiat-Chrysler would most likely be listed on the New York Stock Exchange.

"It's the most efficient capital market I can get my hands on," he said.

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