Revved up: Volkswagen in Brazil jumps back into growth mode, thanks to buyers at home.

For Volkswagen (VW) do Brasil, 2006 was a turnaround year. Brazilian operations of the German automobile giant reported sales figures in the black after several years of losses. The end of red ink didn't come easily but after tough adjustments that included laying off 5,000 employees over five years. Yet the biggest change of all came from an increase in sales, not in export markets, but at home.

In the first four months of 2007, car sales in Brazil rose 22.6% compared with the same period a year earlier. "If this rate continues, sales in the domestic market could easily surpass 2 million units, which would be an all-time best result for the sector," says Gustavo Schmidt, director of national sales at VW do Brasil.

Hitting that goal, VW hopes to end up controlling a 24% stake of the auto market. On the assembly line that produces the Gol--the country's top seller for two decades now--in the Sao Bernardo do Campo facility near Silo Paulo, workers churn out 800 to 900 units a day in two, eight-hour shifts.

Company executives are not at a loss for words to describe the bustle. "The main reasons are the recovery of the Brazilian economy and lower interest rates. Consumer confidence has helped us greatly," Schmidt says.

The company's faith in the Brazilian economy has led to US$1.20 billion in investments scheduled by 2011 with the goal of recovering VW's historical leadership in the market, lost to Italian carmaker Fiat just a few years ago. "We worked hard to redesign products, and for 2008 we plan to be poised to jump back into first place," Schmidt says.

Beyond Brazil's booming domestic car market is the export sector. Up to the year 2000, VW in Brazil exported 10% of production. Then exports jumped to 40%. "Right now, it's at around 30% but we are planning for 20%," says Marcos Vinicius Moya, the company's export director. VW exported 256,000 vehicles in 2005. That figure fell to 202,000 in 2006. Within five years, VW executives want to export 130,000 vehicles produced in the country.

The reason for declining exports is the real's strength against the dollar, which raises the cost of Brazilian vehicles sold abroad. Prices of exports have risen between 40% and 60% since 2004, according to Moya.

Any drop in exports in 2007 should be cushioned by strong demand in Argentina and Venezuela. With automobile exports estimated to hit 65,000 units this year, Argentina is still the largest single foreign market for VW in Brazil The company ships 67,000 units to Europe. Exports to Venezuela have grown between 50% and 60% a year. "These two countries have compensated for the loss of exports elsewhere. The injection of petrodollars into the Venezuelan economy is making the public come back to buy," Moya says. Last year, the company exported 12,000 cars to Venezuela, a figure that could climb to 16,000 or even 20,000 this year.

Competitiveness. Imports into Brazil have risen, too. Automobile companies imported 34,000 vehicles in January and February of this year, 190% more than they did during the same period a year earlier. The big fear is that the vehicles produced in Brazil will begin to lose their competitiveness. Cars produced in Mexico, for example, enjoy a larger market share than those produced in Brazil. "Last year, Mexico exported to Brazil around 25,000 vehicles," says Ademar Cantero, director of institutional relations at Anfavea, the Brazilian automobile manufacturers association.

The strength of the real against the dollar is not the only reason behind the drop in VW's competitiveness. "Inefficient Brazilian infrastructure is increasing logistics costs and we have a problem with import taxes. Export financing is very costly in Brazil and all this is affecting the competitiveness of Brazilian products," Cantero says.

Overall, exports are forecast to fall by 10% in terms of volume through the end of the year. With that, the main driver in the earnings outlook for VW and all other Brazilian car manufacturers will be the domestic market, one in which Brazilians are buying vehicles like never before.

Globally, the Volkswagen Group delivered more vehicles to customers during the first three months of 2007 than in any previous quarter. The company sold 1.47 million vehicles worldwide, a 7.9% rise compared with the same period in the previous year. The big market was China, where sales of passenger cars rose year-on-year by 23% to 203,000 cars. In the company's South America/ South Africa region, 188,000 vehicles were delivered during the quarter, a 21.5% increase. Brazil fueled that demand, with 120,000 cars delivered, a 21.4% increase.

CARLOS ADESE * SAO BERNARDO DO CAMPO