Good Morning Evening,
Apologies it’s been manic!
The events unfolding for VW (Volkswagen AG) and the
automotive industry as a whole were a complete surprise. The share price
decline in comparison to the GM debacle was starting to look overdone until the
outing of a further 10.5 million cars with emission issues. Prudence suggests
it’s wise to consider the unquantifiable liabilities (irrespective of current provisions).
As per most corporate scandals of late, VW’s algorithmic adjustments were
initially implied as being limited to circa 480K cars. Now the very size of the admission raises questions
about the dividend and valuations become wide-ranging. Luckily for VW, the
Suzuki monies will come in handy and are possibly not factored in by the
market.
VW has not been absent of corporate issues before, with the
Porsche hedge fund bonfire, union payments/benefits and now false emissions
data. It would be a very hard/foolish to catalogue all the actions and
conclude, after the fact, that VW was a veritable investment basket case. To do
so, would question the very foundations of any investment. Save of course for
the macro implications upon a company as large as VW i.e. China / Global auto
markets.
With the range of fines and compensation ranges being so
vast, some sensibility is needed. If one was to assume the issues of GM and
subsequent cost implications, plus those of Toyota with their airbag denial
had a similar gravity. Then one can at least ascertain those as being the
minimum liabilities that VW can expect to pay. Admittedly, VW have come out
with a $6.5B figure to side aside for potential liabilities or circa $590 a
unit. Really?
VW and the market have some direction due to
GM’s misfortune and currently (subject to further
news) suggests it’s likely to cost them less than the worst case scenario bandied
around. The media have not so far implicated VW in any deaths or
accidents as a result of their actions.
Having been short across the sector for car manufacturers on the back of the
Chinese data, yesterday’s news was totally unexpected (perhaps a lesson...).
The corporates appear to have played right into the hands of
the ever tightening grip of the enforcements agencies. Such Agencies/Government
Depts. have gained as a result of the poor conduct of corporate entities (banks
and autos), with severe financial penalties being imposed since the financial
crisis (08/09). So one cannot discount too much of the U$D 37,500 per vehicle
penalty, that the US Environmental Protection Agency (EPA) could impose for breaches to Clean Air Act.
Conveniently, America has an option to impose a higher
penalty on VW due to the differences in laws governing the actions of VW, GM,
Hyundai and Toyota. VW is at risk of being a pawn for the protectionism of
America auto manufacturers.
The commentary about the reputation damage often ignores
brand loyalty. It shows the limited understanding by some commentators of a
sector and brands. A quick look at GM’s market share demonstrates they have
maintained near to the level when the ignition faults were uncovered. Albeit,
GM lost their key position of circa 25% market share back 2005 and have never
recovered since. This was in part due to the diversity of the product offerings
in America and quality.
The read across to other markets should not be ignored
either, especially from the perspective of a) reputational damage b) potential
liabilities and c) enforcement notices. Why would VW “conduct such activities”
just in the North American Market? Are they alone in such practices?
VW’s actions have already given rise to questions about an
exit from American market. With China in the crapper and Europe at best showing
a dull glimmer of hope, what other options do they have? Stay and pay the price
or exit?
Perhaps a new plant and improved corporate governance is a
sensible approach. The read across of how quick VW’s hands went up, “we’re
coming out, please don’t shoot” (Classic text book crisis management), would
certainly suggest at this point in time they intend to stay in the US market.
Separately, US authorities have to consciously consider how
much investment VW has made and is likely to make within the US. With recent
speculation of another plant / operations being built. VW is invested in the US
with the Chattanooga Plant, Tennessee (from 2011 onwards)
Chattanooga employs a significant number of people both
directly and indirectly and, depending on how business recovers, could build more
(but unlikely in the near future). The view in the auto industry is that VW is
a big company to weather the storm, and that it's going to make the US work
even if it takes slightly longer than planned. The planning stage may just be a
slight underestimate, but one cannot knock optimisation.
With the litigious nature of such high profile cases, any
costs are unquantifiable at this stage. Having been digging this afternoon, the
likely outcome will not only involve X billions of dollars in fines ($4B
estimate here), but associated warranty costs and, unless there’s a speedy GM
type deal, possible criminal charges for those executives in the know.
As the situation has been dragging on since August 2014, it
would appear VW have been less than open with the EPA investigations. Of
significance is the class-action lawsuits by US Drivers whom bought into the
"clean diesel." Is there mis-selling? What are the refund
liabilities? Do VW have to not only compensate drivers on false promise? Will
vehicles over the longer-term be fit for purpose? Can modifications be made to
rectify the issues?
The market’s reaction so far suggests there is a suspicion
that all manufacturers have been up to similar. Just when the DoJ and American
regulatory system are nearing the end of imposing fines on the banks. America
have a headwind to attempt some protectionism on the back of VW’s woes. What
with the
pharmaceutical price gouging and auto defeat devices, US regulatory depts. and enforcements
agencies may just have another busy year ahead.
VW have so far have been very clever to avoid putting the
matter in context, more so, hands up and we’re cooperating. However, if one is
to read across to the settlement of GM.
- GM had 100+ deaths and injuries.
- Arguably the product defects/flaw are potentially larger
for VW.
- GM’s lawyers and product specialists appeared to be
aware of the situation and limited their actions to protect the consumer and
general public.
- The defeat device appears to be installed to circumvent
existing emissions controls. Whereas, GM appeared to be after the fact. On the
face of it, VW appear to have conspired to ‘beat’ the system and arguable had
an unfair advantage over their competitors.
- Both GM and VW have denied the existence of such a
flaw/fault and as such, it has wider implications for the automotive culture of
avoiding/taking blame.
- For consideration in the liability is the
multiplier effect - where potentially 2 or 3 owners of the same car could have
rights to a claim due to the false statements and/or the practice of utilising
the defeat device. So far, estimates here (EMC) suggest it’s likely to be
around 14-16.5M owners that are affected by VW’s emissions practices. The issue
is, what is the likely class action uptake of this case in comparison to those
of GM? 10%? 15?%
- What of the risks associated with VW’s assets back
securities? VW Bank? Lease and financing packages etc…? Woah, over to DBRS /
Fitch / S&P on that one, that may need a little tweaking.
Whether VW drivers are stalwarts to a brand is another
story, with the reputational damage being another potential unknown. Evidence
so far suggests GM are / have recovered in terms of market share since the
scandal first emerged. Their current market share of 17.2% certainly
suggests the US consumer hasn’t been too phased by the ignition switch issues.
Once upon a time, German car-makers were known for the
reliability, quality and efficiency. As such the sector read across is not
great, but all is not lost. This reputation is unlikely to be irreparable
- theme parks and other such operators manage it over the 16-18 month cycle
(psychology of risk selection). If one reads across to the psychology behind
other brands, irrespective of sector, the norm is circa 12-18 months, more
recently towards longer-periods. The poignant part is to avoid complacency, something
VW should avoid at all costs.
There’s no two ways in putting it, that the industry as a
whole has a crisis to manage. There’s a suspicion that the lack of commentary
by other manufacturers suggests that there’s an element of due diligence being
conducted currently. This comes with a caveat of conjecture at the moment.
Save for an ever expanding number of vehicles involved, one
can look forward to a heavily fed media investigation. The Government agencies
will of course cite the seriousness of such actions, outline a hefty fine $4+B
and with an unknown quantum for recall and reparation costs.
The class actions may be the sticking point, with a
wide range of circa $2-$16B (the latter assuming partial-refunds). In time, VW
can invariably look forward to funding some form of "best practice
centre on emissions" to remove the Government burden.
One could even draw on the past as an indicator of the
future, with a speedy deferred prosecution agreement for three years
(a la GM) to avoid further investigation. If one is the market for a new
car, the plus being that VW cars may just be a buy (not the stock), as they
have to build quality to repair this nightmare shareholder scenario.
The obvious question is which marques in VW's stable are at
risk? Audi, SEAT, Škoda and Volkswagen marques. Greater scrutiny will be placed
on commercial vehicles under the MAN, Scania, Neoplan and Volkswagen Commercial
Vehicles marques?
In assessing the issues, there’s been a number of
valuations. On the sums of the parts, discounting VW brand per se, cash etc.…With
sensibility, assuming no further news, the worst case scenario based on current
news of circa €87.63 (Euros) a share, with potential upside if the matter is
put to bed fully, of near €115 a share.
At near €111 it’s very difficult at this stage to believe
the issues are fully priced in, albeit expect those with greater risk appetites
to be enticed. Perhaps those funds with telescopic calculations based on
earnings in 2022 are being enticed? Can VW recover from here? Undoubtedly,
but if further problems come to light, it’ll be a proverbial fire sale.
VWs exposure to China / Rest of the World is a story for
another day that has not been fully discounted yet.
In other news, the JCB head count reductions and oil rig (including deep sea) count have not
gone unnoticed. Kaz Minerals saga is reaching a conclusion with the market belatedly realising the all in unit costs are 20-30% below (edit) above market prices. ($2.80-$3/lb). Anyone for a rights issue? Previously a £5+B company.
Woes being felt in the UK steel industry by Bangkok's SSI and their Redcar plant with sympathies for Teesside workers. Redcar being a casualty of the Chinese steel exports.
BHP Billiton (BLT)
Global Debt Investor Marketing Announcement is very well timed – considering Roy
Hill is on track etc. raise it whilst you can’t! Did BLT ever update the market on the missing $1.5B capex guidance or is the situation still offline!? Expect more of the same…Copper not assisting Glencore either at circa $2.31/lb currently.
Atb Fraser
