Volkswagen always had a gift for reinvention – Stuart Mitchell believes the emissions scandal won’t stymie its success.
Britain’s postwar relationship with Volkswagen has always been significant. In the aftermath of World War II, Major Ivan Hirst, a British army officer, painted a VW green and gave a demonstration to his peers at the HQ British Forces Germany. An automotive factory that was likely to be dismantled was thereby given a new purpose, as the army quickly placed an order for 20,000 vehicles. The British have been buying Volkswagens ever since.
As of September last year, however, they had a new reason not to do so, since the US Environmental Protection Agency found that VW had intentionally programmed its diesel engines to meet certain emissions targets during lab tests. It transpired that VW had added this programming to some 11 million cars worldwide.1 Court cases and fines promise to cost the world’s eighth-largest company billions of dollars, not to mention the unquantifiable cost of any reputational damage. 2
Inevitably, the company’s share price took an instant hit, falling from around €170 in mid-September last year to barely over €100 by the start of October – in recent weeks it seesawed significantly within a range of €100–130, before the latest report delivered a slight boost. Earlier this month, the company announced the first annual net loss in its 79-year history – and a large cut to its dividend.
The company report revealed that VW had set aside €16.2 billion for projected costs arising from the emissions-fixing crisis – it was this that took its profits into negative territory.3 That is far below the total that many analysts had forecast. Indeed, for those confident in VW’s future, recent market turbulence has provided several opportunities to top up their holdings at a good price.
“We had been waiting for an opportunity,” said Stuart Mitchell of S. W. Mitchell Capital. “We halved our position prior to the scandal as the price was too high and the market was over-enthusiastic about the outlook for Chinese growth – plus VW was doing badly in the SUV market. But today it is significantly undervalued – the share price should be at around €160–170.”
Counting the cost
The company enjoyed a makeover after the Second World War, changing its name to Volkswagen (‘the people’s car’) and the name of its hometown (initially built for its employees in 1938) to ‘Wolfsburg’, both at British insistence. In the 1950s, Beetles sold widely across the UK; in the 1960s, the VW Campervan become the emblem of the hippy movement.
Now VW’s reputation has taken a new turn, since it is seen as guilty of not just shoddy environmentalism but a large-scale deceit. The manufacturer also has to weather the costs of refitting cars, restructuring its corporate governance, and paying the various fines and penalties now coming its way, especially in the US.
As with most major global companies, it can expect a relatively easy regulatory ride in its home country (and across the EU). In the US, however, politics dictates that a foreign company is strongly penalised for such misdemeanours. It is the prospect of these various costs that investors have been factoring in, with some estimates running in excess of €30 billion.
Stuart Mitchell believes the crisis has four crucial cost implications that investors need to understand. The first is reputational. European sales of VWs dropped 0.5% across the eurozone in the first three months of 20164 – certainly not encouraging, but hardly a catastrophe. Moreover, S. W. Mitchell Capital’s own study of similar past cases suggests that the sales impact of a one-off reputational hit should not particularly worry long-term investors.
“We looked at similar past crises at GM and Toyota,” says Mitchell. “What we found was that the loss in market share was limited, while the reputational effects were short term. VW has a large number of product launches slated for 2017 [compared to 2016], which may somewhat explain the company’s recent loss of market share. Most analysts now expect 2–3% sales growth over the next three years.”
Refit, restructure, repay
The second implication of the scandal is that VW will have to alter and refit the emissions monitoring systems on its offending vehicles – in the US, where the regulator’s response has been exceptionally punitive, this means refitting hardware and software in some 325,000 vehicles. However, VW has reported that it no longer expects its case to go to trial in the US this summer, as initially anticipated.
Inevitably, investors’ attention has been trained on the company’s corporate governance practices. Thus the third implication of the emissions story is that VW is expected to undergo a restructuring – not just claiming a few scalps at the top, which has already happened, but changing corporate practices and finding costs savings. (The company has already spoken about reducing the extensive range of complex parts it produces).
“We have been taking a very close look at every asset in the company, partly out of fear over the US charges, but also over fear that VW has become unfocused,” says Mitchell. “What we’ve found is that the company has now bent over backwards to comply with regulators. Moreover, we believe that cost-cutting measures could add $10 billion to the group.”
Then there are the fines. Mitchell recently met with a former head of the US Environmental Protection Agency, the same regulator that led the action against BP following the Deepwater Horizon oil spill in the Gulf of Mexico in 2010.
“He told me that the VW emissions case was simply nothing like what happened with BP,” says Mitchell. “I also spoke to members of the green lobby and to academics, and they tell me that VW is somewhere in the middle of the pack when it comes to their environmental record. The company may have pushed things too hard in the US, but it is a relatively small part of the business.”
After all the uncertainty, investors in Volkswagen were cheered at the weekend when they discovered what the company had set aside in provisions to cover the total damage done by the crisis – loss coverage, refits, recalls and fines. The size of the provision potentially eliminates the largest question mark hanging over the company’s future – and balance sheet.
“The latest news is a real boost for Volkswagen – €16.2 billion is very different to the €30 billion some had expected,” says Mitchell. “It has only added to our confidence in the value of the stock, and we believe there may be significant returns to come.”
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
S. W. Mitchell Capital is a fund manager for St. James’s Place Wealth Management.
This material is not a recommendation, or intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any strategy. The views of S. W. Mitchell Capital are not necessarily shared by other investment managers or by St. James’s Place Wealth Management.
1 http://news.sky.com/story/1556950/vw-11m-diesels-in-global-emissions-scandal , accessed 26 April 2016
2 VW was the world’s eighth-largest company by consolidated revenue, according to a Forbes assessment published in July 2015
3 Reuters. http://www.reuters.com/article/us-volkswagen-emissions-results-idUSKCN0XJ1M3
4 http://uk.businessinsider.com/european-car-data-vw-versus-other-brands-2016-4, accessed 26 April 2016