Wednesday 21 February 2018

As VW shares rise 37pc in a month, the emissions scandal is looking overblown

The CO2 emissions scandal would appear to be all but over, and the carmaker has survived, writes Leonid Bershidsky

€83.4bn - The amount in the VW kitty at the end of September in cash and equivalents
€83.4bn - The amount in the VW kitty at the end of September in cash and equivalents

Leonid Bershidsky

At the beginning of the Volkswagen emissions scandal, it even seemed for a few panicky moments as if the company might go under.

Estimates of the potential cost to the carmaker were in the tens of billions. The markets are beginning to realize that the damage was overestimated; the company will probably pull through without major bloodletting.

That's a big positive, but it comes with a big negative.

First, the good news. VW shares are up 37pc in the last 30 days:

According to Bloomberg Intelligence, since the start of the fourth quarter - and thus since the world learned that VW cheated on nitrogen oxide emission tests - bond dealers were net buyers of VW debt despite the rating agencies' moves to downgrade it; they sold off Ford, Toyota and Honda bonds.

The reason VW attracts investors is that as the company's new chief executive Matthias Mueller gets his bearings in the post-scandal environment, it turns out that he and other managers initially overreacted. First, it turned out that a cheap fix (new software and the installation of a piece of mesh) would probably be enough to eliminate the NOx problem in Europe. The German regulator has already accepted the solution.

Then, on Wednesday, VW announced that it had overestimated the number of cars with real-life CO2 emissions higher than stated. Only 36,000 cars - not 800,000 - are affected, and the extra emissions are too small to matter for car owners' gas costs and taxes. VW won't need to spend the €2bn it had allocated to solving that particular problem.

The €6.7bn the company put aside for the NOx fixes for its diesel cars when it appeared each car might need thousands of euros in repairs and new equipment will probably not be spent on the recall - at least not if the German fix is accepted worldwide.

Essentially, VW now faces three potentially costly problems: The US Environmental Protection Agency may not accept the cheap fixes; US litigation costs may mount; and sales, primarily in English-speaking countries, may suffer due to an erosion of trust.

None of these problems, not even all three of them together, is a recipe for disaster. Even if VW had to buy back all the affected cars in the US, it would cost €8.55bn.

That's a lot of money, but not beyond VW's means; at the end of September it had €83.4bn euros of cash and equivalents.

The Volkswagen brand's sales drops in November were serious in the US (-25pc) and in the UK (-20pc), but these numbers should be taken with a grain of salt.

The problem in the US is that VW still cannot sell its diesel cars because it hasn't reached an agreement with regulators, so it's likely that the sales will rebound somewhat after that happens. Audi, VW's other big brand, increased sales in the US in November.

And the absolute numbers are tiny by VW standards. The November decline means that about 8,000 fewer cars sold. In the UK, the VW brand sold 3,200 fewer cars than in the previous month. In total, the German carmaker sells 120,000 cars in a bad month, so the losses sound worse than they are.

At the same time, in Germany, a far bigger market for the company, sales of the VW brand dropped only 2pc in November, by fewer than 1,200 cars. At home, VW doesn't face much of a trust issue: The U.S. is far away, and its regulators' credibility is not necessarily higher among German consumers than that of one of the country's best-loved industrial producers.

VW is losing market share - car sales are rising in both Europe and the US - but it's still the world's second-biggest carmaker after Toyota. Others would kill for its sales numbers.

This explains why Thursday's press conference hosted by Mueller and VW chairman Hans Dieter Poetsch was a boring event.

Mueller and Poetsch still couldn't estimate the US legal costs or explain exactly how the company came to cheat regulators on such a wide scale. They just mumbled something about a chain of errors and an excessive tolerance for rule-breaking, and they did their best to sound contrite. Yet Mueller also made it clear that VW wasn't going to sell off any of its brands. He didn't announce any big job cuts and said there was no need for further sales forecast revisions.

As far as Volkswagen's top brass are concerned, the scandal is almost contained; they're just not putting an American-style overoptimistic spin on it because they still feel the need to keep apologizing and promising a cleanup.

That the scandal is turning out to be less costly than expected is not all good for the company, though. The current managers are VW veterans, and they - and the workforce - like their company a lot. They will change as little about it as possible. They'll sell the biggest plane of the corporate fleet - an Airbus 319 - but not the other nine planes it uses. And they'll still make fewer cars than Toyota with nearly twice the number of workers.

VW needed the scandal to make it leaner, not just more compliant. If the pressure on managers to cut costs and make the company more efficient subsides, the opportunity may be wasted.


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