Here’s Why The Market Reaction To Volkswagen’s Emissions Scandal Is Justified

September 30th, 2015 by Trefis Team

It’s a long way back for Volkswagen AG (OTCMKTS:VLKAY), after it admitted to falsifying emission test results in the U.S., and later reported that as many as 11 million cars worldwide used the software that would cut emissions while being tested, compared to normal driving conditions. The company is looking at massive fines, not only from the U.S. EPA and DoJ, but with the news that the fudging spreads to Europe, and possibly Asia and South America, the repercussions could be far worse in the coming time.

volkswagen's market cap depletion1

According to our estimates, the net present value of the cost of the entire dieselgate scandal for Volkswagen, including government fines and settlements, private settlements, recall expense, and future loss of sales, could be up to $34.5 billion. However, this figure could go up, yes, further up. Here’s how:

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Future Loss of Sales:

Around 5 million vehicles of the Volkswagen brand, 2.1 million at the premium brand Audi, 1.2 million at Skoda, and 1.8 million light commercial vehicles are reported to have been fitted with the software capable of cheating emission tests. We have estimated that the loss in customer perception, and halting sales of some of the diesel variants, will cause a 1-2% drop in vehicle deliveries for the Group in the next couple of years. However, the deficit could be wider.

We have a $36 price estimate for Volkswagen, which is above the current market price.

See Our Complete Analysis For Volkswagen AG

Volkswagen has sold 482,000 cars in the U.S. since 2008 involved in these allegations, which is 12.24% of all Volkswagen vehicles sold in the U.S. since 2008. So considering that the U.S. forms around 6-7% of all company volumes, 0.7-0.85% of Volkswagen’s annual volume sales are in jeopardy. And get this — this is less than 5% of the 11 million affected cars. Diesel cars aren’t a rage in the U.S., where less than 1% of the new passenger cars sold run on diesel.

 

The true backlash that Volkswagen will have to face might be in its home. Approximately half of the new passenger cars sold in Europe run on diesel. The German government has said that 2.8 million of the 11 million cars that used the defeat device were sold in Germany. Around 36% of Volkswagen’s vehicles are sold in Western Europe alone, and given that roughly half of them run on diesel, the group could be looking at a worse drop in future sales due to the loss in faith and perception. The crime is indeed serious — it affects 11 million cars, which is roughly 20% of all the vehicles sold by Volkswagen since 2008.

Volkswagen has halted sales of the 2015 and 2016 Volkswagen and Audi models equipped with 4-cylinder turbo diesel engines in the U.S., and elsewhere, Switzerland has banned sales of Volkswagen diesel vehicles in the Euro 5 category, which affects around 180,000 cars, including 1.2-liter, 1.6-liter, and 2.0-liter diesel engines for the Volkswagen, Audi, Seat, and Skoda brands. [1] These would all go down as lost sales, and even if refitted or upgraded, the company is facing a loss in profits due to related costs and an expected drop in the selling price of the previously affected models.

Hence, the loss in future sales could be more pronounced. The estimates for this scenario can be viewed and altered on the Trefis website.

Private Settlements:

Volkswagen will also face private class action suits that might extract billions from the company for years to come. 50 class actions have already been launched in the U.S., and the German group might have to pay heavy damages, considering it not only cheated the authorities, but also its customers, who till now thought that they were driving a ‘much’ cleaner car. Lawyers are moving to consolidate widespread litigation, which could cost Volkswagen billions on account of cheating customers into buying cars that were marketed as clean diesel cars, with impressive fuel economy. Some customers even paid premiums exceeding $6,000 for the same, and are now asking for compensation. [2]

 

The consolidated lawsuits called multidistrict litigation could run for a number of years and settle for more than what is currently estimated.

Government Fines and Settlements:

We currently estimate that Volkswagen will have to pay around $13 billion in government fines and settlements, considering that the German group might be able to settle the amount for less, based on future compliance with terms and conditions and requisite damage control. However, given that this scandal affects a broader spectrum of brands and operating units than what was initially disclosed, several countries including the U.S., U.K, and Germany, have launched investigations into diesel emissions. This means that Volkswagen could be looking at bigger fines than it was previously thought.

Assuming that the net government fines and settlements reach close to $15 billion, private settlements rise to $1.3 billion, up from the currently estimated $0.44 billion, and factoring in the higher-than-expected loss of future sales, the net present value of the total cost of the dieselgate scandal to Volkswagen rises to a massive $40.4 billion.

Approximately $32 billion of Volkswagen’s value has been wiped off since the news of the emissions scandal broke. In our previous scenario, where we estimate lower costs to Volkswagen due to future compliance and better-than-expected market recovery, the total cost to the company is estimated at $26 billion. Whether $26 billion or $35 billion, this scandal is bound to hit Volkswagen hard. However, this scenario, where the dieselgate scandal could cost the German group $40 billion, suggests that the slump could continue before the stock truly bottoms out.

See the links below for more information and analysis:

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Notes:
  1. Volkswagen emissions scandal: Switzerland bans sale of some models [↩]
  2. VW faces barrage of litigation, wsj.com [↩]