Volkswagen Emissions Scandal: What We Can Learn From History


The recent Volkswagen AG (OTCMKTS:VLKAY) emissions scandal has slammed the stock and created a lot of uncertainty for investors. Some may believe the large $30 billion drop in market value has created a buying opportunity, as the market seems to have overreacted. Others may think that with future lawsuits and mega-billion fines, the company is facing an uncertain future, and their future sales hit may be larger than anyone currently thinks.
As we try to analyze whether Volkswagen has been overly punished by the market, or still has more pain to endure, investors realize that uncertainty is very high. But can history tell us something about the current situation?

Is it possible to look at past cases and discover that it does, or does not, pay to be tempted after the initial large drop in a stock under these circumstances, or whether it does not pay to be impatient and one must “let the dust settle.” And how long does that take?

That is the question.

We shall endeavor to look at several past cases of other auto companies who were involved in controversies and whose stocks were punished for a time. We shall attempt to discover if there is a certain amount of time that it takes to get all the bad news out — and then investors slowly realize that while it is bad, everyone knows it is bad, so that eventually the market for the stock stops heading lower.

We will look at some auto names as well as BP, and their drilling disaster, to see if we can learn if there is a particular time until investors are ready to get back in — even to bad situations — once it is recognized that the light has been shined on all the bad news.

Let us look at past scandals and controversies, and see what they can tell us about when the present Volkswagen mess may present itself as an opportunity to investors….

Toyota’s Sticky Gas Pedals Issue 

In early 2014, the U.S. Government initiated a criminal probe into the safety issues that emerged following Toyota Motors‘ (NYSE:TM) recall scandal in 2009 and 2010. Toyota’s cars had an issue of “unintended acceleration” because of which the cars would accelerate on their own and not slow down. Initially, the company tried to cover up this issue by refusing to admit that there were any problems, then admitting there were only minor problems, and then blaming drivers for the accidents. Eventually, CEO Akio Toyoda came to the U.S. to testify before a congressional committee and admitted that this was a serious issue that the company would take full responsibility for.

See our complete analysis for Toyota Motors here

The company had already paid out over a billion dollars to settle a class action lawsuit related to the defects and other minor settlements for cases brought up by various state attorneys. Toyota had to pay out $1.2 billion to resolve the issue and undertake a series of measures in order to regain consumer trust. One would expect that the recalls would have damaged the company’s reputation among consumers and the subsequent deception to have made that damage far-lasting, but looking at the sales data it is difficult to come to any such conclusion.

In 2009, when the scandal emerged, Toyota sold 1.97 million vehicles in North America having produced 1.19 million units. In 2010, the company sold 1.93 million vehicles in the region, despite producing 1.4 million units. So production increased but sales decreased, but one also has to remember that this was the time when consumer confidence was at an all-time low, as the U.S. was going through its most severe financial crisis in over 70 years. In 2011, sales fell further to 1.80 million units with a production of 1.2 million units, but in 2012, both sales and production went up, with the company selling 2.28 million units and producing 1.7 million units. So, one might say that sales were affected by the news of these incidents, but the effects lasted only for two years, but it is difficult to attribute the decline entirely to the loss of consumer trust in the Toyota brand, as overall vehicle sales were also falling throughout the period due to the recession.

Similarly, it is hard to separate the company’s performance in the stock market given the macro factors and economic upheaval going on during this time.  Toyota’s stock price held in a fairly narrow range over this affected period. From the middle of 2009, with the stock in the $80 ballpark, over the next two years saw a flat to down performance, until finally, in the beginning of 2012, the stock got back to the $80 level and then performed well, gaining roughly 50%, over the following three years.

GM’s Ignition Switch Scandal

The news of the Toyota settlement with the U.S. Department of Justice emerged at around the same time as when Detroit-based auto maker General Motors (NYSE:GM) was being affected with a recall issue of its own. In the past month, it emerged that GM would only have to pay a fine of $900 million in order to settle the issue with the Government, despite the fact that around 124 deaths have been reported related to the defective ignition switches that were the cause of the recalls. The government offered to defer the prosecution if GM would accede to a list of demands. It could be that the fine was lower than what Toyota paid, because CEO Mary Barra was far more co-operative with investigators than Toyota’s leadership, and the company launched a deep inquest into its internal safety processes.

We have a $41 price estimate for General Motors, which is more than the current market price.

Of course, the company could still face further fines and has already paid more than $4 billion to get over these issues, but one wouldn’t have guessed it from its performance in the auto market. The company’s sales in the U.S. increased from 2.6 million units in 2012, to 2.79 million units in 2013, and 2.93 million units in 2014.  In 2015, year to date sales have increased by 3.2% compared to 2014, with retail sales, which fetch higher margins, up by 6%.

GM’s stock performance has been flat to down over the past year and a half, and despite bouncing in a $30 to $40 range over that time, it is currently at the lower end of that range.  The stock went from around $40 to $35 leading up to the first recall news in February 2014, and despite time going by, the stock has not made any progress since the beginning of this period, and in the past few months has actually gone lower than when the original news hit took place.  So, in this case, a “buying opportunity” did not occur.  Unless, of course, it is still “under a cloud” and the recent settlement news can finally put these events behind the company.

Which, one might argue, is what has happened. This was not a one piece of news story. From the original recall news in February 2014 that 800,000 cars were being recalled, to news in March of another 1.5 million vehicles of additional types being recalled, bringing the total number recalled to 6 million through March. Then another 2.7 million more in May, bringing the total to over 12 million worldwide. Then in  mid-June news that another 3.4 million cars made between 2000 and 2004 would be recalled, then the end of the same month it was announced another 8.4 million more recalls due to faulty ignition switches. By the end of the year over 27 million cars had been recalled for different types of problems, with over 10 million for the defective ignition switch. [1]  So the continual stream of bad news over the year may have caused a stagnant investment situation.

BP Oil Spill Mishap

In April 2010, the world witnessed the largest marine oil tragedy in the history of the petroleum industry, when the Deepwater Horizon oil rig, owned by Transocean and contracted by BP Plc. (NYSE:BP), exploded and sank in the Macondo Prospect in Mississippi Canyon of the Gulf of Mexico. The disaster led to the discharge of millions of barrels of oil into the Gulf of Mexico over a period of 87 days, which had an adverse impact on the marine life, and fishing and tourism industry. On investigations, the federal court found BP guilty of using defective cement on the well and insufficient safety systems.

See Our Complete Analysis For BP

 

In November 2012, the US Department of Justice (DOJ) imposed criminal charges for 11 deaths (missing people declared died), gross negligence and misconduct, while the Environmental Protection Agency temporarily banned BP from any new contracts with the U.S. government. In July 2015, BP finally agreed to pay $18.7 billion in fines, which is the largest corporate settlement in U.S. history, and settled for four years of government monitoring of its safety practices and ethics. As of September 2014, BP had paid $13.2 billion in claims, advances, settlements, and other payments, and has spent more than $14 billion and devoted over 70 million of personnel hours in responding to the spill and cleaning the shoreline.

The company’s stock was trading at close to $60 per share before the spill, and sharply fell to around $28 per share in June 2010 and bottomed. However, it was still a bumpy ride and the stock was not that much higher, at around $36, over a year later in September 2011. And, again  eight months later in May 2012, the stock was still around the same $36, two years after the accident.  From that point onward the stock did well, rising to $53 by the end of June 2014.  After that, the price of oil peaked, and from July 2014 onward it has been all downhill for BP and most other oil related companies.

Conclusion

Volkswagen will also have to face the repercussions of fitting a software meant to cheat on emissions tests, but the question remains as to what will be the approximate dent in its pockets. Given that the German group is looking to comply with the terms and conditions of authorities, the fines could go considerably down, as in the case with GM. On the other hand, given how high profile this scandal is, and how Volkswagen is to blame for ‘conspiring’ to specially fit the software into its diesel cars, authorities might be looking to slam the company with a more ‘BP-like’ fine.

While our look at history to attempt to see if there is a specific pattern to emerge, and suggest how long a company might be in “the penalty box,” is not conclusive, the examples above suggest that often a year or two after the original event, the stock has still not bounced significantly, and an investor’s patience in waiting to invest, may be rewarded.  While those who rush to buy the drop, and jump into the water too soon, may find that there are still sharks there. Only time will tell what unfolds in the case of Volkswagen, and whether this becomes an opportunity, and when that might occur.

See the links below for more information and analysis:

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. General Motors recalls 8.4 million vehicles, CNN Money []