Over the weekend of 19th September, Volkswagen was accused by America’s Environmental Protection of cheating in emission tests. It was alleged that 11 million of Volkswagen’s diesel cars are equipped with software that allows them to detect when they are undergoing emissions and switch to a cleaner running mode. Already, the saga has claimed the scalp of chief executive Martin Winterkorn who resigned shortly after.
Volkswagen has earmarked EUR6.5bn in its third quarter accounts to cover the cost of the scandals while reports mention a potential $18bn fine from regulators. Comparatively, its market capitalisation has shrunk by about EUR30.5bn since the start of the entire scandal. Prima facie, market reaction seems to be overblown, so does this present a buying opportunity for long term investors? In this regard, history may be able to provide some insights.
Salad Oil Scandal and American Express
The scandal involved the company Allied Crude Vegetable Oil in New Jersey, led by Tino De Angelis, which discovered that it could obtain loans based upon the inventory of its salad oil.
Ships apparently full of salad oil would arrive at the docks, and inspectors would confirm that the ships were indeed full of oil, allowing the company to obtain millions in loans. In reality, the ships were mostly filled with water, with only a few feet of salad oil on top. Since the oil floated on top of the water, it appeared to inspectors that these ships were loaded with oil.
Once the scandal was exposed, American Express was one of the biggest casualties as it had written warehouse receipts for millions of pounds of salad oil. Its stock dropped more than 50% as a result of the scandal, which cost the company nearly $58 million.
In the midst of it all, Warren Buffett concluded that the AmEx brand would survive as customers had not stopped using its products. He built a 5% stake in the company for $20 million which he eventually made a killing from.
Will Volkswagen be the next American Express?
As the Salad Oil Scandal tells us, the biggest consideration in entering into an investment position with Volkswagen would be whether people will continue buying Volkswagen cars.
What are the most important factors to consider when buying a car? It seems that quality (workmanship), cost of ownership (price, maintenance and fuel economy) and reliability (durability) rank highly on the list of considerations. Indeed, J.D Power has 3 classifications of car awards – Quality (breakdown or malfunction problems), Performance & Design (8 categories of vehicle performance) and Dependability (owner-reported problems). As far as Volkswagen’s regular cars are concerned, the scandal has no practical implication on a driver’s experience and I would argue that consumers will still continue buying Volkswagen cars. What is the value of trust in a brand? Charoen Pokphand Foods continues to do fine (not well, but fine) despite allegations of relying on forced labour and slavery. I believe consumers, especially when it comes to big ticket items like cars, are practical creatures. A good deal is a good deal and their wallets have no space for sentiments.
Any further downside?
That would ultimately depend on whether Volkswagen is able to clean up its act, pun intended. Already, Switzerland has moved to ban diesel cars manufactured by the Volkswagen Group.
For Volkswagen to resort to such means of deception in the first place, it has to be due to otherwise insurmountable constraint. It has been reported that the work-around came as the company was unable to meet both emission standards and cost controls for their EA189 diesel-motor models. It is entirely possible that the whole diesel division will be scrapped should they be unable to find a cost-effective solution.
I think anyone considering entering a position into Volkswagen should be mindful of its downside. I believe consumers will still buy its regular cars, as long as it continues to provide its own value. In the worst case scenario, Volkswagen loses all its diesel models and incurs a huge fine from regulators. Does this justify is EUR30.5bn drop in market capitalisation?