Volkswagen: the scandal explained

On Sunday 20th of September, the world’ second largest carmaker Volkswagen admitted cheating diesel emissions tests in the US: indeed, according to the Environmental Protection Agency (EPA), several cars sold in America were equipped with software in diesel engines that could detect if tests on the implicated vehicles were being run, adjusting gas emission accordingly to respect the legal restrictions.

The result was the emission of nitrogen oxide pollutant in a quantity 40 times above the US tolerated limit. With VW recalling roughly 482,000 cars in the US alone (on Thursday the group affirmed that the number of cars involved worldwide may dramatically rise up to 11 million units), it has set aside $6.5 billion to cover costs.

The EPA may fine the German giant up to a maximum sum of $18 billion ($ 37,500 per each vehicle that breaches the requirements). In addition, legal actions from consumers and shareholders may follow and there is speculation that the US Justice Department will launch a criminal probe. However, the issues for the Wolfsburg headquartered group might not be limited to the US market only. Indeed, other countries including Italy, France and South Korea are opening investigations as well. Throughout the world, politicians, regulators and environmental groups are questioning the legitimacy of the VW’s emissions testing. France’s finance minister Michel Sapin, for instance, stated that a “Europe-wide probe” is necessary in order to reassure the public. According to main analysts, this concern might become incredibly more severe in case further “defeat devices” were found in other European diesel vehicles, as Europe itself is the largest market for Volkswagen Group with half of the sales represented by diesel cars compared to the tiny 1% in the United States. On the other hand, this event seems not to be considered likely by the UK Trade

Body for the car industry, which reported: “The EU operates a fundamentally different system to the US, with all European tests being performed in strict conditions as required by EU law and witnessed by a government-appointed independent approval agency.” Then it added: “The industry acknowledges that the current test method is outdated and is seeking agreement from the European Commission for a new emissions test that embraces new testing technologies and is more representative of on-road conditions“, opening for the improvement in the test cycle, as suggested also by the financial research firm Bernstein. Undoubtedly, the twelve-firm group is going to face harsh times.

Obviously, there have been different reactions to the scandal. From a chronological point of view, the CEO Martin Winterkorn resigned from his position in the evening of Wednesday (Porsche CEO Müller was appointed as his successor on Monday 25th September). After eight years of indisputable successes, Winterkorn, came under the excessive centralisation of his control and is subject the prevailing underlying assumption “he could not ignore”.

Chart 1: VW’ stock performance on Monday 22th September and following days, Frankfurt Stock Market, (www.boerse-frankfurt.de).

Secondly, the scandal has completely shocked Germany, a nation that is used to treating carefully environmental issues. In the central European country, a deep fear bursts that the scandal could involve, in its entirety, one of the best and wealthiest sectors of the State, with negative consequences over the employment. Concerning this fear the German Minister for the Transports, Alexander Dobrindt, has reassured the Nation saying “the scandal will not have systemic effects on the German economy”. The Frankfurt Allgemein has defined the behaviour of Volkswagen as “the most expensive act of stupidity in the market of car industry”. Literally stupid since manipulating pollution data to boost sales can only be seen as a slap in the face to customers who paid a premium for what they thought was a greener car, with a subsequent loss of brand reputation. Expensive because in few hours 14 billion euros were literally burnt in VW’s market value when the stock market opened on Monday, when the share price show a dramatic decline (up to 23%, see Chart 1) . With reference to Deutsch Bank analysis (dated 22th September), the operational business in terms of volumes, pricing and costs is the main concern. In particular, as a whole, it is believed that the group may face a dramatic downturn in terms of earnings by more than 25 percent. More specifically, it is estimated that the largest reputational damage might be over the upper-level brands such as Audi. In addition, fair price consensus has been strongly affected, with the main analysts’ recommendations switching from “Buy” or “Outperform” to a neutral “Hold” (see Table 1).

Table 1: Changes in analysts’ recommendation* after the scandal * An analyst is a financial professional who has expertise in evaluating investments and puts together “buy”, “sell” and “hold” recommendations for securities. (source: market.ft.com/research)

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