We have a little more Volkswagen (DE:VOWG) info as a follow-up from our trip to Europe.
First, let me summarize our investment view. We don’t like VW and would not own it if we were in the single-stock-risk business. We do own VW where it is a part of larger and broader ETFs. We think that there is risk that VW will incur credit rating deterioration. And there is the developing potential of fines and other penalties and costs, which we think will rise. They may become substantial. The initial reserves announced by VW are likely to be increased. We are still in the very early stages of revelations about this scandal and its impact.
What About A Bailout?
We have also encountered opinions that VW is too big to fail. We agree with that conclusion. That means a bailout of some type may be required if VW suffers sufficient financial damage. Though most of our conversations in and about Europe were private, we are able to quote Derek Riley with his permission. Derek has a distinguished career that includes the role of chief economist of a major oil company and Director of the Conference Board’s European Council of Economists.
“I expect some more reductions in the auto and parts sector’s market capitalizations,” says Derek. He continues,
All the assemblers have been cheating the system one way or another and the backfire is only just beginning to hit. In France, we have a system of bonus and malus on new cars according to their ‘supposed’ pollution of the various gases and particulates. As I said before, these get one notch tighter in 2017. Well, with biased (in favour of the manufacturers) testing procedures called into question + cheating revelations, we are going to see a revamping of the bonus/malus incentives, which are now substantial, i.e. have a lot of influence on buyers’ decisions. Not many US cars here, simply because big engines are automatically high polluters, even though gasoline fueled. These impending changes are bound to affect market shares. While not an engineer by training, I’m ready to bet that VW and its variously named model range will not be able to come up with a fuel-efficient, high-performing, low-fuel-consumption combination in the near-term, notably for diesel engines with the 18 million recalls. It may not be the German federal government that steps in to bail out VW. Remember that the key shareholders are Porsche (32%) and the Land (State) of Lower Saxony (13%). In terms of voting rights, Porsche has an absolute majority, while Lower Saxony has 20%, with Qatar not far behind. Let them roast, many may be inclined to say. To be sure, VW is too big to fail, so when the share price is exaggeratedly low enough, it will become a good buy. Just as Chrysler and Peugeot did. Patience and stalking is the name of the game for investors now.
We thank Derek for permission to share his view with readers.
Paul Horne, formerly the European eyes and ears of Smith Barney and a GIC board member colleague, offered a broader view:
“As an otherwise happy owner of a VW Jetta Sportwagen diesel,” Paul wonders “what Obama has to do with the penalties to be inflicted on VW”:
It seems to me that [the matter of penalties] is an issue for the EPA and Justice Department to decide. From the eagle’s point of view, Obama needs to stay on good terms with Merkel & Co. because Germany is the most important country in Europe, hence our no. 2, possibly no. 1 interlocutor, and because they are going to have to cooperate to make the Climate Change Conference in Paris succeed. As for who knew what when, how could they not have known? But we were all very happy with the low sulphur emissions and great mileage. Who the hell knew how NOXious they were? But I’m reasonably sure that my Jetta Emissions-wagen probably pollutes less than the Expedition, the Suburban, or the Escalade. The question of who tests emissions and fuel consumption is just as corrupt in the US as it is in Europe but done differently. So viva la différence. Basically, the entire industry ought to be suspect. The “light touch” once again proves to be illusory from a supervisory point of view. It’s those “smartest guys in the room” still hard at work.
Here is a research paper on NOx. It was forwarded in a private email chat, so I will keep the sender anonymous. The text speaks for itself. Until VW’s scandal, NOx had achieved little notoriety. In Europe, that has changed.
German Resistance Is Futile
Volkswagen's plight has an indirect but substantial likelihood of adding to monetary stimulus. Now, some may say that's really an overreach. And I admit, it may seem so at first glance.
But we reach that view because the VW affair is adding to economic negatives in Europe and especially in Germany. As Germany evolves in this VW-induced process, German resistance to more ECB stimulus is likely to soften. It certainly will not harden further. And if there is financing needed for either bailout or capital expenditure as a result of the scandal, the cost of that borrowing is likely to be near zero. So, VW leads to a higher probability that ECB stimulus will be extended and negative-rate policy continued for an extended period.
In some conversations in Europe we heard informal forecasts of negative rates for the rest of the decade. We are inclined to think that prediction may come to pass.
David R. Kotok, Chairman and Chief Investment Officer.