For Volkswagen, the Questions — and Costs — Are Continuing to Pile Up – Motley Fool

Posted: Sunday, October 25, 2015


Volkswagen headquarters in Wolfsburg, Germany. Image source: Volkswagen.

Volkswagen (NASDAQOTH:VLKAY) said on Thursday that it is examining some versions of its latest “EA 288” diesel engines to see if they also contain software that temporarily cleans up the cars’ exhaust when it detects that a test is under way.

VW has already acknowledged that it sold 11 million vehicles with the software. Those vehicles use engines with an older design. The company has maintained that its newer engines comply with all applicable laws.

But apparently, that assertion has now also been called into question, added to the long list of questions VW is trying to answer.

Just the recalls will cost VW a fortune
Friday marked five weeks since the U.S. Environmental Protection Agency (EPA) first charged Volkswagen (NASDAQOTH:VLKAY) with cheating on emissions tests, and we still don’t know exactly what happened or why.

Apparently, neither does Volkswagen’s current management team.

The scandal has already hit VW hard. Its stock has lost about a third of its value, its CEO was forced to resign, and several key executives have been “suspended,” or put on involuntary leave, while investigations continue.

And the costs are mounting. While some of the affected cars can probably be brought into compliance with software updates, many of the vehicles containing the “defeat device” software will need significant mechanical changes in order to comply with emissions standards in the U.S. and Europe. 

The modifications aren’t simple replacements of defective parts. An entirely new system will have to be added to the cars in order to properly clean the exhaust. The modifications are expected to take several hours to complete, and they could cost VW a thousand dollars or more per car

About 482,000 diesel VW and Audi cars with the software were sold in the United States. Those will all have to be fixed. But there are also about 3 million cars in Europe that will need the mechanical upgrades, VW has said.

If there are even more cars affected, that will drive the eventual costs of this mess even higher. It’s already clear the costs will be massive.

Lawsuits, investigations, and disgruntled once-loyal owners — and dealers
Analysts are already making sharp cuts to their projections of VW’s future profits. The company has already said it will take a charge of 6.5 billion euros (about $7.3 billion) against its third-quarter earnings to cover the costs of the scandal, but it’s becoming clear that that won’t come close to covering even the near-term costs.

For starters, VW has to design, engineer, test, manufacture, and install systems that will clean up the cars that can’t be fixed with software changes alone. It is also compensating dealers who have 2016-model diesel cars in inventory that they aren’t allowed to sell. (The EPA has stopped the sale of new diesel-powered VWs until it is satisfied the company isn’t cheating.) 


Image source: Volkswagen.

VW may also have to compensate owners who bought the VW diesels because of their good performance and fuel economy. It’s likely the modifications required to bring them into compliance will hurt the vehicles’ performance or fuel economy, or both. Over 300 consumer lawsuits have already been filed against VW, according to Bloomberg. 

The costs could be long-lasting. Diesels accounted for over 20% of the VW brand’s U.S. sales before the EPA announced its charges. Many owners had been loyal VW customers for years. Their loyalty is now up for grabs. Companies like Toyota (NYSE:TM), which has an all-new Prius just now coming to market, are already making not-so-subtle appeals to disgruntled VW owners.

It’s not out of the question that VW could even be forced to buy back the cars (in the U.S., at least) at their pre-scandal blue book prices. An analysis by the Associated Press estimated the cost of a buyback of the 482,000 affected cars in the U.S. at $6.9 billion.

And remember, that’s just in the United States. There are a lot more of these cars in Europe, and elsewhere. VW is by far the biggest seller of mass-market cars in Europe, but this scandal may give rivals like Ford (NYSE:F) and General Motors (NYSE:GM) a big opening. Lost market share in its home region would be yet another lingering cost of VW’s decision to cheat on emissions tests.

When does VW’s beaten-up stock become a buy?
Between repairs, fines, litigation settlements, and lost sales, it’s already clear that this will cost VW a fortune. Estimates are still all over the map, but few are under 20 billion euros ($22 billion), and some are over 30 billion ($33 billion). 

VW can probably afford it and survive, especially if it can manage to spread the payments out over several years. The company had about 21.5 billion euros in net liquidity (cash plus credit lines, minus debt) as of the end of June, and it has moved to raise cash and cut spending since then. 

It seems clear that post-scandal VW will be a very different company from the big-spending global juggernaut it has been over the last few years. But that long list of open questions makes it hard to say whether that future VW is worth investing in now. If you’re considering a buy, I’d keep waiting until we have more answers.

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