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Volkswagen & Ferrari : Alpine Twins In Valuation Only

Volkswagen: Alpine Twins In Valuation Only by Greenwood Investors

Summary: We’ve had a lot of back & forth with our friends and investors about the Volkswagen diesel scandal and the implications for the auto industry. As it happens, we have an engineer that specializes in cooling and controlling NOx emissions at power plants, and have done head-to-head comparisons that suggest Fiat-Chrysler is indeed telling the truth and doesn’t use devices to deceive regulators. The sell-off, which ironically has punished FCA the most (aside from VW of course), has led to an outstanding opportunity to invest in shares of FCA ahead of the important Ferrari IPO in less than a month. We believe the value of Ferrari could eclipse the total current value of FCA shares in the next year or two. Backing out the value of Ferrari, shares of FCA are just as cheap as distressed Volkswagen, yet the company sports the best CEO in the industry, is scandal-free and is catalyst-rich.

Volkswagen Cheap – For A Reason?

While it does seem shocking that the largest automaker in the world, Volkswagen, has been cheating on emissions tests for years, and quickly admitted it, we’re not surprised. The company has lied to investors in the past about assuring no capital raises, which it subsequently and quickly broke. The surprising thing to us is that it’s the middle of a gigantic spending binge of €84.2 billion on new models and technology, yet hasn’t gotten around to fixing this key four cylinder engine. We have consistently doubted Volkswagen’s management’s ability to earn any incremental return from this program, which has kept us neutral to negative on shares of the company and its management team. As it turns out, failing to invest in one of the main engines in its lineup will likely generate a negative return on a portion of this €84.2 billion. Volkswagen’s adjusted enterprise value (take-out valuation) is now just over €50 billion, and if the returns on its capital spending end up being negative, the shares are not a bargain, no matter that the EV/EBITDA is 2.1x. The EV/Capex is 3.1x, which means if management is unable to generate a positive return on this capital spending, the mismanagement will have a severely negative impact on the value of Volkswagen shares.

Thankfully, for investors, a portion of management team has already left the company, but Volkswagen will still be set back by at least five years by this scandal. Navistar International Corp (NYSE:NAV) (NAV) provides a useful example of what happens to an OEM that fails to meet the emissions requirements of environmental regulators. In 2012, the company’s gamble on keeping EGR technology (instead of the more costly SCR technology embraced by its peers) failed to meet EPA standards. The company was unable to get its engine certified. It bought market share through artificially low selling prices, which it has still been unable to recoup. NAV had to use Cummins engines as a temporary fix and is still dealing with significant warranty issues.

Three years later, the company is still struggling to take back the market share it has lost, even though commercial buyers are more forgiving and focus on total cost of ownership – a statistic on which Navistar claims it’s competitive. Now take that snafu and multiply it by several times – add in a healthy dose of deceit, and some destruction of brand and emotional value to the company, and you likely have a company still struggling to come back from this scandal in 2020. Management’s ambition to become the world’s largest automaker will require even more acquisitions or will not happen in this decade.

Ok, all of that is known now, but seriously, Volkswagen shares trade at 2.1x EBITDA as of today’s close!*

FCA Untainted

Guess what? Fiat-Chrysler trades at the exact same valuation if we back out the value of Ferrari, which is making its initial public offering in about a month. Backing out 80% of Ferrari at 12x this year’s...