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To Volkswagen Or Not To Volkswagen?

Summary

After manipulating test results for its diesel engines, Volkswagen has not yet figured out how to fix its rigged emissions software and comply with pollution regulations.

There's a lot up in the air for the potential buyers of Volkswagen's stock.

Given the extent of these uncertainties and their potential impact on the company's balance sheet, Volkswagen's stock looks uninvestable and I prefer to stay on the sidelines.

Introduction

One of Warren Buffett's best quotes is: "It takes 20 years to build a reputation and five minutes to ruin it". This is the case with Volkswagen AG (OTCQX:VLKAY) that has been caught cheating on American air pollution tests during the period of 2008-2015. Specifically, the company's gadget detects when the car is undergoing testing and switches the engine to a low-emissions mode. It then switches off this mode when the car is on the road. Under real conditions, the car spews out far higher emissions than is permitted.

Apparently, this event has tarnished the carmaker's reputation worldwide, while Volkswagen's stock dropped approximately 40% shortly after the scandal was announced, as illustrated below:

And, the million-dollar question now is: Buy, sell or stay on the sidelines until the dust settles? Will the company shine again? Are the company's shares now worth buying at $30.47 from a risk/reward perspective? Well, I am going to try to answer these questions in the next paragraphs.

The Key Facts And The Financial Impact

To date, this is a summary of the key facts and their financial impact on the company's balance sheet:

1) A few days ago, in testimony released ahead of his hearing with the House energy committee, Volkswagen America CEO Michael Horn offered a "sincere apology" over the "deeply troubling" pollution scandal and admitted he was made aware of "a possible emissions non-compliance" as early as spring 2014.

2) Last week, VW engineers admitted that they installed the deception software in 2008 in the company's cars aimed at cheating pollution tests, according to Bild am Sonntag, the largest-selling German national Sunday newspaper. Moreover, VW engineers said the EA 189 engine, developed by VW in 2005, could not have complied with pollution caps and cost targets without the deception.

3) EU's Martin Schulz stated a few days ago that Volkswagen scandal will not only be a heavy blow to the VW brand due to the admitted cheating, but also to the wider German economy, given that metal production and textiles feed into car makers. On that front, Germany's finance and economy ministers have played down the risk of a broader economic danger for Germany from the scandal.

4) According to Germany's Welt am Sonntag, Hans Dieter Poetsch, the incoming chairman of Volkswagen, admitted a few days ago at an internal company meeting at the VW headquarters in Wolfsburg that the scandal around the rigging of emissions tests is an "existence threatening" crisis.

5) The number of affected cars in the U.S. and Europe is about 500,000 and 8 million respectively. This is a fraction of the 11 million VW Group cars around the world, including Audi, Seat and Skoda that have the same equipment. The number of affected vehicles in Germany alone stands at 2.8 million while 1.2 million of its vehicles sold in the UK are fitted with the software involved.

6) As linked above, Volkswagen has outlined a €6.5 billion provision to cover any service costs for these 11 million vehicles and "other efforts" meant to restore public trust, but that amount could be amended as investigations continue.

7) The automaker could face fines of $37,500 per vehicle in the U.S., the EPA told reporters last week. With around 500,000 of its diesel vehicles sold in the U.S. since 2008, this could mean a penalty of up to $18 billion (approximately €15 billion) in the U.S. alone.

8) UBS's experts predict that the bill for legal costs, settlements with regulators, recalls to modify engines and vehicle buybacks will hit €35 billion, while Societe Generale puts the cost at €32 billion over two years.

9) In late September 2015, Suzuki sold its 1.5% stake in Volkswagen to Porsche Automobil Holding SE and recorded $304 million in special profit.

10) Fitch...


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