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Volkswagen Tumbles Again As Emissions Scandal Deepens, Gas Engines Dragged In: Wall Street's Reaction

The thing about sweeping corporate scandals is that once you start finding out where all the bodies are buried you usually discover that whatever event or revelation served as the impetus for the investigation was in fact just the tip of the proverbial iceberg. 

Indeed, it now looks as though that assessment will certainly apply to the Volkswagen emissions scandal because as it turns out, in addition to software installed on some 11 million diesel vehicles designed to game nitrogen oxide tests, Germany’s largest carmaker has also been habitually understating CO2 output on around 800,000 cars sold in Europe.

As Bloomberg reports, the company found “unexplained inconsistencies” while conducting an internal probe related to carbon-dioxide output.

For the first time, gasoline engines are also said to be affected. 

"VW is leaving us all speechless," Evercore ISI’s Arndt Ellinghorst said. "It seems to us that this is another issue triggered by VW's internal investigation and potentially related to Europe."

It “seems” that way to us as well. Meanwhile, the company is fighting allegations by the EPA that some SUVs sold in the US are also equipped with questionable “software.” From Reuters

U.S. environmental regulators said on Monday that similar "defeat devices" were installed on larger 3.0 litre engines used in luxury sport utility vehicles from Porsche and Audi, although VW has denied those allegations.

 

Porsche's North American unit said it was discontinuing sales of Porsche Cayenne diesel sport utility vehicles until further notice, citing the allegations.

And from BofAML:

The EPA issued a second notice of violation of the Clean Air Act to VW, potentially increasing the fines the company is liable for. Under the Clean Air Act, the EPA can fine a car manufacturer up to $37,500 per vehicle for violations. The EPA held a press conference yesterday to announce the results. The EPA (along with counterparts in California and Canada) found that, when the defeat device was deactivated, total emissions of nitrogen oxide were up to nine times the amount permitted. Since the VW diesel scandal broke in September, the EPA has been testing all the new diesel models available in the US. So far, only VW has been implicated. 

Finally, from Bloomberg:

The 3.0-liter diesel motors targeted on Monday by the EPA probe aren’t part of the latest company finding. Volkswagen rejected allegations that its cheating on diesel-emissions tests included the Porsche Cayenne and VW Touareg sport utility vehicles and as well as larger sedans and the Q5 SUV from Audi, setting up a showdown with the regulator.

 

“You’re fighting against the biggest regulator in the world,” Arndt Ellinghorst, a London-based analyst in Evercore ISI, said on Bloomberg TV. “This can get pretty ugly.”

Yes it sure can. And speaking of ugly, here’s a look at the reaction in VW shares:

As far as the new findings regarding CO2 emissions are concerned, the company said the issue could add some €2 billion to the nearly €7 billion already earmarked for vehicle "repairs." Here's a peak at the sellside reactions: 

  • Exane BNP Paribas (neutral, PT EU116)
    • Adding EU4b in VW recall/compensation costs for the latest 800k cars to previous est. EU12b costs
    • Reducing 2016 EPS by 10%, may affect customer behavior more than diesel engine recall
    • See potential ramifications across sector; sees CO2 risks greatest at Daimler and least at Renault
    • Tire makers may be safest place in sector
  • JPMorgan (neutral)
    • Latest news brings total provisioning to EU8.7b, JPM est. total liability now EU13.2b including legal claims
    • Co. leaving “no stone unturned,” has EU27.8b net cash to face crisis
  • Credit Suisse (underperform)
    • New EU2b provision implies cost of EU2,500/car for gasoline engine vehicles affected vs EU609/car for diesels
    • “Key question” remains whether there will be other disclosures
    • See VW’s credibility deteriorating; uncertainty not priced in
  • UBS (buy)
    • Will add to pressure on VW shares and concern about costs and governance
    • Reiterates investment case; sees EU32b negative value after EU35b in total fixing and litigation costs, co can cope with those costs over 5+ yrs without raising capital

So yeah, bad news all around. Barclays is also out with a bit of commentary on the near-term implications: 

According to Automotive News Europe, the models affected are VW, Seat and Skoda vehicles that use 1.4-, 1.6- and 2.0-liter diesels built in 2012 and later. These so far include VW Golf, Polo, Passat, Audi A1 and A3, Seat Ibiza and Skoda Octavia models. VW's 1.4-liter ACT gasoline engine in the Polo that has cylinder on demand technology is also affected. The issue of potentially false CO2 levels mainly affects Europe, the biggest market for diesel cars, where a model's carbon emissions are always communicated to consumers. 

 

We believe that this latest development increases the risk of a downgrade at Moody’s (A2 negative) given that the agency only changed the outlook from stable to negative so far. Fitch (A Watch negative) could also decide to act on its negative watch and cut by one notch and keep the company on watch negative, as S&P did in October 2015 (A- Watch negative). 

 

As for the longer-term implications, just about the last thing Germany needs is for its exports to be crippled by the demise of the largest player in the country's proud auto industry just as demand from China collapses. On that note, we remind you that the surest sign of a problem is when officials and policymakers start telling the public there's no problem and with that, we close with comments out today from German Economy Minister Sigmar Gabriel:

"I’m firmly convinced, with more than 100 years of experience in quality from the ‘Made in Germany’ label in industrial production, that this problem will be overcome. I’m very certain that this won’t mean sustained damage to German industry."

 

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