How will the VW emissions scandal impact the auto industry?

  • VW uses software to disguise car emissions during testing
  • VW violates the Clean Air Act
  • VW shares fall around 35%, fines loom
  • Scrutiny falls on wider industry
  • Is there any future for diesel in the US?

The story so far...

Over the weekend news broke that the US Environmental Protection Agency (EPA) had issued a notice of violation of the Clean Air Act to Volkswagen Group.

In simple terms it emerged that a number of VW diesel engines include software which has enabled cars to enhance their emissions performance during tests between 2009 and 2015.

Bluntly this software appears to represent a sophisticated and calculated tool designed to defeat EPA regulations.

VW has subsequently admitted the issue, which could impact 11 million cars, and announced they will set aside €6.5 billion to cover compensation costs.

Bluntly this software appears to represent a sophisticated and calculated tool designed to defeat EPA regulations and its use appears widespread within Volkswagen across a number of brands.

What are the implications for VW shares?

The negative reaction of the shares has been rapid and sizeable with VW losing c.35% of its market capitalisation in two days, as the market has struggled to quantify the near term cost of recalls and potential fines, and the longer term impact on the VW brand.

Investors can run any number of scenarios around the size of fines looking at historical precedents etc, but assigning accurate probabilities to those outcomes is almost impossible and investors have quickly moved to price in worst case scenario fines.

Fines are only part of the equation, the market is grappling with the potential cost of:

  • Class action lawsuits
  • Increased research & development to meet emission requirements
  • The reputational impact on volumes all add complexity to the issue

Sadly legal issues are not new to the auto industry and if we look at history it would indicate that they cast a long shadow over share price performance.

Whether we look at Toyota or Porsche closer to home, underperformance tends to persist for years not days, partly because legal issues take years not days to resolve.

This would appear to be the death knell of diesel in the US.

Stepping away from the near term financial impact the existence and widespread use of this illegal software across the VW group is indicative of very poor corporate governance within the company, and this is a difficult and slow trait to change and leaves you wondering what else is lurking.

What are the implications for the car industry?

The wider automotive sector has also underperformed the market in recent days, with the main worries relating to the spillover into the European market, the future of diesel for the industry and the outlook for car sales in general.

This would appear to be the death knell of diesel in the US, which sounds dramatic but remember it only represents approximately 1% of the US market.

The implications for the diesel market outside the US are complicated by differing regulatory environments and the importance of the OEMs (original equipment manufacturers) as employers within European countries.

However, with stricter emission controls in Europe likely, diesel is rapidly becoming uneconomic for consumers and manufacturers alike.

As discussed above, sadly scandals of this type are not new to the automotive industry and its long term impact on volumes and demand is likely to be limited in our opinion.

The sectors and securities mentioned above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.