Volkswagen Accused by EPA of Manipulating Diesel Emission Tests

Lowering Fair Value to EUR 210

Richard Hilgert 21.09.2015 | 14.21
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Opprinnelig publisert 21.9.2015.

We have lowered our fair value estimate to EUR 210 from EUR 230. The decrease is as a result of the potential Environmental Protection Agency, or EPA, and California Air Resources Board, or CARB, fines and probable court litigation that may result from alleged manipulation of diesel engine emission testing for regulatory requirements in the U.S. Even though some media reports have speculated that the EPA fine could be as much as $18 billion, we have reserved $9 billion in our DCF model for fines and litigation. We think that any weakness in the shares of Volkswagen stock should be viewed as an opportunity for long term investors to own the shares at discounted prices. Prior to the circulation of media reports about the EPA and CARB accusations, the stock was already trading at a 23% discount relative to our new EUR 210 fair value estimate.

At this point, there is no additional information from Volkswagen regarding the accusations. CEO Martin Winterkorn put out a statement over the weekend stating how seriously the Board of Management is taking the matter and expressed deep sorrow for breaking the trust of its customers. He also said that the company was cooperating fully with the respective agencies' investigations. While we applaud the company for quickly making a public response to the matter, we also recognize the standard corporate nature of the language in the press release. In our view, if there is any truth to the allegations, it is highly unlikely that Volkswagen executive leadership had any knowledge of emission testing manipulation.

Media reports speculated an $18 billion EPA fine owing to comments from the EPA and CARB which said that under federal law, in theory, Volkswagen could face fines up to $37,500 per vehicle. The agencies accused the company of deliberately manipulating through software algorithms in roughly 428,000 diesel equipped vehicles, the activation of anti-pollution controls during emissions tests only. If a vehicle were to algorithmically deactivate anti-pollution controls in normal driving conditions, diesel particulate and nitrous-oxide emissions would go up while engine power and fuel economy would increase.

The fines from the BP Deepwater Horizon Gulf oil spill could have been as high as $13.7 billion but were established at $5.5 billion, excluding court settlements. The Toyota deferred prosecution settlement for sudden acceleration was $1.2 billion. Even though the GM ignition switch case has not yet been fully completed, so far, the company has reached a deferred prosecution agreement whereby the company will pay $900 million. The GM victims' fund is expected to pay out approximately $600-$700 million. Morningstar analyst David Whiston has reserved $7 billion for ignition fines and litigation in our GM DCF valuation model. So long as Volkswagen adheres to the terms of any agreement reached, the respective government agencies could settle for a predefined sum and defer any prosecution.

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Richard Hilgert  Richard Hilgert is a securities analyst on the Industrials Team.

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