Auto Shares Rally as Volkswagen Prepares $10 Billion Diesel Settlement

Investors cheered by news that Volkswagen hopes to finalise compensation offered to US car owners and authorities

Karen Kwok 21 June, 2016 | 11:23AM
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Shares in Volkswagen (VOW3) posted sharp gains on Monday, rising by 5.5%, after the beleaguered car manufacturer was reported to be making progress on a $10 billion settlement in the US, after it admitted cheating on diesel emission tests last year.

This settlement – expected by the end of this month - could see it fix half a million emission-cheating cars, or get them off US roads, even though the regulators have yet to approve the proposed ‘fixes’.

Citing unnamed sources, Bloomberg said it has learned that Volkswagen, Europe’s largest automotive manufacturer, plans to set aside $6.5 billion to cover compensation for car owners and $3.5 billion for the US government and California regulators. Part of the deal also includes an option for car owners to request their vehicles be repaired, however that would not guarantee an approved fix, according to same sources.

Lawyers for Volkswagen are due to submit the proposed deal to the San Francisco federal judge overseeing US lawsuits by June 28.

In September 2015, Volkswagen admitted that it was cheating in emission tests by making its cars appear far less polluting than they were, affecting 11 million diesel-engine cars worldwide.

The scandal has cast a shadow over the whole market for diesel cars. German car giant Daimler also started an internal investigation into emission testing in April this year.

Volkswagen is scheduled to meet its shareholders at its annual meeting on 22 June. The meeting is expected to be dominated by discussion of this emission scandal and subsequent compensation claims.

Global Auto Shares Up

Volkswagen isn’t the only car manufacture to post gains on Monday, following this news. While Volkswagen gained 5.5% to 124.75p at the closing time on Monday, Daimler (DAI) shares were up 4.5% - to 58.35p. Shares of Bayerische Motoren Werke (BMW) increased 4.7% to 72.34p, Renault (RNO) gained 3.5% to 78.87p, and Peugeot (UG) gained 4.2% to 13.7p.

Volkswagen Scandal a Buying Opportunity for Long-Term Investors

This emissions-scandal, which emerged nine months ago has caused shares in many car manufacturers to tumble. This follows uncertainty among investors about what the final compensation costs may be, but this could create a buying opportunity for some investors. Shares in Volkswagen are currently trading at a discount, according to Morningstar analyst Richard Hilgert. Therefore he rated the stock as an undervalued stock with a four-star rating.

The risk that the company is constantly making news headlines – for the wrong reasons – creates near-term stock price volatility, Hilgert said. However, this creates an opportunity for long-term investors willing to accept higher risk, he added.

He is confident with the degree of financial flexibility Volkswagen has to deal with the inevitable fines and compensation - provided there are no additional surprises from the emission scandal.

“With an enviable portfolio of brands, a bevy of new and redesigned model introductions, and leading shares in many of the world's markets, as well as a healthy pile of cash, we think Volkswagen is well buffered to endure potentially substantial fines and judgements,” Hilgert said.

Volkswagen’s global automotive strategy also successfully reduces the company's dependence on domestic volume by diversifying geographical and profitable operations.  A broad array of brands, serving multiple segments, reduces reliance on any one vehicle category, according to Hilgert.

Recovering European Auto Demand Improves Dividend Payouts

European auto demand is in recovery, therefore Hilgert expects Daimler, the owner of the Mercedes-Benz brand, to average relatively higher free cash flow over our five-year explicit forecast period, which should support an improvement in dividend payouts to shareholders.

Another automotive manufacturer BMW also benefits from the recovery of demand in Europe, offsetting weak demand in some developing markets. Owing to an ingrained culture that obsesses over the details that the company's customers demand, Hilgert thinks BMW will continue to successfully manage its brand images, ranging from premium-priced BMW motorcycles and Mini Cooper passenger cars, to luxury BMW passenger cars and ultra-luxury of its Rolls-Royce brand. This should lead to economic value creation for investors, he said.

Investors are paid a small dividend, which Morningstar analysts think is likely to increase, given the company's solid cash flow and dividend payout history.

Both stocks are currently trading a discount, rating as undervalued stocks by Morningstar analysts with a four-star rating.

Nicolas Walewski, manager of Silver Rated Alken European Opportunities and Bronze Rated Alken Absolute Return Europe funds says that the automotive sector has been one of the poorest performers in Europe this year; however he said he believes the industry offers “compelling value” for investors.

He said the industry could benefit from a rally in oil prices, renewed innovation which has seen significant increases in R&D – and a more global approach: “The market is currently fixated on the environment for US manufacturers, investors need to realise the auto market is not just the US – it is global. The US constitutes 18 million cars, out of a global market of about 73 million.”

He added: “It is true volumes in the US have probably peaked. this landscape may not be positive for a US-dominant manufacturer such as Ford (F), this is a strong tailwind for the likes of Peugeot and Renault, as well as major automotive supplier Valeo (FR).”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Alken Absolute Return Europe A136.09 EUR-0.39Rating
Alken European Opportunities R297.05 EUR-1.03Rating
Bayerische Motoren Werke AG79.98 EUR0.00Rating
Daimler AG62.88 EUR0.00Rating
Ford Motor Co14.56 USD0.00Rating
Renault SA24.15 EUR0.00Rating
Valeo SA17.56 EUR0.00
Volkswagen AG150.20 EUR0.00Rating

About Author

Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk