Decades ago I bought my first German automobile, a Mercedes Benz. Since then, I appreciated the quality of German workmanship and had owned BMWs and an Audi, and over the past six years, I have become a fan of Volkswagen's (OTCPK:VLKAF) products. When I moved to Las Vegas in 2012, I bought a small EOS hardtop convertible that was an excellent car that offered both performance and value. When I heard that the company was ending production of the EOS, I quickly traded my three-year-old EOS for a new model in the final year of its availability.
The time came for a bigger car, one I could fill with weekly goodies from Costco, and I exchanged the little zippy EOS for a Tiguan, the small SUV offered by the company. The three VWs I have driven over the past six years have never given me any problems and have only been a source of enjoyment. Even when VW's reputation was at its nadir a few years ago over the emissions scandal, I have found the company's product meet my requirements and sales and service were superior to other dealerships in my experience. VW has gone through a tough time, but it seems they are emerging stronger than ever in the U.S. market.
The emissions scandal is in the company's rearview mirror
The scandal came to light in September 2015. The U.S. EPA issued a notice of violation of the Clean Air Act to Volkswagen Group. The agency accused VW of intentionally programming turbocharged direct injection diesel engines to activate their emissions controls only during laboratory testing which caused emissions to meet U.S. standards. However, in real-world driving, the car's emissions turned out to be forty times higher. VW deployed the programming software in eleven million cars worldwide, of which 500,000 were in the U.S. in model years from 2009-2015.
As the chart shows, the price of Volkswagen shares dropped from highs of $264.05 in late April 2015 to lows of $113 in late September of that year as the scandal caused the stock to more than halve in value.
Since the low, VLKAF consolidated between just above the $120 level and $162.30 per share until early 2017. In April 2017, a U.S. Federal court judge ordered Volkswagen "to pay a $2.8 billion criminal fine for rigging diesel-powered vehicles to cheat on government emissions tests." The deal was a plea that put the scandal behind the company when it came to U.S. government prosecution for the misdeeds of the company.
All the while, VLKAF stock continued to make a series of higher lows, and it broke out of its consolidation range in late 2017 and traded above the $200 per share level last December for the first time since 2015. Since then, VLKAF reached a high of $232.45 in late January when the stock market was on the highs, but over recent weeks the shares dropped back to the $200 level.
Bondholder lawsuit dismissed, but others pending
Late last week, a U.S. judge dismissed a civil lawsuit filed by institutional investors who had purchased bonds from Volkswagen AG's U.S. unit. The plaintiffs said the automaker made false and misleading statements before the emissions scandal became public in 2015. Investors had purchased $8.3 billion in dollar-denominated bonds that Volkswagen Group of America Finance LLC sold in 2014 and 2015.
Meanwhile, the company still faces lots of suits totaling around $11 billion in claims from damages around the world. Approximately 1,600 lawsuits are pending at a regional court in Braunschweig near the company's headquarters in Germany. Most of the litigation is seeking damages because of the sharp fall in the value of VW shares following the scandal.
VLKAF offers value in its products, and it is reflected in their share price
In the aftermath of the scandal, VW agreed to spend more than $25 billion in the U.S, to address all claims from owners, environmental regulators, states, and dealers and offered to repurchase all 500,000 of the polluting vehicles.
Meanwhile, the company's shares have made a comeback since the scandal, and their products have been doing well once again in the U.S. market. In February, VW sales in the U.S. increased by 6%. For the 2018 model year, most new Volkswagen vehicles in the U.S. will come with the company's People First Warranty, a six-year or 72,000 miles bumper-to-bumper New Vehicle Limited Warranty which can be transferred to subsequent owners throughout its duration. When it comes to German cars, VW's price point is lower than Mercedes, BMW, and Audi. I can attest that the equality of the cars, in my experience, has been for the most part excellent.
Tariffs and car companies present challenges
It is likely that the recent drop in the price of VLKAF shares has been the result of two issues. Frist, the overall correction in the stock market has taken most equity prices lower. VLKAF has dropped from a high of $232.45 on January 22 to recent lows of $190.40 on March 5. On March 7, the shares were at the $198.20 level. The second issue comes from the potential for tariffs on foreign products imported into the United States. While VW owns a plant in the U.S., some of their cars come from abroad, and a trade war could put a hefty price tag on some of the company's products. Moreover, 25% tariffs on steel and 10% on aluminum could increase costs for the company on the automobiles manufactured in the United States. VW will not be alone when it comes to the impact of tariffs on the two metals that are requirements for car production, U.S. automobile manufacturers would also face increasing production costs.
I believe that the President's announcement of tariffs last week is likely a bluff to posture for better trade deals with countries around the world. While the announcement came last Friday, President Trump has not yet signed any executive orders putting the tariffs in place. As I wrote in an article on Seeking Alpha earlier this week, there is likely lots of horse trading going on behind the scenes as even members of the administration have issues with the President's proposed tariffs which amount to a new tax.
Platinum and palladium in cat converters
As a commodities trader, it is impossible for me not to address the raw materials angle on any investment. As a car manufacturer, VW is a significant consumer of the commodities required to build cars. Steel and aluminum are essentials for the body, but when it comes to the part of the car that gave rise to the scandal in the first place, platinum and palladium are the metals with high resistance to heat that are requirements for the production of catalytic converters.
Diesel-powered cars tend to use platinum in their converters that clean the poisons from the car. Gasoline-powered cars tend to use palladium. Car manufacturers have favored palladium because of its historical price relationship with platinum. While both precious metals can clean emissions, automobile manufacturers have become addicted to palladium because it has typically been a lot less expensive than platinum. However, that changed in September 2017.
As the monthly chart highlights, the price of platinum has spent the vast majority of time above the price of palladium dating back to 1982. In 2008, an ounce of platinum was $1600 more than an ounce of palladium, and it traded at over a $500 premium from 2003 through 2014. In late 2017, a rally in palladium caused the metal to rise above platinum, and in December it rose to an almost $150 premium to the price of platinum. Over recent months, platinum has appreciated against palladium and was only trading at a $13 discount on March 7.
Platinum is a denser metal and has a higher resistance to heat, but car manufacturers have used palladium in their catalytic converters over past decades because of the historical price relationship between the two metals. It is likely that some consumers have begun to replace palladium with platinum given the recent price action in the two metals. When it comes to VW, those diesel vehicles that caused all the problems likely have platinum-based converters. After paying all of those fines, repairing cars, and paying off a myriad of lawsuits the company is likely to be a model corporate citizen. It is possible that VW is using more platinum than palladium these days given the price action in the two metals.
When it comes to VLKAF, sales and prospects for the company have improved dramatically over recent months. The P/E at 11.85 times earnings makes it a little pricey when compared to some of the other car manufacturers. However, I believe these shares are a buy below the $200 level and that we will eventually see they recover to the pre-scandal level at $250 or higher.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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