Volkswagen's 2016 Passat. Image source: Volkswagen Group.
It's been a wild ride during the first two months after news broke of Volkswagen Group's (VWAGY -0.17%) diesel emissions scandal. Executives have been tossed to the wayside, vehicle inventory at VW dealerships has hit a 12-month low, consumers aren't happy with Volkswagen's goodwill offer of cash -- basically, there's enough drama to create a great recipe for the next season of Big Brother.
This is certainly shaping up to be a very costly mistake for Volkswagen and its investors, but how much did it ding its third-quarter results, and is it a strain on the company's cash pile? A recent development suggests that it might be.
Costliest mistake ever?
Just about everyone remembers General Motors' (GM -0.47%) massive recall last year that covered more than 30 million vehicles globally and cost Detroit's largest automaker more than $4 billion in total before it was all said and done. Many investors may also remember that GM set aside hundreds of millions for victim compensation, set aside even more cash for future recalls, and payed a hefty fine to the Department of Justice. The most significant expense for General Motors' recall, however, was the cost to repair the vehicles on the road that had the defect. That's the reason Volkswagen's diesel emissions scandal will be more costly than even GM's batch of recalled vehicles.
While Volkswagen's worldwide repair of roughly 11 million diesel vehicles isn't nearly the volume of vehicles GM's recall covered, it's going to be much more expensive because GM's ignition switch defect was more simple to repair while Volkswagen will be required to install parts for vehicles on the road that weren't designed for the equipment, and it could require special tools and/or shops to complete.
"I can't think of any other recall that would be as comprehensive," said Jake Fisher, director of automotive testing at Consumer Reports magazine, according to Bloomberg. "It's really an expensive rework."
In addition to the recall repair costs themselves, Volkswagen of America is offering $1,000 via a gift card for 2.0-liter diesel vehicle owners -- and many consumers hit the social media waves expressing dissatisfaction at the amount offered. The total direct cost for Volkswagen's scandal is going to be huge, and that doesn't measure the potential backlash from lost sales and a battered brand image.
Back to direct costs, here's a good look at exactly how it affected Volkswagen's third quarter, when it took the first round of special charges -- though it's not likely to be the last round .
Image source: Volkswagen Group's Q3 interim report.
You can immediately see the large impact of its 6.6 billion euros in special items, almost all of which was set aside for the diesel scandal costs, but that isn't likely to be the final cost. In fact, Stanford C. Bernstein analysts believe that the cost will amount to at least 10 billion euros this year and an additional 5 billion next year. Barclays recently posted an estimate that was even more dire, expecting the cost to reach roughly 25 billion euros.
Is Volkswagen feeling the financial strain?
Volkswagen is taking necessary steps to ensure it can take a big financial hit. The automaker is cutting its annual investment in its namesake brand by about 1 billion euros and delaying nonessential projects. Volkswagen also sold shares it owned in Suzuki Motor Corp. for roughly 3.4 billion euros.
There is no question that the costs of this scandal will be enormous, but fortunately for investors, Volkswagen does have a substantial cash pile. As of the third quarter, Volkswagen's automotive division had cash and cash equivalents of 19.2 billion euros, and the automaker's net liquidity sits at more than 27 billion euros at the end of September.
Furthermore, beyond its pile of cash, Volkswagen is working with banks to put together roughly 20 billion euros in short-term financing to ensure investors and creditors that it has an ample financial cushion during the scandal fallout.
The takeaway for investors here is that this may end up being one of the costliest mistakes in the automotive industry's history, but Volkswagen can indeed survive and has the cash and financing to do so. The question facing investors is: How long will the pain last before Volkswagen can repair its image and convince consumers to buy its vehicles again? The simple answer is that we unfortunately have no idea, and investors looking for a potential value play with shares of Volkswagen -- whose stock is trading at a 35% discount since the scandal broke -- would be wise to sit on the sidelines while this plays out.
