Volkswagen's (NASDAQOTH:VLKAY) stock has fallen 29% since the day before news broke about its massive emissions test fraud, but that doesn't mean it's a buy yet.
In this industrials segment from the Industry Focus podcast, Sean O'Reilly and John Rosevear talk about why investors had doubts about the company even before the scandal, and why the current discount doesn't necessarily make the company a good investment.
A transcript follows the video.
This podcast was recorded on June 30, 2016.
Sean O'Reilly: For investors, it seems like what you're describing isn't just a cloud over Volkswagen's head. It seems like a hurricane over Volkswagen's head.
John Rosevear: Yeah, and it has been for a while. While we have some clarity about what it's going to take to settle most of the charges in the U.S., there's still a lot of uncertainty.
Let's back up a little bit. Volkswagen's American Depository Receipts -- the shares that trade here in the U.S. -- as of yesterday, they were down 29% since the day before the scandal. The thing is, they were trending down anyway even before this scandal broke, because people were concerned about VW's costs. Their cost structure is kind of crazy. VW is owned in part by the German state of Lower Saxony. They have, under German law, they have union representatives. Labor representatives have a lot of seats on their board and so forth.
O'Reilly: I remember -- Sorry to interject.
O'Reilly: I remember when the Berlin Wall came down, there was a hedge fund manager named Julian Robertson, he ran the Tiger Fund.
O'Reilly: He was all excited, and he went over to Germany, and he's like: "Oh, they're going to become capitalists and make all this money," or whatever. He toured a Volkswagen plant, and he saw the union reps, the sweet cafeteria that all the employees get, and he's like: "These people just don't get it." He didn't invest in them for the reasons that you just cited.
Anyway, sorry to interrupt!
Rosevear: Yeah. The comparison is -- you take GM (NYSE:GM), Toyota (NYSE:TM), and Volkswagen. They all, worldwide, sell about the same number of cars. Toyota's slightly ahead of VW, slightly ahead of GM, but they're all about the same size. Volkswagen has something like twice the employees that Toyota or GM does, maybe a little more. It's full employment for everybody. I believe they are Germany's largest employer, and that's a big part of their thinking. They don't want to cut costs, they don't want to cut back.
What that means is that while Volkswagen has been very profitable, at least before the costs of this scandal came up, most of that profit was coming from luxury cars. Audi and Porsche have great profit margins, like their competitors, and VW is generating a lot of money off of those. The VW brand itself was making very little money. There were some years where...
O'Reilly: Jettas are not a moneymaker.
Rosevear: Yeah. This is the bulk of their sales volume, and it's kind of breaking even. There was growing investor concern and pressure about that, like if there's a downturn, if people turn away from luxury cars. Audi has been a huge brand in China. If people step away from that, and there's been some sign that they might, what happens to Volkswagen's profit?
There were these concerns coming in even before this scandal blew up, and now, with this uncertainty hanging over it, this sort of shareholder unfriendliness of the company, the sense that it's run for their few big investors and the workers, the employees, the government, is not so much a concern for the average-guy shareholder. It's tough to make a case to buy it, even though the stock has been beaten up, and even though this settlement seems like a big step forward for them.
O'Reilly: Got it. All right. Bottom line, stay away from the shares, even though they could be a bargain.
Rosevear: Yeah. Right now, I'm still on stay away. Yeah, it's a big company selling at a good price. There are signs that the new management team is a good one, and that Volkswagen will go in a good direction from here. They're really doubling down on things like electric cars, future technology, so forth, as a way to get past this scandal, but it's also the smart move because that's where the industry is going. They have a lot of clout, and a lot of R&D power, and an opportunity to be a big player there, but the picture is still very unclear. They could get whomped with another huge settlement in some other country.
They're still looking -- The settlement in the U.S. doesn't settle the Department of Justice investigation. The possibility is that there's criminal charges still. They may have to accept outside monitoring of their engineering practices for some period of time, and that could add costs, and inhibit innovation, and so forth. It's hard to know yet. I like to recommend companies when I think there's a good story, and maybe the market hasn't seen it yet. The story here is really muddy.
O'Reilly: Got it. All right. Well, thanks for your thoughts, John!
John Rosevear owns shares of General Motors. Sean O'Reilly has no position in any stocks mentioned. The Motley Fool recommends General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.