VW Is Back and Rolling in Cash. And That Could Be a Problem

By William Boston Features Dow Jones Newswires

Volkswagen AG, the world's biggest car maker, is returning to strong profits after CEO Matthias Müller managed to turn the diesel crisis into a rare opportunity to push through unpopular restructuring and cost cuts.

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But as the emissions-cheating scandal that once looked capable of sinking one of Germany's corporate flagships begins to fade, analysts say Mr. Müller still has plenty of work to do to wean the German car maker off diesel and prepare for tougher emissions regulation.

"The broader lesson is that VW used the crisis to do things that it couldn't do under normal circumstances and it is now stronger than it was before the scandal," said Christian Stadler, a professor of strategy at Warwick Business School.

Its strong position, however, also puts Mr. Müller in a bind. The CEO knows he must remake VW to secure its future in a post-diesel world. But as it emerges from the crisis and profits continue to rise, the company loses incentive -- and leverage -- to change.

The company that makes the best-selling Golf and Jetta sedans reported Wednesday that net profit in the first three months of the year surged 45% to EUR3.35 billion ($3.66 billion), boosted by cost cutting and higher margins at its VW brand. Adjusted operating profit, which strips out one-time items, gained 27% to EUR4.4 billion. Revenue rose 10% to EUR56.2 billion.

In September 2015 the company admitted to rigging millions of diesel cars to cheat on emissions tests, triggering the worst crisis in its nearly 80-year history.

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In the aftermath of what has come to be known as "dieselgate", Volkswagen faced civil litigation and criminal prosecution. Its share price tanked, and has still not fully recovered. Sales plunged and at the end of 2015 the company posted its worst-ever loss. The financial impact of the scandal so far is just under $25 billion in fines, penalties and compensation.

One reason this price tag now looks manageable is that Volkswagen booked the anticipated charges for the diesel scandal in 2015 and 2016. That means this legacy is now reflected in its cash balance, not profits, and can be paid out incrementally.

Volkswagen reported net cash outflows of EUR2.6 billion in the automotive division related to the diesel scandal in the first three months of this year -- essentially the cost of buying back tainted vehicles in the U.S. in January, it said it had bought back nearly half of the 475,000 affected cars. Frank Witter, the company's finance chief, said he expects diesel-related cash outflows in the "double-digit billion euro range" this year.

Nevertheless, net cash on the company's balance sheet remained strong at about EUR23.6 billion at the end of March.

The company is in the midst of cutting its expensive German workforce by 23,000, nearly 10% of its entire headcount in Germany, which includes the VW brand, Porsche and Audi. It is also streamlining development. Developers at Audi and Porsche, once jealous rivals for internal contracts, recently agreed to intensify joint development. In the company's big volume brands -- VW, Skoda and Seat -- Volkswagen is reducing the number of engines available for new models by as much as 40%.

Volkswagen also is stepping up standardization of models and sharing components between different brands. By sharing parts developed by the VW brand, Czech car maker Skoda has been increasingly profitable and Seat, the long embattled Spanish car maker, reported its first profit in years in 2016.

But diesel-related risks are still clouding the company's future.

Volkswagen surpassed arch rival Toyota Motor Co. last year to become the world's biggest car maker by sales, but in the past eight months the decline in diesel vehicle sales has accelerated.

Sales of diesel versions of the Golf, Volkswagen's biggest seller, fell 23% in March, helping Ford's Fiesta overtake the Golf as Europe's best-selling car in the first quarter. And sales of new diesel models across VW's brands also retreated.

The drop wasn't limited to Volkswagen's stable. The share of all diesel cars in new registrations in Europe dropped from 50% in August 2015, the last full month of sales before the diesel scandal hit, to 45% in March according to Jato Dynamics, an automotive research group. And things could get worse after several big cities in Europe moved to ban diesel vehicles on their streets.

Volkswagen is taking some steps to cut this reliance. At the prestigious annual Vienna Motor Symposium last week, Mr. Müller said the company would triple its investment in electric vehicles to EUR9 billion and invest another EUR10 billion to develop cars that run on natural gas.

But these steps are long-term. In his presentation, Mr. Müller made it clear that diesel, with its flaws fixed and its reputation repaired, would stay central to Volkswagen's strategy. The company, he said, would invest EUR10 billion over the next five years into making its traditional engines more efficient.

Volkswagen expects that 75% of new cars sold will still sport such engines in 2025. Automotive analysts predict that despite falling battery costs for electric vehicles and rising costs to meet emissions standards, small battery-driven vehicles won't be cheaper than their diesel equivalents until 2030.

"Even 124 years since its invention, diesel still holds the potential to become more efficient. We are going to leverage that," Mr. Müller said in Vienna.

(END) Dow Jones Newswires

May 04, 2017 05:44 ET (09:44 GMT)