Volkswagen Looks Down the Road -- WSJ

By William Boston Features Dow Jones Newswires

Volkswagen AG, the world's biggest car maker, is returning to strong profits after CEO Matthias Müller took advantage of the company's diesel crisis to push through unpopular restructuring and cost cuts.

Continue Reading Below

But as the emissions-cheating scandal that had threatened to sink one of Germany's corporate flagships begins to fade, analysts say Mr. Müller still must work hard 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 paradoxically puts Mr. Müller in a bind. The chief executive knows he must prepare Volkswagen for the eventuality of a post-diesel world. But as it emerges from the crisis and profits rise, the company and its management lose incentive -- and leverage -- to change.

The company that makes the popular Golf and Jetta sedans reported on 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. As the scandal known as "dieselgate" unfolded, Volkswagen faced civil litigation and criminal prosecution. Its share price tanked, and still hasn't fully recovered. Sales plunged and at the end of 2015 the company posted its worst-ever annual loss.

Continue Reading Below

The financial impact of the scandal so far is just under $25 billion in fines, penalties and compensation -- and yet it now looks manageable. Volkswagen booked charges for the expected cost in 2015 and 2016. That means the legacy is reflected in its cash balance, not its bottom line, and can be paid out incrementally.

For its automotive division, Volkswagen reported net cash outflows of EUR2.6 billion 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 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 head count in the country, which includes operations for 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 efforts. 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. Using 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 Corp. 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 replace it as Europe's best-selling car in the first quarter. And sales of new diesel models across VW's brands also retreated.

Diesel's decline isn't limited to Volkswagen. Overall, diesel cars' share of 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 of this year, according to Jato Dynamics, an automotive research group. The trend could intensify after several big cities in Europe moved to ban diesel vehicles on their streets.

Some car makers have pushed diesel because it provides high performance, better mileage and lower carbon dioxide emissions than gasoline. But diesel produce NOx, a cause of smog. When VW couldn't get its "clean diesel" engines to meet U.S. emissions targets, it rigged the engines to cheat on emissions tests.

Volkswagen aims to diversify its offerings. 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 an additional EUR10 billion to develop cars that run on natural gas and make conventional engines more efficient.

But these are long-term efforts. In his presentation, Mr. Müller made it clear that diesel, with its flaws fixed and reputation repaired, would stay central to Volkswagen's strategy.

even resumed selling diesel vehicles in the U.S. In mid-April, Volkswagen dealers were offering so-called third-generation diesel vehicles that had been kept on lots after a government-ordered sales stop in the wake of the emissions scandal. So far, they have sold 3,169 diesel vehicles, leaving 11,000 still on dealer lots.

Volkswagen expects that 75% of new cars sold in 2025 will sport traditional internal-combustion engines. 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.

Write to William Boston at william.boston@wsj.com

(END) Dow Jones Newswires

May 05, 2017 02:48 ET (06:48 GMT)