Death of the dirty diesel?
16 May 2017
Short sellers are buckled up for a car manufacturer crash, according to David Lewis, senior vice president at FIS Astec Analytics
Image: Shutterstock
A couple of years ago, diesel engine cars were very much the way forward. Tax incentives, cheaper fuel, advancing performance technology and higher miles per gallon all attracted buyers to fuel the boom in diesel car sales.
The tax incentives were put in place by the UK government, and others, in order to promote sales and help towards the reduction of carbon dioxide emissions. This should have been the first clue that it was a mistake. As soon as politicians back something, particularly a technology or engineering, the clock has started ticking towards an implosion of some sort. The small matter that was missed, with regards to promoting diesel engines, was the increased emissions of nasty gases, such as nitrogen oxides, which are deemed to be much more harmful to the environment than the petrol equivalents. Cue political U-turn and a re-think of all the prior incentives turning attention more to hybrid and electric vehicles. What does this mean for the automobile industry, particularly in the UK and mainland Europe where diesel has become king?
In the UK and Germany, two of the biggest car markets in Europe, sales of diesel cars dropped 27 percent and 19 percent, respectively in April. These are changes too large and fundamental to be ignored as seasonal blips. The drop in demand for new cars is also just the tip of the iceberg, or, perhaps more appropriately, the edge of the black smog cloud gathering over the car industry. As much as 90 percent of UK car sales are now undertaken using a personal contract plan of some sort. Ten years ago, this was less than 50 percent. These packages allow the user of the vehicle, note, not the owner, to pay a small deposit and monthly payments, typically over 24 or 36 months, and take delivery of a shiny new vehicle. At the end of the term, they can pay a final fee and purchase the car or hand it back, to its legal owner, the finance company, and start again.
Sounds great. But if the residual value of the vehicle is less than the final payment, the client will hand it back to the finance company, which will take the loss. With falling demand for new diesel vehicles, residual values are also being hit hard. In the US, residuals are down some 20 percent as a result of the manufacturers ratcheting up the incentives to buy new cars to restart the stalled boom they were enjoying. The same knock-on effect is likely to occur in Europe as manufacturers look to make up the hole in their order books left by the disillusioned diesel buyers.
While electric vehicles are on the rise, they are far from being capable of taking over for some time yet.The impact on the car industry should not be underestimated. While share prices have been on the rise as the European economies enjoy greater levels of demand, there is certainly a cloud on the horizon and the short sellers have been quick to take their positions in the expectation of some potentially dramatic corrections.
The big four names, BMW, Daimler Benz, Volkswagen and Peugeot are all seeing increased short selling activity, as shown in Figure 1. Volkswagen, and others by association, have, of course, had their own issues with regards to diesel emissions and the management of regulatory tests, so the 26 percent increase in the Volkswagen share price over the past six months should be taken in context. Even now, at €144, it remains more than €100 a share below its March 2015 peak. All four companies have seen a healthy share price improvement over the past 12 months, but this appears to have only made them even more attractive to the short sellers.
As Figure 1 shows, the past month has seen significant jumps in short interest, and over the past six months BMW and Daimler Benz saw levels more than triple, Peugeot an increase of over 75 percent and Volkswagen, almost 50 percent.
These major manufacturers, battling legislation and the environmental lobby, must insulate themselves against the march of the pure electric vehicles being produced by the likes of Tesla (US) and BYD Co (China), but that is not the only issue these groups face. With the rise of the personal contract plan method of buying new cars, these manufacturers have become large finance houses, and not just as a side line.
The finance arms of large car manufacturers are now big businesses. In 2016, the Volkswagen Audi Group made profits of €14.6 billion, which included the profits made by Volkswagen Financial Services of €2.1 billion. With falling residuals potentially leaving a financial time-bomb for the finance providers, which will have to take back cars worth less than the remaining finance, greater deposits and/or higher monthly rental charges will be needed, potentially squeezing the pockets of the 90 percent of people buying new cars.
While the share price performance of these companies looks attractive to the long investor, the rising share values and the potential slow motion car crash that may be just around the corner is certainly attracting those willing to take short positions against them, in the expectation of a significant correction that may be on the way. As a final thought to ponder, any interest in a 3.0 Audi A5? It’s a diesel.
Figure 1: Short interest volumes—November 2016 to May 2017
Source: FIS Astec Analytics
The tax incentives were put in place by the UK government, and others, in order to promote sales and help towards the reduction of carbon dioxide emissions. This should have been the first clue that it was a mistake. As soon as politicians back something, particularly a technology or engineering, the clock has started ticking towards an implosion of some sort. The small matter that was missed, with regards to promoting diesel engines, was the increased emissions of nasty gases, such as nitrogen oxides, which are deemed to be much more harmful to the environment than the petrol equivalents. Cue political U-turn and a re-think of all the prior incentives turning attention more to hybrid and electric vehicles. What does this mean for the automobile industry, particularly in the UK and mainland Europe where diesel has become king?
In the UK and Germany, two of the biggest car markets in Europe, sales of diesel cars dropped 27 percent and 19 percent, respectively in April. These are changes too large and fundamental to be ignored as seasonal blips. The drop in demand for new cars is also just the tip of the iceberg, or, perhaps more appropriately, the edge of the black smog cloud gathering over the car industry. As much as 90 percent of UK car sales are now undertaken using a personal contract plan of some sort. Ten years ago, this was less than 50 percent. These packages allow the user of the vehicle, note, not the owner, to pay a small deposit and monthly payments, typically over 24 or 36 months, and take delivery of a shiny new vehicle. At the end of the term, they can pay a final fee and purchase the car or hand it back, to its legal owner, the finance company, and start again.
Sounds great. But if the residual value of the vehicle is less than the final payment, the client will hand it back to the finance company, which will take the loss. With falling demand for new diesel vehicles, residual values are also being hit hard. In the US, residuals are down some 20 percent as a result of the manufacturers ratcheting up the incentives to buy new cars to restart the stalled boom they were enjoying. The same knock-on effect is likely to occur in Europe as manufacturers look to make up the hole in their order books left by the disillusioned diesel buyers.
While electric vehicles are on the rise, they are far from being capable of taking over for some time yet.The impact on the car industry should not be underestimated. While share prices have been on the rise as the European economies enjoy greater levels of demand, there is certainly a cloud on the horizon and the short sellers have been quick to take their positions in the expectation of some potentially dramatic corrections.
The big four names, BMW, Daimler Benz, Volkswagen and Peugeot are all seeing increased short selling activity, as shown in Figure 1. Volkswagen, and others by association, have, of course, had their own issues with regards to diesel emissions and the management of regulatory tests, so the 26 percent increase in the Volkswagen share price over the past six months should be taken in context. Even now, at €144, it remains more than €100 a share below its March 2015 peak. All four companies have seen a healthy share price improvement over the past 12 months, but this appears to have only made them even more attractive to the short sellers.
As Figure 1 shows, the past month has seen significant jumps in short interest, and over the past six months BMW and Daimler Benz saw levels more than triple, Peugeot an increase of over 75 percent and Volkswagen, almost 50 percent.
These major manufacturers, battling legislation and the environmental lobby, must insulate themselves against the march of the pure electric vehicles being produced by the likes of Tesla (US) and BYD Co (China), but that is not the only issue these groups face. With the rise of the personal contract plan method of buying new cars, these manufacturers have become large finance houses, and not just as a side line.
The finance arms of large car manufacturers are now big businesses. In 2016, the Volkswagen Audi Group made profits of €14.6 billion, which included the profits made by Volkswagen Financial Services of €2.1 billion. With falling residuals potentially leaving a financial time-bomb for the finance providers, which will have to take back cars worth less than the remaining finance, greater deposits and/or higher monthly rental charges will be needed, potentially squeezing the pockets of the 90 percent of people buying new cars.
While the share price performance of these companies looks attractive to the long investor, the rising share values and the potential slow motion car crash that may be just around the corner is certainly attracting those willing to take short positions against them, in the expectation of a significant correction that may be on the way. As a final thought to ponder, any interest in a 3.0 Audi A5? It’s a diesel.
Figure 1: Short interest volumes—November 2016 to May 2017
Source: FIS Astec Analytics
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