Dynalect Sells Position in GM Among Emerging Emissions Scandal

On Thursday, the news broke that GM had been accused of using illegal devices in its Chevrolet Silverado and GMC Sierra trucks to cheat on nitrogen oxides (NOx) emissions tests, making it the latest automaker to be caught up in a NOx emissions scandal. According to reports, the amount of illegal pollution generated by the trucks is at least as much as that generated by Volkwagen’s cheating passenger cars before their lawsuit in 2015, a lawsuit which has resulted in enormous fines, recalls, and sales declines for VW. There’s real potential for GM to face serious consequences as this scandal unfolds, but a few key factors suggest that GM stock might not fare as poorly as that of VW in the wake of scandal.

To gauge precedent, I took a look at the other recent emissions test cheating debacles of Volkswagen and Fiat Chrysler, which have proven so far to be pretty different cases.

In the case of Volkswagen, the EPA formally accused the automaker in September 2015 of deliberately programming auxiliary emissions control devices (AECDs), which normally modulate engine function to protect the car’s engine, to turn on emissions controls only during simulated tests. This illegal programming was present in about 500,000 cars sold in the US, and many more worldwide. Shortly after news began to break about the incident, Volkswagen began to acknowledge their wrongdoing and in early 2017 plead guilty to criminal and civil charges. Due to the relatively egregious and quickly transparent nature of VW’s violations, the price of VW’s main stock (ETR:VOW) tumbled by over a third in the week after they were formally accused.

In the case of Fiat Chrysler, regulators’ suit was less open-and-close, and Fiat continues to deny claims that they specifically intended to cheat on emissions tests. While Fiat’s AECDs allow more NOx emissions, on average, in real use than on tests, they implement emissions controls in a variety of conditions and it’s not yet entirely clear to what degree their programming is actually intended to circumvent testing. Additionally, the allegations to date only regard about 100,000 autos sold in the US, despite the fact that Fiat’s share of the US auto market is about five times that of VW, so the potential consequences of legal action represent a proportionally much smaller threat to their overall operations. Their stock (FCAU) dropped by about 16% on the day in January of this year that allegations were first announced, but quickly recovered as it became clear that the case would not be as momentous as VW’s. The formal filing of a lawsuit by the US Department of Justice against Fiat just earlier this week made weaker allegations than those in the VW case, and it had a fairly minor effect on Fiat stock.

For GM, the future is not clear. The suit filed against them alleges that 700,000 units sold in the US deliberately used illegal programming, even more than VW. Also, since truck emission standards are looser than those for passenger cars, the total amount of illegal pollution belched by GM trucks could be much more. So far, GM looks like it will fare better than VW – its stock fell by only about 2.5% on Thursday, a drop from which it has already fully recovered. GM’s market share in the US is larger than both Fiat and VW, so they may be better prepared to absorb financial penalties, and their valuation is already so low with a P/E ratio of about 5 that it’s hard to imagine their stock price falling much lower.

That being said, many facts about this matter have yet to come to light, and until a fuller picture of the truth is known to investors holding a position in GM is a dangerous gamble. Especially given their stock’s sluggish performance of late and Dynalect’s much longer term interest in the company, the risks seem to outweigh the benefits for the time being, and for the first time we at Dynalect are opting to sell off one of our holdings.

We purchased GM on April 19 at $33.79, and sold at $33.53, for a .77% loss. This is a relatively minor hit, given that we are up 4% on lithium mining companies and 18% on gaming companies from the last two reports. Stay tuned for our quarterly report at the end of June for full details on the performance of the Dynalect portfolio.

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