B14| Wednesday, March 18, 2020 ** THE WALL STREET JOURNAL.
HEARD
ON
THE
STREET
FINANCIAL ANALYSIS & COMMENTARY
VW Is Better Built
For a Crash Than Most
The severity of the Covid-19
pandemic in Europe is a huge test
forVolkswagen, the local market
leader. In reality, though, it is one
of the more fortunate ones.
In a press conference Tuesday to
discuss its 2019 financial results,
the world’s largest car maker by
sales said it was “almost impossi-
ble to make a reliable forecast” for
the current year and didn’t give
formal financial guidance. But
Chief Financial Officer Frank Wit-
ter did give investors a rough read
on the current quarter: The all-im-
portant operating margin will
likely fall by at least half from its
8.1% level in the same period last
year.
Volkswagen had already been hit
by the coronavirus crisis in China,
where it is also the market leader.
In January and February, its global
sales were down roughly 15% com-
pared with the same period of 2019
as the country closed for business.
Now China is slowly ramping back
up and consumers are returning to
showrooms, but Europe is moving
into lockdown to fight the virus.
Car makers hemorrhage money
when their production lines aren’t
running. As it moves to shutter its
European factories, Volkswagen—
one of the world’s largest private-
sector employers, with roughly
671,000 staff—has shifted into
cash-conservation mode.
Chief Executive Herbert Diessinsisted that its big investments in
electric vehicles wouldn’t be de-
layed. But other plans, such as ac-
quisitions in the pipeline, might be.
The company’s heavy-truck unit
Traton, which owns roughly 17% of
U.S. peer Navistar International,
made a $2.9 billion bid for the re-
maining shares in late January.
Navistar stock is now 35% below
Traton’s bid, suggesting that inves-
tors don’t expect the deal to go
ahead on existing terms.
Mercifully, Volkswagen is start-
ing from a position of strength,
having been given a big kick in the
pants more than four years ago by
the diesel-emission fraud. Last
year, a 22% increase in operating
profit, lower diesel-related fines
and legal bills and a big reduction
in inventories all pushed its net
cash flow up to €10.8 billion
($12.04 billion), from an outflow of
€300 million in 2018. Even after
more than €31 billion in provisions
for “dieselgate” since 2015, Volks-
wagen ended 2019 with €21.3 of
net cash or close equivalents, ex-
cluding its banking activities.
In the evolving European shut-
down, that cash will be all-impor-
tant
The company was wounded
early in the unfolding coronavirus
crisis. Much remains uncertain, but
it could also be earlier than most
to recover.
—Stephen WilmotKudos toAppleInc. for finally
sending the right message about
the seriousness of the coronavirus
pandemic. It is a message that
Wall Street still doesn’t seem to
have fully received, though.
The iPhone maker announced
the closure of all of its retail
stores outside of China over the
weekend. The company had closed
its Chinese stores early last month
in response to the spreading virus
there, though all of those have
since reopened. In a post on the
company’s website, Chief Execu-
tive Tim Cook said the latest clo-
sures will last at least through
March 27 and noted that all hourly
employees will continue to be paid
“in alignment with business as
usual operations.”
Apple’s share price skidded 13%
Monday, in line with the broader
market’s crash. The company’s
stores account for a fairly small
portion of its overall sales.
Apple stopped breaking out its
retail results at the end of its 2014
fiscal year, when retail’s share of
overall revenue had declined to
12% compared with 19% in fiscal
2008, the first full year of the
iPhone. The contribution from its
stores is likely even less now as
an increasing share of the
company’s business comes
from services.
But many of Apple’s products
flow through stores it doesn’t own,
such as those operated by wireless
carriers and big-box retailers—
Best Buy, for example. So the
company will likely share in the
pain felt by the broader retail cat-
egory as more shoppers stay home
during the pandemic. Many of
those stores also could be closed
involuntarily as local communities
deal with the outbreak.
Closures over the near term
don’t address the much more im-
portant question of longer-term
demand in a global economy,which is about to take a very seri-
ous hit. In a note over the week-
end, Citigroup’s technology hard-
ware team said the new
coronavirus “will materially im-
pact the tech supply chain and
end demand which we view as ac-
tual demand declines and the
shortfalls will not be recouped
later in the year.”
So Wall Street still seems too
optimistic about Apple. According
to FactSet, analysts have slashed
their revenue estimates for Apple’s
March quarter by more than 8%
since the end of January. But
revenue estimates for the full fis-
cal year ending in September
have come down less than 3%
in that time.
Many have cited the six-week
closure of Apple’s China stores as
a good sign that the effects of the
outbreak will be short-lived. But
simply reopening stores doesn’t
mean business jumps back to nor-
mal. Apple in particular needs a
large base of customers able to af-
ford its products. That base is
likely to be much smaller for a
long while.
—Dan GallagherConsensus revenue estimates
forApple’s2020fiscalyearSource: FactSet$3000100200billion2019 ’20Oil May Drive
Past Rebound
Signal
Historical sign of recovery is likely to be
overpowered by virus and Russian-Saudi disputeRussia plans to add an additional 500,000 barrels a day to supply from April. A Russian oil field.ANDREY RUDAKOV/BLOOMBERG NEWSVolkswagen has shifted into cash-conservation modeUWE MEINHOLD/EPA/SHUTTERSTOCK
Apple Shuts Stores,
But Wall Street
Stays Too Optimistic
OVERHEARD
Adjusting to social distancing
is a major challenge for all of so-
ciety. This is especially true for
sports gamblers, who are seem-
ingly left with nothing to bet on
until the world begins to return
to normal.
The U.S. likes to gamble on
sports, legally or otherwise, and
it doesn’t seem likely there will
be many options in the immedi-
ate future.
Online sports book Bovada
has a solution to the boredom: It
is allowing patrons to wager on
the weather.
Gamblers can bet on Tuesday
whether or not the high temper-
ature for Wednesday in a host
of North American cities will ex-
ceed the casino’s projection. If
you have a strong point of view
that Houston will top 81 degrees
on Wednesday, today might be
the day to start a hot streak.
The thrill of competition
might not exactly translate to in-
tently watching the sundial at
midday, so Bovada allows betting
on overnight-low temperatures
as well. Gamblers can sleep
through the “game” or wake up
in the middle of the night to
check their favorite weather app.
The offering is careful to respect
local customs: Canadian city bet-
ting lines are quoted in Celsius.
This new pastime might
seem silly, but it certainly beats
putting your money at risk in the
stock market these days.How low can it go? In recent
years, the oil price has stabilized
soon after dipping below the cash
costs faced by the most expensive
producers. This time the signal
isn’t so clear.
Brent oil futures fell below $30
a barrel Monday, well under the
$37 mark at which the price of
crude is no longer sufficient to
cover the operating expenses and
production taxes of higher-cost
producers, according to research
and brokerage firm Bernstein.
Producers with lower cash costs
are still likely to lose money on pa-
per. Once a well is online, however,
or a big project is far enough along
toward completion, companies will
keep pumping. It is when prices fall
below the direct cash costs of rais-
ing another barrel that many will
consider shutting production.
Prices rebounded within one quar-
ter after breaching this threshold
in 2008, 2015 and 2016, according
to Bernstein.
This time, there is much more to
consider. While prior shocks were
caused by too much supply or in-
sufficient demand, the current situ-
ation combines both. Saudi Arabia
and Russia, respectively, low- and
moderate-cost producers, began a
ruinous war for market share just
as global demand faced its most
rapid collapse ever from the coro-
navirus pandemic.
The only modern example that
compares is the 1997 Asian debt
crisis that crimped demand just as
the Organization of the Petroleum
Exporting Countries raised produc-
tion. Prices fell to around $10 a
barrel and didn’t recover until six
quarters after they dropped below
the marginal cash cost.
This time looks worse on both
the supply and demand side. Thereis also a fresh twist. Neither Mos-
cow nor Riyadh look likely to back
down soon, but the newly crowned
top producer in the world, the U.S.,
has no oil minister calling the
shots. Operators of America’s pro-
lific shale fields can’t possibly drill
a well profitably at these prices,
and won’t. Those wells already pro-
ducing will continue to pump even
if their owners enter bankruptcy,
as they did in 2016, but shale has a
precipitous decline rate. Drilling
activity already was muted in late
2019, so it may only be a matter of
months before U.S. output begins a
rapid drop.
Squeezing shale producers who
have enjoyed the higher prices sup-
ported by recent OPEC+ production
cuts appears to be part of Russia’s
plan. Its leaders also value market
share and power and have memo-
ries of the part low oil prices
played in the collapse of the Soviet
Union in the late 1980s.
Russia plans to add an addi-
tional 500,000 barrels a day to
supply from April, and the Saudis
about two million. Others could fol-
low suit. Inventories will build and
likely continue to depress prices af-
ter the war for market share ends.
It will take a while to work
through that supply. The pandemic
is unpredictable but has already hit
trade, travel and the wider econ-
omy hard. A prolonged price war
and global recession could lead to
a daily surplus of as much as 10
million barrels for a few months,
generating a total glut of around 1
billion barrels by the summer, ac-
cording to research firm IHS
Markit. Low prices could buoy the
eventual economic recovery, but
for energy producers it will be bru-
tal.
High-cost producers are likely tobe squeezed hard. As margins are
squashed, costs can be trimmed
and wells coming online can add
some cash flow, but it is balance
sheets that are crucial: low gearing
(defined as net debt as a percent-
age of total capital) will help; andproducers with more discretionary
than committed capital expendi-
tures will have greater scope to
conserve cash. In the extreme, divi-
dends could be issued in script or
suspended.
Integrated majors are leaner af-ter the 2014-2016 price rout so
they will need to be creative. U.S.
shale producers are expected to
struggle given their high levels of
debt, though Washington is consid-
ering some relief. Russian officials
have said they have sufficient for-
eign exchange reserves for a de-
cade of prices under $30 a barrel.
At its full-year results Monday,
the Saudi Arabian Oil Company
also assured investors it could
withstand sustained $30 oil prices.
It has plentiful low cost reserves
and low gearing (though acquiring
SABIC will raise it) but it is the na-
tional balance sheet that is most
important. Riyadh captains
Aramco, relies on its income and
spends more than it earns, but the
kingdom can hold out, for a while.
It is a hostile environment for
all oil producers. Politics is trump-
ing economic signals, and all are
watching Russia and Saudi Arabia.
Investors looking for an oil-price
inflection point likely still have
quite a wait.— Rochelle ToplenskyPrice rebounded quickly after touching marginal cash cost in recent times,
but recovery took longer in 1998.Source: Bernstein$1500255075100125a barrel1990 2000 ’10 ’20BrentEstimatedmarginalcashcostISTOCK