The electric vehicle revolution is coming to a highway near you. Before the decade is done, one out of every five cars sold will be a battery-powered EV, according to Morningstar forecasts.

The hybrid vehicle—that curious mix of internal combustion and battery storage—will also occupy more space on the road, says Morningstar equity analyst Seth Goldstein.

“By 2030, battery electric vehicles will account for one out of every five cars sold,” says Goldstein.

“The 2020s will also be the decade of the hybrid, as these partially electric vehicles will reach 30 per cent of new auto sales by 2030. Indeed, by 2030, half of all new cars sold will be EV or hybrid.”

Once EVs are as affordable and functional as internal combustion engine cars their use will increase, says Goldstein.

He measures parity between EVs and ICEs by looking at total cost of ownership, range, recharge time, and availability of charging infrastructure.

Battery innovation should increase driving range and shorten recharge times so that driving distance and recharging time will reach parity with internal combustion engines.

But if the revolution is to occur, EV owners will want certainty that chargers are as ubiquitous as the conventional fueling stations.

“Electric vehicles will reach cost and functional parity with ICEs by 2025, which will be the global tipping point for mass market EV adoption. After 2025, EVs will begin to see rapid market share gains,” Goldstein says.

“We believe that China and Europe will have the necessary charging infrastructure to support mass market adoption, while the US will only have enough infrastructure in place in some parts of the country to drive higher EV adoption.”

As for actionable investing opportunities, the EV supply chain is where to look, says Goldstein, who has identified sectors that stand to benefit. They include lithium producers, auto manufacturers, auto parts suppliers, and battery makers.

“Our top picks are lithium producers Albemarle and SQM and battery manufacturer Panasonic,” says Goldstein. “We also like auto supplier BorgWarner and auto original equipment manufacturers BMW and General Motors.”

The other name in EVs is of course Tesla. The no-moat carmaker has a chance to be the dominant electric vehicle firm and is a leading autonomous vehicle player. The Elon Musk-run company is also a vertically integrated sustainable energy company with energy generation and storage products. Despite that, Morningstar sector strategist David Whiston does not see Tesla having mass-market volume this decade.

“Tesla's product plans for now do not mean an electric vehicle for every consumer who wants one, because the prices are too high,” says Whiston.

6 undervalued names in the supply chain

six undervalued names in the EV supply chain

Source: Morningstar Direct; data as at 31 August 2020

The names in the above table span the EV value chain and are trading at significant discounts of up to 50 per cent. All but two carry a Morningstar narrow-moat rating, which implies a ten-year competitive advantage.

In this article, we examine in more detail the Morningstar case for these names.

CHEMICALS

Albemarle

Increased adoption of EV and hybrid adoption is in turn tipped to boost demand for the secret ingredient in this evolution: the lithium-ion battery. In short, these batteries are dense in energy and release their charge slowly and can handle thousands of charge and discharge cycles. For comparison's sake, a non-rechargeable alkaline AA battery provides four watt-hours. The lithium-ion battery of a Tesla Model S has 100,000 watt-hours—enough to power the average American home for about three days.  Morningstar tips EV adoption will help boost global demand for lithium to 16 per cent annually. It expects global lithium demand of about 775,000 tonnes by 2025, up from 175,000 tonnes in 2015.

Chile’s Albemarle is a large low-cost producer of lithium, which generates roughly half of total profits. Its second-quarter results disappointed—and the share price fell—but that was to be expected, says Goldstein, who sees light at the end the tunnel. He says the market is likely focusing on the continued weakness in the lithium business despite favourable announcements of more electric vehicles being produced and sold.

“Given our favourable long-term outlook for lithium based on our above-consensus electric vehicle forecast, we view the pullback as an excellent opportunity for investors to pick up shares of the high-quality, cost-advantaged lithium producer at a discount,” Goldstein says.

“The lithium market is currently oversupplied, which has driven prices down to US$7250 per metric ton for lithium carbonate based on current London Metal Exchange prices. We expect low prices to persist throughout 2020. Even as auto plants resume production and EVs and hybrids are produced, we think it will take a few quarters to move through the excess inventory. However, we continue to believe the market will tighten by the end of 2021. This should send lithium prices higher in the coming years, towards our long-term price forecast of US$12,000 per metric ton.”

Sociedad Quimica Y Minera De Chile

Narrow-moat SQM is a Chilean commodities producer with significant operations in lithium, specialty potassium fertilisers, iodine (for X-ray contrast media), and solar salts. The company extracts these materials through its high-quality caliche ore and salt brine deposits. Meeting the demand for lithium will require higher cost and higher quality supply to come online, which Goldstein argues will boost prices and SQM's profits.

“SQM’s crown jewels are its geologically advantaged lithium and caliche ore assets. SQM’s low-cost lithium deposit in the Salar de Atacama boasts the highest concentration of lithium globally and benefits from high evaporation rates in the Chilean desert.

“As electric vehicle penetration increases, we expect high-double-digit annual growth for global lithium demand, one of the best growth profiles among commodities.”

AUTO MANUFACTURERS

BMW

In addition to being one of the world's leading premium light-vehicle manufacturers, BMW Group produces BMW motorcycles and provides financial services. Premium light-vehicle brands include BMW, Mini, and ultraluxury brand Rolls-Royce. This brand power is key to its moat, says Morningstar analyst Richard Hilgert—and it is indeed  one of a handful of carmakers that carries a moat. In the long-term, Hilgert argues, BMW will maintain one of the highest levels of profitability among global automobile manufacturers. In 2023 (two years ahead of BMW's original plan), the company targets 25 electrified models: 12 all electric and 13 plug-in hybrid electrics.

“Despite the covid-19 drubbing in the second quarter, management maintained its full-year guidance for a 0–3 per cent pre-tax earnings margin.

“Even though BMW shares have rebounded 49 per cent since their 19 March low, they still trade at a 50 per cent discount to our EUR 120 fair value estimate. While the pandemic will continue to create near-term stock price volatility, this 5-star narrow-moat-rated stock is attractively valued for patient long-term investors, in our opinion.”

General Motors

Covid shutdowns hurt General Motors, but Whiston expects a strong rebound for the company, which emerged from the bankruptcy of General Motors Corp. (old GM) in July 2009. GM has eight brands and operates under three segments: GM North America, GM International, and GM Financial. The US now has four brands instead of eight. The company remains the market leader in the US with 17.4 per cent share. GM Financial became the company’s captive finance arm in October 2010 via the purchase of AmeriCredit.

“We think General Motors' car models are of the best quality and design in decades,” Whiston says. “The company is already a leader in truck models, so a competitive line-up in all segments, combined with a much smaller cost base, says to us that GM is starting to realise the scale to match its size.

“We are maintaining our fair value estimate because we expect a strong rebound in second-half 2020 provided covid-19 does not force more long-term shutdowns. GM is also investing US$20 billion in BEVs for 2020-25 and believes in an all-electric future, though not soon.”

AUTO PARTS

BorgWarner

BorgWarner is a Tier I auto-parts supplier that has two operating segments. The engine group makes turbochargers, emissions system components, timing chains, and other items that enhance fuel efficiency and reduce emissions. Engine group products have averaged about 60 per cent of sales. The drivetrain group produces rotating electrical components, power electronics, control modules, transmission components, and four-wheel-drive/all-wheel-drive system components that facilitate the distribution of engine torque to the wheels. The company has made a series of smaller acquisitions, the most recent and notable of which is Delphi Technologies (DLPH), which Hilgert says boosts BorgWarner’s EV capabilities. Delphi Technologies’ main products are fuel injection and valvetrain systems along with the sensors and software controls for each, representing about 68 per cent of 2019 total revenue.

“In our opinion, BorgWarner is well positioned for the trends in the auto sector that will result in revenue growth in excess of the growth in global automobile demand,” says Hilgert. “We estimate 7 per cent average annual revenue growth over our five-year forecast, roughly 3–5 percentage points higher than our expectations for 1–3 per cent long-term growth in global light-vehicle demand.

“BorgWarner is also well positioned for growth in hybrids and battery electric vehicles. Through its 2015 acquisition of Remy, the company possesses electric motor technology. Integrating electric motors with other BorgWarner technologies enables the company to capitalise on the increasing penetration of hybrids and battery electrics. Regardless of the powertrain automakers chose, we think BorgWarner's revenue growth potential remains unchanged.”

BATTERIES

Panasonic

Panasonic is a conglomerate that has diversified from its consumer electronics roots. It has five main business units: appliances (air conditioners, refrigerators, laundry machines, and TVs); life solutions (LED lighting, housing systems, and solar panels; connected solutions (PCs, factory automations, and in-flight entertainment systems); automotive (infotainment systems and rechargeable batteries); and industrial solutions (electronic devices). Since 2012, it has sought to boost the proportion of B2B businesses to mitigate the tough competition in consumer electronics products. Another key component of its business is its rechargeable battery supply deal with Tesla.

“The key risk for Panasonic is that electronics is extremely competitive,” says Morningstar analyst Kazunori Ito. “While Japanese firms used to dominate this industry in the 1980s and 1990s, Korean and Chinese manufacturers have been providing very high levels of competition over the past 10 years, and we assume that this competitive intensity will increase in various products.

“Panasonic is also well known as an exclusive supplier of rechargeable batteries to Tesla. Panasonic has signed a deal to invest in Tesla’s US$5 billion Gigafactory in Nevada, which is the largest factory in the world to produce li-ion batteries. We believe that capacity ramp-up will be faster than expected, as we observe enough backlog for the brand-new Tesla 3 model.

“We estimate that Panasonic’s battery production capacity will increase 6–8 times as a result, and therefore, we believe Panasonic will obtain a cost advantage against competitors with this business.”

Growth of ALB, BMW, BorgWarner, General Motors, Sociedad Quimica, Panasonic

Price chart for Albemarle, GM, SQM, BorgWarner, BMW, Panasonic

Source: Morningstar Direct; data as at 31 August 2020

 

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