(ATF) Climate change looms large across a number of industries. Nowhere is this felt more than in transport, where emissions continue to rise as a proportion of the overall total. Cars are comfortably the biggest contributor in this segment.
Tackling this has forced the auto industry into a fierce battle between traditional industry behemoths, such as Volkswagen and Ford, and pure play electric vehicle (EV) producers led by Tesla and NIO, which has created a disconnect among investors about who they favour.
This was highlighted by the contrasting stock market experience of Tesla and Volkswagen in the past year. While Tesla’s share price surged by 690%, VW saw its share price fall 1.8%, despite reporting a big expansion in its own electrification efforts.
The German car giant produced over 130,000 EVs and 210,000 electrified cars – up 197% and 158% on the previous year – with the company expecting to produce one million EVs a year by 2023. So why doesn’t the market seem so convinced of its, or other traditional automakers', prospects?
The ‘froth’ on top
As shown with Tesla, capital markets voted strongly in favour of EV producers. The market capitalisation of Tesla rose more than seven-fold in 2020, even though many sell-side analysts had already called its 2019 multiples ‘frothy’.
2017-2020 auto market capitalisation, Tesla versus European ‘Big Five’ (US$m)
Source: Bloomberg, Aviva Investors, as of January 18
Meanwhile, Tesla’s market capitalisation has become almost 13 times bigger, compared with a 17% drop in the market capitalisation of traditional manufacturers. This example of overtaking is even more dramatic than the one that saw Apple catch up with Nokia around 14 years ago, shortly after the launch of the iPhone.
This saw the smartphone overtake the traditional feature phones produced by Nokia in six short years. One billion feature phone units were sold in 2007 compared with just 700 million in 2014, while smartphones jumped from 100 million to 1.3 billion in the same period.
In contrast, most forecasters currently expect EV’s global market share to reach just 20% in the next 10 years, a much-lower penetration than smartphones have achieved since the first iPhone was sold.
Who is the leader in EVs? It’s complicated …
Markets seem to believe a different story. Comparing Volkswagen with Tesla shows Tesla only overtook the market leader in terms of market capitalisation in 2019, followed by a stunning acceleration in 2020.
Tesla, however, still sells just a fraction of the vehicles sold by the largest five European carmakers, with the latter accounting for over 20 million vehicles in 2020 versus only just over 430,000 for Tesla. Moreover, the European Big Five recently achieved a larger global market share than Tesla itself in EVs, ranging between 25% and 32% over the first three quarters of 2020 versus a decline for Tesla, from 25% to 11%.
While Tesla does not have to spend much money to convert old internal combustion engine (ICE) plants into EVs, it does need to spend money to scale up. It could easily raise capital at current funding levels, however, and has taken full advantage of this option. In late 2020, Tesla raised $5 billion in cash through an equity capital increase. At this pace, it could easily outspend peers as it internationalises and scales up production.
According to estimates from Continental AG and Bloomberg New Energy Finance, 80% of cars sold in 2030 will still have an ICE, making it unlikely that all the Big Five’s assets will become stranded. In addition, converting a plant from ICEs to EVs is costly, but not as punishing as writing down a coal mine or an expensive oil project for an energy company.
New threats from familiar names
Tesla is not alone in commanding what seem to be expensive multiples. Many other new EV companies or start-ups are trading at multiples traditional carmakers can only dream of. Tesla’s equity valuation stands at just over 14 times its one-year sales forecast, but other EV start-ups are trading at even higher multiples, while the European Big Five show a multiple of just 0.4 times.
Ratio of equity valuations to one-year sales forecasts
Source: Bloomberg, Aviva Investors, as of January 7, 2021
The jury is out for what will happen in the coming year to EV producers and traditional carmakers. However, both may face pressures from new challengers, but familiar names. Apple and Amazon seem increasingly likely to start building their own EVs to seize new opportunities in the mobility market and, for Amazon in particular, to control its delivery costs and carbon dioxide emissions.
The Silicon Valley giants have enormous financial resources: if they begin manufacturing vehicles at scale, they could squeeze traditional manufacturers’ market share and margins.
The great technological transformation of the nineteenth century was to harness the power of fossil fuels for industrial growth. The twentieth century rode the wave of innovation that followed, and inadvertently put the planet on track for massive warming. The defining industrial project of this century will be to leave carbon behind.
As the automotive industry embarks on this enterprise, financial markets are seeking to price in the winners. Replacing horses with cars took about 30 years, from 1900 to 1930. Replacing feature phones with smartphones took six years. EVs replacing ICEs may be somewhere in between, given the rapid pace of technological change and the massive sums being invested in renewables and EVs.
Traditional carmakers have a fighting chance of catching up to new players like Tesla if they move decisively and rapidly, but until they do, there are reasons to remain cautious about their prospects.
Alessandro Rovelli is Senior Credit Research Analyst at Aviva Investors