How to invest in the electric vehicle revolution
The electric vehicle (EV) revolution has moved up a gear over the past few months as Britain and France confirm plans to phase out the sale of diesel and petrol cars by 2040.
Car manufacturers such as Volvo and Jaguar Land Rover are developing electric or hybrid vehicles as fast as they can; and even non-car companies including vacuum cleaner specialist Dyson are moving into the electric vehicle space. Furthermore, airline EasyJet (EZJ) now says it could be flying electric planes within a decade.
This rapid acceleration of activity presents an opportunity for investors to hitch a ride on one of the biggest industrial and technological developments in the world for a long time.
In this article we discuss the likely winners and losers on the UK stock market from the electric vehicle revolution, as well as looking at ways to play the space through investment trusts.
We will look at a wide range of industries, from car part suppliers and service companies to miners hoping to dig up the raw materials needed to power electric vehicle batteries.
WHY IS THE WORLD MOVING TO ELECTRIC VEHICLES?
There are several reasons why the world is shifting from combustion engines to electric vehicles.
First, it has been proven that electric vehicles can perform as well as their petrol equivalents. Lithiumion battery costs are falling, and this has prompted the car industry to believe that electric vehicles can eventually become affordable to the mass market.
Second, anti-pollution legislation in many parts of the world is forcing the automotive industry to change. Europe is introducing stricter limits on carbon dioxide emissions from 2021, for example.
‘Air quality concerns have been a big driver from a legislative point of view,’ says Marcus Stewart, head of energy insights at National Grid (NG.). ‘Governments have jumped on the bandwagon. Technology was taking us there anyway.’
Like any significant development, there are a few negative issues to overcome. You have to think about how electricity is generated in order to power electric vehicles. Parts of the world are heavily reliant on coal-fired power stations to produce electricity, so using that source to power electric vehicles is clearly counterintuitive from an environmental perspective.
You then have to think about how vehicles will be charged. At present there are very few charging stations for electric vehicles in major cities, let alone rural areas. For example, China has some charging stations in car parks but only in a small fraction of its overall parking facilities.
In the UK you’re more likely to see charging points on someone’s house than in city centres. More on the charging debate later in this article. For now, let’s discuss how companies on the UK stock market fit into the equation.
VEHICLE MANUFACTURERS There are no vehicle manufacturers on the UK stock market. UK investors will need to buy shares in overseas-listed stocks in order to have electric vehicle manufacturers in their portfolio. The alternative is to buy an investment trust or fund which has stakes in some of the players, although you would have to consider the manufacturer(s) may only be a small proportion of the fund. Our top pick in this situation is to buy Scottish
Mortgage Investment Trust (SMT). Its second largest holding is Tesla, the American company which is considered to be one of the pioneers of the electric vehicle industry.
Tesla hopes its Model 3 car will push EVs into the mainstream. Model 3 is already out in the US (on a small scale) and is expected to be sold in the UK from 2019. Later this month Tesla will unveil an electric heavy-duty haulage truck called Semi. VEHICLE PARTS AND ASSOCIATED SERVICES Electric vehicles are far less complex mechanically than combustion engine vehicles, although electronic complexity is higher. In a nutshell, there are far fewer bits to drive an electric vehicle. For example, investment bank UBS claims there are 24 moving parts in electric vehicle Chevy Bolt’s powertrain versus 149 in the VW Golf.
UBS also believes an electric vehicle like the Chevy Bolt could almost be maintenance-free. ‘Not only do fewer parts need to be replaced over the car’s life, it also does not require a regular change of fluids, such as engine oil.’
That’s very important. It implies a significant reduction in revenue for companies which provide spare parts or maintenance services. For example, car dealerships typically generate more than 40% of their gross profit in service and maintenance.
Clearly such an impact is not going to be felt in the next few years, but we believe the market will eventually start to price in a tougher future for nonvehicle sales income for car dealerships.
Two stocks already being scrutinised by investors for how they will adapt in an EV world are automobile engineers GKN (GKN) and Ricardo
(RCDO). The former supplies drivelines to car manufacturers, enabling power to be delivered from the engine to the wheels. Ricardo undertakes a wide range of work including emissions testing for cars and engine design and testing, as well as work in the rail and water sectors.
Shares in Ricardo went through a lengthy weak period earlier this year as investors started to question if EV posed a longer-term structural threat to its business, given heavy exposure to the combustion engine.
Ricardo believes that full scale electrification will not happen but it isn’t sitting on its hands. ‘There is a lot of invested capital in engines around the world,’ says Ricardo. ‘Car manufacturers still need to produce excellent engines with low emissions. But in a worst case scenario we would just do EV and hybrid work which represented 17% of our order intake in the last financial year.
‘We’ve done EV work since 2000 and have growing expertise,’ adds the company. ‘On the hydrogen side, we are working with Toyota on a hydrogen truck and we also design battery packs.’
Ricardo says it has been talking to unnamed parties about potentially becoming an electric vehicle battery manufacturer.
INVESTMENT BANK UBS BELIEVES AN ELECTRIC VEHICLE COULD ALMOST BE MAINTENANCE-FREE. NOT ONLY DO FEWER PARTS NEED TO BE REPLACED OVER THE CAR’S LIFE, IT ALSO DOES NOT REQUIRE A REGULAR CHANGE OF FLUIDS, SUCH AS ENGINE OIL
SHOULD YOU BUY SHARES IN RICARDO?
Investment bank Berenberg rates Ricardo as a ‘sell’ and says there is a lot wrong with the business beyond the EV market threat including deteriorating cash generation. In contrast, investment bank Liberum takes a different view, saying ‘auto evolution is more opportunity than threat’ for Ricardo and that its shares are worth buying.
‘Projections suggest that 30% of all new passenger cars will have electric powertrains by 2025 (hybrids and EVs),’ says Liberum analyst Ben Bourne. ‘Ricardo has secured a diversified range of programmes in vehicle systems, hybrid and electric systems, advanced driveline, and in the core powertrain areas, focused on both new and existing product upgrades to help lower CO2 and NO2 emissions.’
As for GKN, UBS estimates that 15% to 20% of its profits today could be at risk in an all-hybrid/electric world. GKN is adapting, nonetheless, including the recent launch of an advanced electric driveline which it claims will deliver ‘unrivalled capabilities’ for the next generation of electric vehicles.
GOOD NEWS FOR AB DYNAMICS
One lesser known engineer already benefiting from the advent of electric vehicle development is
AB Dynamics (ABDP:AIM) which undertakes track trials for vehicle steering and suspension, as well as providing driving robot systems to test vehicles in crash scenarios. Switching to electric vehicles doesn’t change how its robots work as they sit on the steering wheel, not the engine.
‘A lot of car companies are trying to adapt their architecture to accelerate electric vehicle development,’ says chief executive Tim Rogers. ‘They are doing a lot of chassis development which drives in part what we do.
‘We are seeing more virtual simulated development and less prototyping,’ adds Rogers. That shouldn’t be a problem for AB Dynamics because it has recently developed advanced driving simulators produced in partnership with Williams F1. These enable automotive customers to undertake vehicle dynamics modelling and evaluation of ADAS (driver assistance) technology.
Both AB Dynamics and Ricardo make the point that car manufacturers are still spending a lot of money on combustion engine vehicles and that part of the industry is not going to disappear overnight.
RICARDO HAS SECURED A DIVERSIFIED RANGE OF PROGRAMMES IN VEHICLE SYSTEMS, HYBRID AND ELECTRIC SYSTEMS, ADVANCED DRIVELINE, AND IN THE CORE POWERTRAIN AREAS, FOCUSED ON BOTH NEW AND EXISTING PRODUCT UPGRADES TO HELP LOWER CO2 AND NO2 EMISSIONS.
THE CHEMICAL COMPANY
FTSE 100 chemicals giant Johnson Matthey
(JMAT) saw its share price jump back to life last month after explaining how it hopes to crack the EV market. We think it is an essential stock to own for the EV revolution.
Investors had previously worried about the company’s position given it has historically generated a lot of money from making catalytic converters to control harmful pollutant emissions from diesel vehicles which is now a market under threat.
That’s why the company has been trying to expand into battery technology. Johnson Matthey has now unveiled its eLNO (enhanced lithium nickel oxide) cathode material which it claims to offer higher energy density and require less cobalt relative to current market leading cathode materials.
The reduction in cobalt could be one of the most important factors. As we discuss later in this article, cobalt is one of the commodities expected to shoot up in price as demand is expected to significantly outweigh supply. So battery technology that requires less cobalt is a plus factor for car companies.
‘We expect that near term, investors will be focused on the merits of JM’s new cathode material in terms of (1) what value should be ascribed, and (2) how large the market opportunity could be should this new technology prove to deliver a step change,’ says investment bank Morgan Stanley.
‘However, it is important to acknowledge there is still further progress to be made to secure customer contracts, and then scale up the necessary capacity. One thing is clear, perception is changing in regards to JM’s ability to carve out a market position in the high growth EV supply chain as the powertrain evolves.’
POWER TRANSMISSION AND CHARGING
One of the key challenges to increasing electric vehicle adoption is having adequate charging infrastructure. Converting petrol stations may not be the solution as you can’t charge a car at the same speed in which you fill up the petrol tank.
While Royal Dutch Shell (RDSB) is working on systems to provide fast-charging for EVs at its petrol stations, we doubt it would be able to charge an electric vehicle in two minutes.
Speaking at a recent conference held by the Natural Resources Forum, chief executive Erik Fairbairn of electric charge point supplier POD Point predicted the future would be 60% of charging done at home, 30% at work, 7% at destination and 3% en-route.
National Grid’s Marcus Stewart says an electric vehicle is just a ‘battery on wheels’. As such, it could be used to provide energy as well as consume it. ‘We are taking to manufacturers, looking at how your car could provide energy back to the grid, such as when you aren’t using it.’
Investing in a company involved in setting up the charging infrastructure would be an obvious way to play the electric car theme. We can’t see any obvious contenders on the UK market at the moment, although there are two stocks which have relevant interests on a small scale.
AN ELECTRIC VEHICLE IS A JUST A ‘BATTERY ON WHEELS’
Engineering services group Nexus Infrastructure
(NEXS:AIM) makes most of its money from hooking up new-build properties to electricity, water and drainage services as well as building reinforced concrete frames and roads. It is also trying to develop services around electric vehicle charging points.
AIM-quoted venture capital firm Draper Esprit
(GROW:AIM) has a stake in POD Point, although it is only a small part of its overall investment portfolio. POD Point has made and sold more than 27,000 charging points since being founded in 2009, according to Draper.
BATTERY RAW MATERIALS
Lithium is often touted as the magic commodity to play the electric vehicle revolution given its role as a key battery component. In reality, nickel might be the better commodity to seek when looking at mining stocks linked to the EV revolution.
There is plenty of lithium in the world and experts believe there will be sufficient new projects to meet increased demand.
In contrast, there is expected to be a shortfall in cobalt and nickel in the future, claims private equity firm Pala Investments. That situation implies higher future selling prices.
Cobalt is generally produced as a by-product of nickel. It is the fourth largest commodity by revenue for FTSE 100 miner Glencore (GLEN).
Car and battery manufacturers are expected to strike deals over the coming years in order to secure future cobalt supply, even if it means stockpiling the commodity for a while. For example,
Volkswagen is rumoured to have asked producers to submit proposals on supplying cobalt for up to 10 years from 2019.
Increased usage of nickel scrap could help to meet supply requirements on the nickel side, yet it is unlikely to fill the market gap entirely.
UK-listed miners with nickel exposure include
Glencore among the large caps and Horizonte Minerals (HZM:AIM) among the small caps.
WHAT ABOUT OTHER MINERS?
Vedanta Resources (VED) is looking at ways to produce cobalt for batteries rather its current output of copper-cobalt alloy. It already produces aluminium which is another commodity in increasing demand for electric cars. Anyone considering an investment in Vedanta should note legal action in connection with pollution allegations in Zambia.
BHP Billiton (BLT) is focusing on copper as the ‘metal of the future’ in terms of the feeding the electric vehicle revolution. Talking to Reuters last month, it says electric vehicles require four times as much copper as cars which run on combustion engines.
There are risks that cobalt might play a smaller role in the future than people currently think. For example, we’ve already talked about Johnson Matthey finding a way to develop battery technology with lower levels of cobalt. Investment bank Berenberg goes as far as saying that cobalt could even be phased out of lithium-ion batteries over the next five to 10 years. It predicts no demand increase for the metal during this period.
‘In our view, EVs will not significantly benefit copper and cobalt miners such as Glencore and BHP,’ it says.
Berenberg believes a shift to ultra-nickel-rich batteries could occur faster than expected due to Johnson Matthey’s aforementioned breakthrough. ‘Nickel is becoming crucial as its content in a battery determines the range of EVs. We estimate that 20m EV sales by 2026 will translate into 0.7m tonnes of high quality nickel sulphide demand which is 85% of 2016 production levels,’ it comments.
HOW DO YOU PLAY THE LITHIUM GAME?
As for picking lithium-related stocks, we think miners with a decent asset stand a chance of making a profit once in production – but we don’t share many people’s enthusiasm that you will make a lot of money from investing any miner with a lithium exploration project. Most of the lithium plays on the UK market are many, many years away from generating revenue.
If you like the lithium story, the only stock we’d suggest you examine is Bacanora Minerals
(BCN:AIM), which is close to releasing the final feasibility study on its Sonora project and should be in a position to raise finance in early 2018 and then start an 18-month mine construction phase.
‘Lithium hydroxide rather than lithium carbonate will be the preferred material for creating high nickel cathode materials,’ says Berenberg.
Unfortunately for Bacanora, it is no longer pursuing the hydroxide route. The company did have an agreement a few years ago to supply Tesla in the US with lithium hydroxide. That deal has now lapsed and the miner is focused on the Asian and German markets (the latter is via a less advanced second project) with lithium carbonate.
Bacanora is still appealing from an investment perspective, nonetheless. It has already agreed to sell lithium to Japanese battery chemicals trader Hanwa in the future and this partner has taken a 9.35% stake in the miner which shows commitment. Analyst 12 month price targets for Bacanora are in the range of 120p, implying about 50% upside from the 78.4p trading price at the time of writing. (DC) DISCLAIMER
The author Daniel Coatsworth has a personal investment in Scottish Mortgage mentioned in this article
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