Financial Mail - Investors Monthly
REVolution
Gearing up for the electric car market
The electric vehicle (EV) market is a bit like e-commerce: it dominates the headlines and promises strong growth potential, but it isn’t a particularly profitable model unless companies achieve significant scale.
Motoring consumers have enjoyed healthy competition from several automotive powerhouses across the world, so winner-takes-all economics would be a foreign concept in this space. It’s more common in the Big Tech world, where initial investment is high and only one or two competitors ultimately earn extraordinary profits.
Tesla investors are backing the company to achieve world domination, evidenced by a valuation greater than any other car company in the world. Sure, there is a broader renewable energy component to the business which may be the real money-maker in the long term, but much of the current share price hype has been based on the automotive division.
Tesla is the clear market leader in EVs, with estimated current global EV market share of 18%, up from about 12% in 2018. The Model 3 has been a runaway success, selling nearly 200,000 units year to date and achieving 14% EV market share.
The share price has had a roller-coaster few weeks after peaking at nearly $500 per share, after it started the year at about $85. At the time of writing it is about $435, a yearto-date increase of 412%.
EV market bulls believe this is only the beginning. Cathie Wood of Ark Investment Management has put forward a bull case for Tesla that could see the company rise to a share price of $6,000.
Are the Robinhood traders and Elon Musk cultists right about what Tesla could achieve? Or is the company — and the broader EV market — overhyped?
Among top-selling EV models, Tesla has pole position with the Model 3 and strongly features with the Model S and the Model X. Other manufacturers with meaningful EV sales include Nissan, Renault, BMW and Chinese domestic market brands.
The Volkswagen Group is late to the party but has entered with force, pitching the
“More than 1-million EVs are sold in China annually, representing about 5% of the Chinese market and about 50% of the global EV market
“Low oil prices in the US won’t be doing the EV market any favours, but Tesla plans to mine its own lithium in Nevada and localise its supply chain
VW ID.3 as an affordable small EV and the Audi e-tron as a luxury SUV with electric power.
Tesla is the global leader in this space, but the company by no means operates in a market devoid of competition.
The market has evolved to become appealing to car enthusiasts, evidenced by Porsche selling more Taycans than any other model in the US in the third quarter. Some of this would have been pent-up demand for an EV Porsche, but it still points to demand for performance EVs among highend consumers.
That’s a far cry from the marketing strategy for plug-in hybrids in the first half of the decade, which only made sense for environmentalists or those who did extremely high mileage and could claw back the premium for an EV car vs an internal combustion engine car.
Naturally, the pandemic has caused significant market disruption. China remains the largest market in the world for EVs, driven by strong regulatory tailwinds as the country grapples with congested and polluted cities.
More than 1-million EVs are sold in China annually, representing about 5% of the Chinese market and about 50% of the global EV market. China’s objective is to achieve 20%25% participation by EVs in the Chinese new car market by 2025.
The government has given considerable support to local manufacturers in recent years. To improve relations with the West, the Chinese government made a surprising policy move in 2018 when it relaxed requirements for foreign investors in the automotive industry to enter into joint ventures with Chinese firms.
Tesla jumped at the opportunity to create a Chinese manufacturing base without having to share the profits. It was a great move, as a Model S that would sell for about $80,000 in the US was carrying a ticket price of $140,000 in China due to import tariffs.
After acquiring a 50-year lease for the land and raising funding from state-owned Chinese banks, Tesla built a “Gigafactory” in China. Tesla will need to start paying $320m in tax to China every year from 2023 as part of the deal and had to commit to $2bn in capital expenditure in the plant.
However, Tesla derived nearly a quarter of its revenue from China in the second quarter of 2020, a colossal increase from 11% in the second quarter of 2019. Based on 2020 figures, Tesla holds more than 30% market share in the Chinese EV market.
China’s new passenger car sales figures have been well over 20-million units in each of the past five years. The overall market is growing at 6%. Assuming this continues and the lower range of the EV participation target is achieved, China will contribute unit sales of more than 5-million EVs by 2025.
If Tesla can hang on to 30% market share despite stiff competition from local companies, that’s 1.5-million units in China alone. That’s three times more than Tesla’s ambitious target for global sales in 2020 (500,000 units — a target based on a record third quarter where Tesla delivered 139,300 cars).
There has been alarm this year over the phasing out of EV subsidies by the Chinese government. Chinese EV sales dipped considerably in the second half of 2019 as the subsidy issue came to the fore. In response, the government extended the subsidies until at least 2022.
One can never be sure of Chinese policy direction, but the state is strongly invested in the success of the EV market and it seems unlikely that action will be taken that is at odds with the goal of growing EV market participation.
The question isn’t whether the Chinese EV market reaches full potential, but rather whether Tesla can remain the dominant force. Chinese domestic market competitors like BYD and BAIC are learning from Tesla.
More importantly, VW has announced a €2bn investment in China, taking a 50% stake in
Chinese manufacturer JAC and a 26.5% stake in an EV battery manufacturer.
Market adoption of EVs varies. In the US, Tesla dominates. The company has more than 80% market share of EVs there. Nearly 90,000 units were sold in the first half of the year, so market adoption of EVs remains slow. In 2019, just 2% of US sales were EVs.
Low oil prices in the US won’t be doing the EV market any favours, but Tesla plans to mine its own lithium in Nevada, localising its supply chain and building further awareness of the EV alternative.
Europe is a far more lucrative market for EVs but is home to some of the world’s finest carmakers. It’s the market in which Tesla is likely to face the stiffest competition.
Norway is obsessed with EVs, with September sales figures indicating that EVs and plug-in hybrids achieved more than 80% participation in new car sales. This is not reflective of the rest of the continent but is an interesting test case for the popularity of models.
VW’s new ID.3 took top spot in sales in Norway, ahead of the Tesla Model 3 and the Polestar 2. Polestar is a joint venture by Volvo and its Chinese parent company, Geely. Year to date, though, the Audi e-tron is the top-selling EV in Norway.
In Germany, EV sales are about 4% of total new vehicle sales in 2020, with a year-onyear growth rate far higher than the internal combustion engine market’s. Tesla’s market share in Germany fell from more than 18% to less than 9%, though some of this was due to supply chain issues at its Fremont factory, which was closed during the lockdown.
Tesla may enjoy home ground advantage in the US but it is certainly playing an away fixture in Europe and won’t find it nearly as easy.
McKinsey has estimated 20% global penetration of EVs by 2030 and 35% of new sales in Europe. The current trends suggest these numbers might need to be relooked at. Despite low oil prices and general economic turmoil in the world, the EV market has come flying out the post-pandemic starting blocks.
If the EV market follows the trend of Big Tech, then winnertakes-all economics could be a reality. If that comes to pass, I wouldn’t bet against Tesla. The company has the best battery technology in the world and is working around the clock to maintain that advantage.
Tesla recently announced a plan to achieve a 56% reduction in battery cost and a 54% increase in range. Musk said it could take up to 18 months to start realising these gains and three years to achieve them fully, but that’s still impressive. Tesla also announced a plan to build a $25,000 EV, which would be a game-changer.
IM believes the network effect enjoyed by Big Tech companies in winner-takes-all economics won’t apply here. Motoring consumers love having a choice of vehicles. Tesla has strong prospects, particularly in China, but the Germans are coming.