This article is authored by MOI Global instructor Ole Soeberg, founder of Nordic Investment Partners, based in Copenhagen.
Ole is an instructor at the upcoming European Investing Summit 2022, to be held fully online from October 11-13. Members enjoy complimentary and exclusive access.
It’s a well-known fact that component supply for the automotive sector has been under tremendous stress in the last two years. Shortage of semiconductors and closure of production in spring and summer of 2020 caused global light vehicle sales to drop from 90 million in 2019 to 78 million in 2020 and only to make a partial recovery to 81-83 million units in 2021-22. Hence, there’s pent-up demand for up to 30 million units.
There are several factors at play that could be a game changer for the automotive industry. And looking at past periods of slumps in unit sales those periods are followed by three to five years of solid performance for the sector. The 2003 version MSCI World Auto incl dividends outperformed until 2006, while in the version since 2009 outperformed significantly until 2015.
So, will the current slump result in a period of solid outperformance from 2023 to 2028? No-one has privilege to know the future, however there are a few facts and observations that provide direction:
1. Current estimates are for unit sales suggest 100-million-unit sales in 2025 or and CAGR from 2022 of 8% per year.
2. The share of electric or hybrid electric will rise to at least 25 million units in 2025 from 5 million units in 2021 or a 50% CAGR.
3. Consumers in general are in a financially healthy position with good employment situation and spare cash after the lockdowns, so a new light vehicle is within reach.
4. The average age of light vehicles in large markets like USA and parts of Europe is 11-12 years versus average life time of 15 years, hence there’s an increased potential for replacement sales.
5. Automotive penetration in emerging markets is still relatively low and leaves a long run-way for future light vehicle unit sales.
The skepticism towards electric vehicles, i.e., range angst, lack of charging infrastructure and unclear resale prices held back consumer appetite some years ago. Those arguments for being reserved has changed in the last couple of years and electric car adoption is rising fast. Simple micro-observations from friends and family now show that a two-car family have or are in process of changing to at least one electric car. And once you get comfortable with the convenience of the home charger, there’s no turning back.
How will the carmakers perform in this upswing?
The carmaker landscape is in constant change and has been from the early days. The new players like Tesla, Nio, and Fisker are challengers to the traditional players like Ford, Toyota and Volkswagen. The incumbents have been a bit slow on their feet to embrace the future of electric mobility. By now the incumbent carmakers have woken up helped by Tesla and the transition to electric is now in the fast lane.
A new production line for a new model is estimated to costs €0.5 to 1.0 billion, while a facelift and engine/interior upgrade is estimated at €100 million. The incumbent car makers know their Internal Combustion Engine (ICE) cars have limited future, so those models will not see much more than required engine improvements and other changes to live up to regulation and some customer appeal. All new models will be electric and lots of the new instrumentation features will not be available even in the facelifted ICE cars.
As all the big capex plans are directed towards electric, there’s a big productivity opportunity. Car making is a very complex system of “just-in-time”. An ICE car has 25,000-30,000 components that need to at the right place at the right time, while an electric car has only 11,000-12,000 components. Less components means faster assembly and hence better productivity.
Carmakers’ gross margin runs around 20% and R&D, sales, marketing, and administration at 12-15%. Tesla gross margin is closer to 25%, so first movers from the incumbent side should be able to transform the simplicity advantage of electric vehicles into a gross margin improvement. This is not reflected in current consensus forecast.
How to invest in this opportunity?
When Apple launched the iPhone in 2007 close to nobody guessed unit sales would jump to more than 200 million per year and in that process Apple and Samsung would take down the king of the hill at the time, Nokia.
I don’t think the automotive industry will see a similar dominance by one player that is able to sell its product at a significant premium simply due to its looks and easy user interface. But you never know.
People’s relation to automotive brands goes from indifferent to “would never set foot in any other vehicle” and is embedded over several decades. Smartphones is after all only 15 years old, so it was a brand-new category.
One investment road is simply buying the give largest automakers measured by unit sales or revenues, buy an ETF can gives general exposure. Either will give exposure to the expected volume growth for the next three to five years.
Another investment road is to find a car maker with a clear vision of the future and yet not priced insanely or at least out of reach for investors that consider valuation as part of the investment criteria.
I have been looking through the sector and will present my best pick at European Investment Summit 2022.
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