Seeking value in the auto sector

Covid-related supply chain disruptions had a dramatic impact on the industry, curtailing demand by around 30m units, or around one-third of pre-pandemic global auto sales.

This supply-driven consumption deferral gives us confidence in the outlook for unit volumes for the auto sector. As supply chains have normalised, production has been increasing across all price points to meet pent-up global demand: cars have a finite life and remain indispensable to most people.

Positive outlook for electric vehicles

Despite slowing growth, we remain positive on the outlook for Electric Vehicles. Regulation is one of the key drivers of EV demand. Original equipment manufacturers (OEMs) have a variety of tools to meet emissions targets, including EVs, hybrids and emerging alternative technologies such as hydrogen.

We believe sales of EVs in Europe will need to increase from 15% of total auto sales in 2023 to the low 20 percents to meet the standards coming into force in 2025. Sales will need to increase further to meet 2030 standards.

At the same time, we believe the competitive threat from Chinese OEMs is exaggerated. Chinese OEMs accounted for just 3% of sales in the European market in 2023, up from 2% in 2015. Chinese automakers suffer from overcapacity, so they need new markets to sell their products. However, autos are a highly sensitive area politically. The industry accounts for 7% of European GDP, for example, and employs around 30 million people. Given trade tensions, shifting production to Europe would appear the main option for Chinese OEMs. However, if they localise production, their cost advantage will disappear.

Hybrids here to stay?

The popularity of hybrids was not anticipated by the market. Companies such as Toyota and Hyundai continued to pour billions of dollars of investment into hybrid EVs. That decision has been vindicated, with consumers attracted to the affordability and versatility of hybrids. Moreover, from a societal perspective, it might be wiser to spread the electric cells that are needed by one EV across three or four plug-in hybrids. So, while hybrids were once thought of as merely a stepping stone to EVs, opinion is now shifting. Toyota, for example, believes that EV global penetration will peak at 30%.

Toyota may be proven right, but as investors we need to keep an open mind on where the industry will head – particularly given the pace of change in technology and regulation in the auto sector.

Autonomous vehicles a step too far?

Developing autonomous or self-driving vehicles is among the most difficult challenges humanity has ever attempted. The Chinese are among the most advanced in commercialising the technology, yet it remains unclear whether fully autonomous vehicles will ever be privately owned, given all the complexities associated with a self-driving car.

Potential winners and losers

Profitability in the auto sector may decline from very high levels as supply widens out across price points and EV penetration increases. In terms of winners and losers, our Pragmatic Value approach involves judging whether the share price of a company accurately reflects its future prospects. Many of the incumbent OEMs are trading on multiples of just three to four times earnings, indicating that these are businesses priced to disappear relatively soon. But that is looking less and less likely. Moreover, the industry’s approach to shareholder returns has improved. So, while we are cognisant of the threats facing the sector, we believe it also offers real value.

We have a long-standing position in Toyota based on the company’s financial resilience, operational excellence and technical prowess, and we suspected the market would pivot to hybrids. Toyota is also leading in developing solid-state batteries that could revolutionise the EV market. These batteries provide a longer range than conventional models and can reportedly charge in 10 minutes.

This position has worked well for the portfolio, and we have rotated some of the holding into other names, such as Hyundai Motor, which has strong EV technology and a compelling hybrid offering. It’s gaining share in key markets and is priced at around 5x earnings.

By contrast, Tesla faces difficult challenges. Arguably, it has over-penetrated key segments by slashing prices, hurting margins in the process. In addition, it doesn’t have an ICE (Internal Combustion Engine) business to fall back on if EV penetration continues to slow. Finally, it has no new mass-market product releases until mid-2025, when its US$25,000 entry-level car, code-named Redwood, is due for release. Given Tesla’s overly optimistic record, that launch could well be delayed. The new car may simply draw buyers away from its higher-priced models, so hitting earnings.

To find out more about our views on the global auto industry, listen to our latest podcast episode: https://antipodes.com/blog/winners-and-losers-in-the-auto-industry/

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