E-Ladestation

Automotive sector: 2021 will be a pivotal year

Benjardin Gärtner

An article by Benjardin Gärtner

Head of Equity Portfolio Management  and
a member of the Union Investment Committee

The equity market’s verdict on the automotive sector is clear. With a market capitalisation of around €330 billion, the valuation of US electric vehicle manufacturer Tesla is twice as high as those of German car makers BMW, Daimler and Volkswagen combined. However, Tesla’s revenue for the current year will come to only around €26 billion and it is likely to be a record year for the manufacturer, whereas the three largest German manufacturers can be expected to generate combined revenues of more than €460 billion. So the all-important question is: Have traditional car makers fallen irrevocably behind in the stock markets? Or is there a chance that their share prices will regain traction?

There are opportunities on the horizon. The EU is putting greater emphasis on sustainable transport and wants to implement stricter emissions targets. This is good news for Germany’s automotive sector, as car makers are on the brink of launching a whole host of models in the electric vehicle segment. So far, this has barely been priced in by investors in the stock markets.

Tesla and Toyota dominate the global automotive Industry

Tesla and Toyota dominate the global automotive industry
Sources: Refinitiv; as at 23 October 2020.

Market capitalisation of the biggest automotive sector stocks (€ Billion)

Market capitalisation of the biggest automotive sector stocks (€ billion)
Sources: Refinitiv; as at 28 October 2020.

It is clear that the traditional manufacturers have yet to achieve the transition to a product range that is fully focused on electromobility. The big automotive companies are like oil tankers – they take a long time to change direction. The transition to electric-powered vehicles can succeed – provided that it goes hand in hand with significant cost savings and efficiency increases for car manufacturers. Selling electric vehicles will initially generate lower margins than selling, for example, a premium model with an internal combustion engine. And car manufacturers earn this margin only if they are able to produce and sell a sufficiently large number of cars. Companies will need time to make the vast array of adjustments that this transformation requires.

Solid balance sheets help with the Transformation

A majority of investors are currently more willing to pay a higher premium for a business model with an exclusive focus on electric-powered transport than for a dwindling business model based on internal combustion engines with a prospect of growing revenue from electric vehicles. As a result, shares in companies such as BMW, Daimler and Volkswagen currently have a low price/earnings ratio compared with other sectors.

Traditional car manufacturers should not be written off as an equity investment option.

Benjardin Gärtner

However, traditional car manufacturers should not be written off as an equity investment option because they offer attractive and relatively safe dividend payments that are underpinned by the recovery in their core business. Strong net cash positions and solid balance sheets provide additional financial security.

Automotive sector weathers the COVID-19 storm

At present, automotive sector shares are enjoying a tailwind created by rising sales in the key markets in the US and China. Due to the coronavirus crisis, many manufacturers drastically reduced their production in the spring and are only now ramping it up again gradually. This means that there is not a great deal of excess supply of new vehicles. The European market is also recovering from the slump in the spring, albeit at a slower pace. In Germany, a scheme subsidising purchases of electric vehicles, which will continue to run until the end of 2021, has triggered a mini boom in the lucrative plug-in hybrid segment.

All in all, car makers such as Daimler, BMW, Volkswagen and Peugeot reported better results for the third quarter than many investors had expected. The V-shaped recovery in China suggests that this market can probably be counted on for a healthy level of demand, especially in the high-margin premium segment. In the US, an election victory for Joe Biden should not interfere with a continued recovery in the market. Further fiscal stimulus measures can be expected that will boost consumer demand and also indirectly support the car market. Under a Biden administration, the expansion of electric-powered transport should gather pace, for example through the installation of more charging points.

This means that things are looking positive for the sector in terms of its operating business, despite – or to some extent even because of – the uncertainty created by the second wave of the pandemic. After all, concerns about the risk of contracting COVID-19 are driving up demand for individual transport solutions such as cars. This is particularly true for countries such as China, where a high proportion of commuters normally use trains and buses. But the same trend is also observable in many European countries. The recovery in the automotive sector should therefore continue as long as no further widespread lockdowns are imposed.

2021 is shaping up to be a pivotal year for the industry. It will see more launches of new electric vehicle models by German manufacturers than ever before. Daimler alone – long regarded as a latecomer in this respect – will bring four purely electric-powered models to the market. So this is not just about plug-in hybrids, which could realistically reach double-digit growth rates in Europe, but also about fully electric models. In terms of the number of vehicles produced, Volkswagen is on track to dethrone Tesla as the biggest global manufacturer of electric cars.

Electric cars: proportion of new registrations in Europe

Electric cars: proportion of new registrations in Europe
Sources: Transport & Environment, as at October 2020. New vehicle registration figures for 2019 and estimates for 2020 and 2021.

Electric vehicle production will take several years to generate a Profit

Stronger growth in the market for electric vehicles and rising sales will diminish the pain that will be inflicted upon traditional manufacturers in Europe in the form of penalties for missing emissions targets. But becoming profitable in the electric vehicle segment will require a lot of patience. Toyota is expecting to break even only with its second generation of electric vehicles by the end of 2021. With the third generation, scheduled to be available from 2025/2026, the company expects to finally generate a positive EBIT margin, i.e. an operating profit. German manufacturers will probably be looking at a similar timeline.

The greatest risk in the long term will be linked to how these traditional car makers manage the transition to electric-powered vehicles. Going into mass production is the key to economic success. High output volumes are required to really benefit from economies of scale and to run a profitable business in the medium term. On the supply side, we can see how difficult it has been for US pioneer Tesla to scale up production to large numbers of vehicles. The company was founded in 2003 but has only recently entered profitable territory after years of huge losses. And Tesla has yet to prove that it is capable of mass producing its cars at a consistently high level of quality. The existing production facilities are reaching their limits. The Y model, for instance, faced mounting reports of manufacturing defects.

The recovery of operating business and advances in the electric vehicle segment are the drivers of share prices in the automotive sector. Attractive dividend yields further improve the appeal of shares in solid manufacturers with strong balance sheets.

Benjardin Gärtner

Traditional car makers should be capable of setting up mass production lines for electric vehicles that work efficiently and deliver reliably. This would enable them to tap into economies of scale relatively quickly, provided take-up grows at the same rate. The challenge for these companies is that their regular operations will have to support the setup of an initially loss-making business. Sufficient financial and organisational resources to cope with this transformation are therefore of the essence.

German and Japanese manufacturers that are already strongly represented in the market for electric vehicles are in a good position. They all have electromobility strategies in place that focus on platforms and economies of scale. In addition, they have solid balance sheets that provide them with the necessary financial latitude to invest in creating and developing expertise and innovation. After all, there are still many possible bumps in the road on the way to becoming an electric vehicle manufacturer. It is not yet certain, for example, which type of battery will come to dominate the mass market or whether fuel cells might yet win the race.

Shares in German car makers are relatively cheap and pay high dividends

The continued recovery of operating business and advances in the electric vehicle segment are the drivers of share prices in the automotive sector. Substantial share price increases are not expected in the foreseeable future because the shift to electric vehicles will put pressure on margins. But investors who buy shares in solid car manufacturers with strong balance sheets will also benefit from attractive dividend yields.

 

As at 27 October 2020