New technologies are set to revolutionise the autos industry and the transport sector, and in the process become one of the key investment themes over the coming years.

 

Commuting from the suburbs to the City of London in winter can be a dreary affair. You walk through damp, cold and dimly-lit streets; wait on a bleak platform, before crowding onto a train full of glum-looking souls. Passengers stand for the journey, cursing the cost of the season ticket. When the train arrives at Waterloo, commuters shuffle down the stairs into the Underground; only to be tortured by adverts saying a tropical beach lies just a few hours away.

The advent of new, disruptive technologies could soon liberate millions from this daily misery. Alessandro Rovelli, Senior Credit Analyst at Aviva Investors, believes it is conceivable to imagine a world where self-driving electric vehicles (EVs), packed with entertainment options, take commuters directly to their place of work. Passengers could work, watch a film or simply sleep during the ride.

The journey should theoretically be safer, as new technologies have consigned most car crashes to the past; environmentally-friendly; and potentially cheap enough to leave passengers with enough money to pay for that tropical holiday. Moreover, the vehicle will meet their passengers outside the office in the evening, whatever time they decide to go home.

Sound far-fetched? Not according to Rovelli, who says the technologies to deliver this vision are already in place and encompass three strands that will transform the auto industry and our lives in the coming years. They are: EVs; shared mobility; and autonomous driving.

An electrifying future

Tesla Motors of the US is driving the electrification revolution. “The company has created electric-only driven cars, replacing the internal combustion engine, which until now has been the only practical means of propelling a vehicle,” he says. Tesla is the first successful auto setup in the US since Chrysler in 1925 and already has a market capitalisation of just under half of Volkswagen, the world’s largest automaker[1].

The first electric cars were introduced more than 100 years ago, according to the US Energy Department. However, it is only recently they have become practical for general use.  Tesla’s chief executive Elon Musk believes 200 miles is the “minimum threshold” for broad public adoption of electric cars. While early EVs had a maximum range of around 50 miles, Tesla’s Model S can drive for 300 miles before it needs recharging.

Tesla’s strategy involves focusing on top-end cars first, before moving into the mainstream market. In the UK, the price of the current Model S ranges from £63,000 to over £100,000, according to Tesla’s UK website[2]. However, the Tesla Model 3, which will include full driverless options, is set to launch next year at a price of around US$35,000, according to Tesla, which will announce local pricing in 2017[3]. Demand for the Model 3 is strong, with 400,000 people putting down a US$1,000 deposit to reserve a Model 3 vehicle[4]. By comparison, VW sold 533,000 Golfs in Europe in 2015 - the continent’s most popular car[5].

Rovelli believes the price drop will “significantly boost sales, particularly in urban areas with strong refuelling infrastructure”. He adds that potential sales both in the UK and worldwide are huge. In Norway, as an example, EVs already account for around a quarter of passenger vehicles[6]. Significant tax breaks on the cars and major investment in charging infrastructure are driving the Norwegian revolution.

Government regulation will prove critical in promoting the transition to EVs. Norway and the Netherlands plan to phase out all fossil-fuel cars by 2025, while a draft EU directive, expected to come into effect by 2019, will require an EV recharging point to be incorporated in every new or refurbished house built in Europe[7].

Note: Plug-in hybrid electric vehicles and battery-electrics; light vehicles only. Excluding low-speed vehicles and hybrid electric vehicles without a plug. Battery prices are an average of battery electric vehicles and plug-in hybrid electric vehicle battery packs.

Source: Exhibit from “An integrated perspective on the future of mobility”, October 2016, McKinsey & Company, www.mckinsey.com. Copyright (c) 2016 McKinsey & Company. All rights reserved. Reprinted by permission. 

Bloomberg New Energy Finance

 

US charging ahead

Europe certainly needs to act to boost investment in technology. “Most of the best innovations in the automotive sector over the last 10-15 years or so have emanated from Germany, as well as Japan, but the centre of gravity is now shifting to the US,” says Rovelli.

Firms such as Tesla and Uber, based in Silicon Valley, are driving that change. Meanwhile, Apple has over a thousand engineers working on its auto ambitions, known as Project Titan, while Google has invested heavily in self-driving technology since 2009.

General Motors and Ford are also undergoing a transformation. The two US auto giants produced dull, conventional cars 10 years ago and both required US government bailouts during the global financial crisis. Today, they have embraced the new technologies. GM is on course to launch the first truly mass-market all-electric vehicle, the Chevrolet Bolt EV, towards the end of this year. It will cost around US$37,495 and have a range of 238 miles on a single charge[8]. Meanwhile, Ford is investing in self-driving cars with plans to produce fully autonomous vehicles for ride-sharing services by 2021.

The likes of Ford and GM have no option but to adapt. Rovelli believes some major automakers may struggle to survive unless they make rapid progress in EVs in the next year or so. “They won’t go out of business immediately, but as demand for EVs increases the likes of Fiat Chrysler, Groupe PSA, which includes the Peugeot and Citroen marques, and some of the smaller Japanese producers could well disappear over the next 10 years or so,” he explains.

Germany has most at stake. The country’s automobile industry, which accounts for around 20 per cent of German industrial revenues, produced over 15 million vehicles in 2015 – equivalent to more than 19 percent of total global production[9]. BMW already has an electric car, while Audi is launching one in 2018. 

The German government, one of the leaders of the global shift from nuclear to renewable energy, is likely to adopt an equally aggressive approach in promoting EVs. In October, the Bundesrat, which represents German states at the federal level, passed a resolution calling for a ban on combustion engine cars by 2030. The resolution received cross-party support.

However, governments face a quandary in promoting EVs. They gain significant revenues from fuel taxes, as well as speeding charges, road tax, and parking charges, but politicians don’t want to lose the green vote. “The authorities will have to think hard about how they replace revenues lost as part of the drive to EVs,” says Rovelli.

Oil-producing countries face the biggest challenge although the situation varies. “Norway is already such a rich country that it is not afraid of losing the income from the drive from petrol to electric cars. They are looking to a future, alternative economic model and are around 10 years ahead of most other countries. By contrast, Brazil, another major oil producer, faces significant economic challenges, including a very large budget deficit, and will be more reluctant to push for complete electrification,” explains Rovelli.

Shared mobility

Shared mobility is a far more familiar story than EVs thanks to Uber’s apparently infinite capacity to generate headlines, both good and bad. The rise of ride-hailing services from the likes of Uber and competitors such as Lyft, have already had a devastating impact on the US taxi industry. For the first time in the third quarter of 2016, for example, more business travellers in North America chose ride-hailing services than traditional taxis and rental cars, according to expense report software company Certify[10].

But these ride-hailing services also pose an increasing threat to car ownership, according to Rovelli, who argues the need for car ownership is diminishing. “This is as valid for a single person as a family. Uberisation will take place gradually in large cities, and will not wholly be a substitute car ownership. The problem for carmakers is that privately-owned cars are parked for 90 per cent of the time, while Uber cars are driven 90 per cent of their lives. This inevitably will result in lower sales of cars,” says Rovelli.

A study by the University of Michigan’s Transportation Research Institute (UMTRI) appears to support this view. It found that autonomous vehicles may reduce the number of vehicles a family needs, but may lead to an increase in total miles driven. The study was based on sharing of completely self-driving vehicles that employ a "return-to-home" mode, acting as a form of shared family or household vehicle. This would mean that driverless vehicles could operate without any passengers at all. In the most extreme scenario, self-driving vehicles could cut average ownership rates of vehicles by 43 percent—from an average of 2.1 vehicles to 1.2 vehicles per household, according to the UMTRI study[11].

Automakers are seeking to mitigate the threat by expanding into shared mobility. GM, for example, has bought a share in Lyft, while Volkswagen has acquired an Uber-like service called Get, an Israeli start-up. “We are likely to see increasing M&A activity as carmakers seek to develop their offering of shared mobility to influence these large volume buyers of cars,” argues Rovelli.

Not owning a car could bring big savings to individuals. The average cost of owning a car in Europe is about €6,000 a year, according to Robin Chase, co-founder of car-sharing business Zipcar Chase[12].

Autonomous driving

There are four levels of autonomous driving, according to the US Department of Transport, namely:

No-Automation (Level 0): The driver is in complete and sole control of the primary vehicle controls – brake, steering, throttle, and motive power – at all times.

Function-specific Automation (Level 1): Automation at this level involves one or more specific control functions. Examples include electronic stability control or pre-charged brakes, where the vehicle automatically assists with braking to enable the driver to regain control of the vehicle or stop faster than possible by acting alone.

Combined Function Automation (Level 2): This level involves automation of at least two primary control functions designed to work in unison to relieve the driver of control of those functions.

Limited Self-Driving Automation (Level 3): Vehicles at this level of automation enable the driver to cede full control of all safety-critical functions under certain traffic or environmental conditions, and to rely heavily on the vehicle to monitor for changes in those conditions requiring transition back to driver control. The driver is expected to be available for occasional control, but with sufficiently comfortable transition time.

Full Self-Driving Automation (Level 4): The vehicle is designed to perform all safety-critical driving functions and monitor roadway conditions for an entire trip. Such a design anticipates that the driver will provide destination or navigation input, but is not expected to be available for control at any time during the trip. This includes both occupied and unoccupied vehicles.

Rovelli believes the industry is currently at level two and anticipates major automakers such as VW, General Motors, Ford, BMW, as well as Tesla, will launch cars that can self drive “most of the time” in the coming years.  He adds “we are just waiting for the regulatory environment to catch up with technological developments. For example, who is responsible when a self-driving car collides with a manually-operated vehicle?”

There are numerous advantages to self-driving cars. Apart from liberating drivers, safety is a key advantage. “Autonomous-driving cars don't get angry or drink and drive, nor are they distracted by mobiles,” says Rovelli. Indeed, Pascal Demurger, director-general of French insurer MAIF, estimates that driverless cars will reduce accidents by around 90 per cent[13]. There were around 1.25 million road traffic deaths worldwide in 2013, according to the World Health Organisation[14]. By contrast, armed conflicts resulted in 167,000 fatalities in 2015, according to the International Institute for Strategic Studies[15].

Other advantages include giving new found mobility to the old, the disabled and teenagers.  It is difficult, however, to predict the impact on congestion. Some argue it will decline as driverless cars could result in a large fall in vehicle numbers while transporting the same number of people. Cars won’t spend time searching for parking spots or getting lost. However, there is an argument congestion will increase as people switch from public transport at peak hours. Fatigue or being occupied by another task won’t prevent you from sending your car to pick up shopping. 

Moreover, it could be argued that people will make more use of self-driving EVs, given their relative cheapness. The Energy Saving Trust, an independent organisation, says that a full charge of an EV will cost around £2 to £3 and will give a typical range of 100 miles. Driving 100 miles in a petrol or diesel car will cost around £9 to £13 in fuel, or around four times the cost of the electric car.  The Trust adds that as there are fewer mechanical components in an EV compared to a conventional vehicle, servicing and maintenance costs will be lower[16].

Autonomy and shared mobility are interconnected with Uber operating self-driving cars in a trial programme in Pittsburgh. However, the current self-driving Ubers always include a driver to address technical failures and unexpected situations. “Rather than owning a car, people may use an Uber-like service. Or they may decide to rent out their car so offsetting the cost of ownership,” explains Rovelli.

Safety concerns

However, Matthieu Rolin, US Equities Portfolio Manager at Aviva Investors, believes security issues pose a major threat to the successful launch of fully self-driving cars. He cites an incident in September when a team of Chinese security researchers took control of a Tesla Model S from a distance of 12 miles. Fortunately, it was an 'ethical hack’ and the researchers reported their findings to Tesla, which issued a software update to address the problem. However, Rolin believes the incident highlights the vulnerability of self-driving cars.

Investment implications

Rovelli recommends that investors adopt a cautious attitude to automakers given the uncertainty surrounding the implications of these trends. He believes investing in auto parts suppliers rather than final assemblers could be the best approach. “Automakers already face the burden of new environmental regulations and are investing heavily in EVs, self driving and shared mobility and that will hit profit margins,” says Rovelli.

Giles Parkinson, Equities Fund Manager at Aviva Investors, regards the car industry in general with scepticism. “Cars are not a good place to invest, as is evident from the low returns on capital.” However, he likes Amphenol, which supplies advanced interconnect systems for automotive safety devices and on-board electronics in cars. “Around a fifth of its business derives from the auto sector and the move towards EVs should boost sales.” Conversely, Parkinson is wary of companies supplying the diesel/petrol auto industry “given that EVs are clearly the future of the industry”.

Parkinson believes companies such as LKQ could be beneficiaries of the increasing complexity of cars. LKQ stands for Like Kind Quality and is the US legal term for the components of a vehicle that can be replaced by recycled parts, rather than those supplied by the original equipment manufacturer, when a car is involved in a collision. It is much cheaper to use the recycled parts. Although advances in technology, such as self-parking and the use of reversing sensors, means cars are less likely to collide, it is increasingly expensive to repair cars when they do. “For now these two offsetting trends are in balance, but if we reach a stage where cars hardly ever crash that would spell bad news for LKQ,” says Parkinson. 

Like Parkinson, Ed Kevis, European Equities Portfolio Manager at Aviva Investors, generally avoids the auto industry. “The sector is highly cyclical and the data suggests it has probably reached its peak in various parts of the world, including the US, and is characterised by generally outdated business models and highly variable margins,” says Kevis, who is also concerned about the “exceptionally high” debt levels related to auto financing in the US.

Moreover, European automakers are investing heavily to ensure their cars meet tight new Co2 emission targets, whilst also facing the disruptive challenge of self-driving autos, EVs and shared mobility. “Ultimately you could reach the stage where people no longer own cars, but just hail self-driving Ubers. On the other hand, there are many examples of industries where the regulators strive to protect the incumbents,” adds Kevis.

Kevis agrees with Rovelli that some carmakers may disappear in the coming years. “In some ways, Groupe PSA and Renault are better placed than BMW or Mercedes because the former build smaller cars with smaller engines than the latter. However, Groupe PSA, for example, operates on very thin margins and the increasing requirement to invest heavily in new technologies could result in operating losses. Ultimately it may not be able to generate enough cashflow to remain in business.”

Rather than carmakers disappearing, it is more likely we will see increasing M&A activity if that is allowed by the regulator. “Given that car markers are of national importance, would Berlin allow a French firm to take control of a German automaker?” asks Kevis.

He, too, prefers auto parts suppliers such as Continental of Germany over carmakers. “Continental is a high quality business and a beneficiary of the drive towards ever more complex cars,” he says.  “Historically, Continental’s profit margins have been much stable than that of the automakers and it has delivered higher returns.”

Kevis believes that while European carmakers, such as Renault, are investing heavily in EVs, Silicon Valley has skipped over that stage and focused on self-driving cars because that is the 'game changer' for the industry. “We already have EVs and hybrids, but self-driving cars are going to revolutionise the industry in the next 10 years as long as they can overcome the safety concerns.”

Computers on wheels

Rolin is focussing on companies such as NXP Semiconductors, which supply computer chips to auto companies. Cars have been transformed in the past decade in terms of their technological content and now contain features such as reversing sensors and cameras, as well as self-parking capabilities.  “Where once automakers competed on the quality of their engines and seats, now it is on the basis of their electronic componentry,” says Rolin. The more sophisticated the car, the higher the price it commands and the greater the profit margin for the automaker.

The stock prices of automakers are cheap for good reasons, adds Rolin, citing GM, which trades on just five times next year’s earnings. “Automakers are investing billions to keep pace with technological developments in EVs and self-driving cars, yet we still don’t know what the car industry will look like in 5 to 10 years time; whether the technology will prove successful or who the winners and losers will be.” Moreover, Rolin points out that Tesla, a new entrant to the auto sector, “builds incredibly impressive cars, which suggests that the long experience of the established automakers is essentially worthless”.

Rolin argues the entry of technology giants such as Google and Apple provides a further challenge. “Whereas the added value in a car once accrued solely to the likes of Ford or GM, in the future it is likely to be shared with Google and Apple. The problem is nobody knows what the breakdown of the value added will look like a decade hence,” he says.

 

 

[1] Thomson Reuters, November 18th 2016

[2] https://www.tesla.com/en_GB/new?model=ms

[3] https://www.tesla.com/en_GB/model3

[4] http://www.usatoday.com/story/tech/news/2016/10/18/buy-tesla-model-3-today-and-wait-until-2018/92363992/

[5] https://www.wired.com/2016/10/german-auto-industry-finally-maybe-done-gas/

[6] http://www.independent.co.uk/environment/climate-change/norway-to-ban-the-sale-of-all-fossil-fuel-based-cars-by-2025-and-replace-with-electric-vehicles-a7065616.html

[7] https://www.theguardian.com/sustainable-business/2016/oct/11/electric-car-charging-point-new-home-europe-renault

[8] http://www.chevrolet.com/bolt-ev-electric-vehicle.html

[9] https://www.gtai.de/GTAI/Content/EN/Invest/_SharedDocs/Downloads/GTAI/Industry-overviews/industry-overview-automotive-industry-en.pdf?v=10

[10] https://www.certify.com/PR-2016-10-20-Ride-Hailing-Accounts-for-Majority-of-Ground-Transportation-Expenses-Nationwide--In-Latest-Certify-SpendSmart-Report-for-Q3-2016

[11] http://www.umtri.umich.edu/what-were-doing/news/driverless-vehicles-fewer-cars-more-miles

[12] https://www.ft.com/content/042a04f0-958c-11e6-a80e-bcd69f323a8b

[13] https://www.ft.com/content/042a04f0-958c-11e6-a80e-bcd69f323a8b

[14] http://www.who.int/gho/road_safety/mortality/en/

[15] https://www.iiss.org/en/about%20us/press%20room/press%20releases/press%20releases/archive/2016-3b31/may-2fc6/acs-2016-press-release-b853

[16] http://www.energysavingtrust.org.uk/travel/electric-vehicles

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