With traditional carmakers under intense pressure to cut emissions in the fight against climate change, investors are putting their money behind pure play electric vehicle producers. Alessandro Rovelli digs into the numbers to assess whether this trend is sustainable.
When it comes to the history of automobiles, there are two undisputable truths. First, they have fundamentally transformed societies; increasing the mobility and independence of individuals in a way that was previously inconceivable. Second, they have also been a major contributor to the biggest crisis facing the planet, climate change. And, despite all the efforts to cut greenhouse gas emissions (GHG) to meet the Paris Agreement targets to limit global warming, emissions in transport (with cars comfortably the biggest contributor) continue to grow.
Over the past three decades, while overall emissions in the US have increased 3.7 per cent, to 6,676.7 million metric tonnes of carbon equivalent (MmtC),1 transport emissions have increased by 23.3 per cent to 1,882.6 MmtC.2 At 28 per cent of total emissions, the sector has gone from being the third biggest contributor in 1990 (behind electricity generation and industry) to the biggest today.3
The same picture can be seen in Europe. Despite a 24 per cent reduction overall in GHG emissions since 19904 in the European Union, emissions from transport have increased by 33 per cent,5 with the proportion increasing from 15 per cent to 25 per cent.6 The prospects of that changing over the next decade aren’t much better – with projections that by 2030 emissions from transport will be anywhere between 17 and 32 per cent higher than they were in 1990.
Carmakers in the spotlight
It is little wonder then there is so much attention from consumers, manufacturers and policymakers on tackling the issue. But with seemingly slim prospect of people willingly giving up their right to own cars any time soon, the auto industry is locked in a fierce battle to deliver the new vehicles consumers demand – still big on performance, but less damaging to the planet. In one corner are the traditional industry behemoths, from Volkswagen in Europe to Ford in the US; in the other are the pure play electric vehicle (EV) producers, including the likes of Elon Musk’s Tesla in the US and its Chinese rival NIO.
The auto industry is locked in a fierce battle to deliver the new vehicles consumers demand, but less damaging to the planet
Investors are understandably paying close attention to the shift towards EVs, with a disconnect emerging recently over who they are favouring, as highlighted by the contrasting stock market experience of Tesla and Volkswagen in the past year.
In 2020, Tesla’s share price rose by 690 per cent, from $88.60 to $699.99, an astonishing surge for a company rated BB/B3 by S&P and Moody’s and which has never reported an annual profit in its history (although that may change when its full year 2020 results are announced).7
VW, meanwhile, saw its share price fall 1.8 per cent, from €173.25 to €170.10 – this was despite reporting a big expansion in its own electrification efforts. The German car giant produced over 130,000 EVs and 210,000 electrified cars (including hybrids and plug-in hybrids) – up 197 per cent and 158 per cent on the previous year. These numbers are a fraction of where VW says it can get to – the company expects to produce one million EVs a year by 2023 – so why doesn’t the market seem so convinced of its, or other traditional automakers, prospects? It’s worth delving deeper into the numbers for clues.
The froth on top
No single area offers greater opportunities for deep decarbonisation than electric power. The use of electricity does not increase or reduce emissions in itself; electricity delivers energy that may or may not be clean depending on how it was generated. An electric car, for instance, doesn’t do much good against global warming if all the electricity comes from conventional coal plants.
Transportation accounts for 27 per cent of global energy use and nearly all of it relies on oil
Overall, transportation accounts for 27 per cent of global energy use, and nearly all of it relies on oil. The car industry has had some success in changing this: the latest EVs rival high-end conventional cars in performance and cost. Electric cars now make up almost 10 per cent of new sales in California (although only two per cent across the US as of December 2020) and nearly 56 per cent in Norway, where the government offers massive subsidies to buyers.
As we have illustrated through the example of Tesla, capital markets voted strongly in favour of EV producers. The market capitalisation of Tesla went up by more than seven times in 2020, even though many sell-side analysts had already called its 2019 multiples ‘frothy’. Figure 1 shows Tesla’s market capitalisation three years ago versus today, compared with the total market capitalisation of the top five European carmakers (VW, BMW, Daimler, Renault, Peugeot).
Figure 1: 2017-2020 automotive market capitalisation – Tesla versus the European ‘Big Five’ (US$m)
The smartphone comparison
Tesla’s market capitalisation has become almost 13 times bigger, compared with a 17 per cent drop in the market capitalisation of traditional auto manufacturers. This example of overtaking is even more dramatic than the one that saw Apple catch up with Nokia around 14 years ago, shortly after the launch of the iPhone, as Figure 2 highlights.
Figure 2: Apple and Nokia’s market capitalisations, 2000-2009 (US$bn)
The iPhone heralded a new disruptive technology, the smartphone, which overtook the traditional feature phones produced by Nokia in six short years.
Figure 3: Mobile phone units sold, 2007-2019 (bn)
In contrast, most forecasters currently expect EV’s global market share to reach just 20 per cent in the next ten years (as shown in Figure 4), a much-lower penetration than smartphones have achieved since the first iPhone was sold.
Figure 4: Expected share of global auto sales by type of engine, 2020-2030
Who is the leader in EVs? It’s complicated….
However, as we have mentioned previously, markets seem to believe a different story. Comparing Volkswagen with Tesla shows Tesla only overtook the market leader in terms of market capitalisation in 2019, followed by a stunning acceleration in 2020.
[As an aside, the performance of bonds issued by Tesla and VW tells a different story, one that is closely correlated to their respective credit ratings (BB/B3 from S&P and Moody’s for Tesla; BBB+/A3 for VW). In mid-January 2021, Tesla’s $1.8 billion 2025 bond was yielding around 2.7 per cent in the secondary market; VW bonds of the same maturity were yielding around 1.2 per cent].
Figure 5: Tesla and Volkswagen market capitalisations, 2010-2020 (US$bn)
Meanwhile, Figures 6 and 7 show that Tesla still sells just a fraction of the vehicles sold by the largest five European carmakers. Moreover, the European Big Five recently achieved a larger global market share than Tesla itself in EVs.
Figure 6: Vehicles sold, 2017-2020, Tesla versus the European Big Five
Figure 7: Global market share, 2017-2020, Tesla versus the European Big Five
While Tesla does not have to spend much money to reconvert old internal combustion engine (ICE) plants into EVs, it does need to spend money to scale up. It could easily raise capital at current funding levels, however, and has taken full advantage of this option. In late 2020, Tesla raised $5 billion in cash through an equity capital increase. At this pace, it could easily outspend peers as it internationalises and scales up its production capabilities.
Figure 8 shows Tesla’s net fixed assets against those of the European Big Five. According to estimates from Continental AG and Bloomberg New Energy Finance, 80 per cent of cars sold in 2030 will still have an ICE, making it unlikely that all the Big Five’s assets will become stranded. In addition, converting a plant from ICEs to EVs is costly, but not as punishing as writing down a coal mine or an expensive oil project for an energy company.
Figure 8: Net fixed assets, Tesla versus the European Big Five (US$m)
New threats from familiar names
Tesla is not alone in commanding what seem to be expensive multiples. Many other new EV companies or start-ups are trading at multiples traditional carmakers can only dream of. Figure 9 shows that Tesla’s equity valuation stands at just over 14 times its one-year sales forecast, but other EV start-ups are trading at even higher multiples, while the European Big Five show a multiple of just 0.4 times.
Figure 9: Ratio of equity valuations to one-year sales forecasts
The jury is out for what will happen in the coming year to EV producers and traditional carmakers; however, both may face pressures from new challengers, but familiar names. Apple and Amazon seem increasingly likely to start building their own EVs to seize new opportunities in the mobility market and, for Amazon in particular, to control its delivery costs and carbon dioxide emissions.
Figure 10 compares the market capitalisations of Apple, Amazon (potential entrants), Google and Tesla (already playing in the mobility space) against the European Big Five. The Silicon Valley giants have enormous financial resources and if they begin manufacturing vehicles at scale, they could squeeze traditional manufacturers’ market share and margins.
Figure 10: Market capitalisation of potential and emerging entrants versus the European Big Five (US$m)
The great technological transformation of the nineteenth century was to harness the power of fossil fuels for industrial growth. The twentieth century rode the wave of innovation that followed, and inadvertently put the planet on track for massive warming. The defining industrial project of this century will be to leave carbon behind.
Traditional carmakers have a fighting chance of catching up to new players like Tesla if they move decisively and rapidly
As the automotive industry embarks on this enterprise, financial markets are seeking to price in the winners. Replacing horses with cars took about 30 years, from 1900 to 1930. Replacing feature phones with smartphones took six years. EVs replacing ICEs may be somewhere in between, given the rapid pace of technological change and the massive sums being invested in renewables and EVs. Traditional carmakers have a fighting chance of catching up to new players like Tesla if they move decisively and rapidly, but until they do, there are reasons to remain cautious on their long-term prospects.