Electrification's hidden winners

AB Dynamics (ABDP) is not a household name to anyone but Aim investors. Its services, however, provide an eerie glimpse into our possible future. Videos on its website show empty cars gliding along dual carriageways. One swerves effortlessly around a foam motorcyclist. Another stops inches from a dummy in the shape of a child. 

The group does not make vehicles – it simply tests them. As such, it is a second-hand beneficiary of the electric revolution, and the wave of new products it has ushered in. Attention is lavished on energy giants, battery makers and car companies, but as the world turns away from fossil fuels a host of unlikely businesses are also set to prosper, either as a result of shrewd foresight or simple good fortune.

AB Dynamics is a useful starting point. In many ways, the business hasn’t changed much since it was set up in 1982. It has been ensuring vehicles are safe for years, using steering and pedal robots to test-drive new models – hence the lack of humans. However, growth has been accelerated by the rise of electric vehicles (EVs) and the subsequent push to make cars perform more functions themselves. 

The group’s promising growth trajectory is “not so much to do with car volumes”, said Henry Carver, an analyst at Peel Hunt. “It’s more to do with the numbers of car models that need testing.” In this context, short-term sales movements are less important than long-term trends. 

As vehicles become increasingly autonomous, the amount of tests they must pass before hitting the roads also swells. In 2014, vehicles were subject to 44 test runs across six different scenarios. By 2020, this had increased to 263 tests across 39 situations. 

According to Carver, AB Dynamics is “essentially a unique offering”. No other company offers the “full gamut” of testing equipment across a car’s entire development cycle, he says. Bigger names could yet muscle in – Spectris (SXS) is one company that has a growing business arm in an adjacent area of automotive testing. But AB Dynamics' focus on growth at least looks to be on surer footing than some of the other richly valued companies whose share prices have been marked down this year.

Vehicle safety is a lucrative and burgeoning industry. And it’s not just about checking whether the brakes work. As more electronics are embedded into cars, manufacturers are enlisting the help of cyber security experts and ‘ethical hackers’ to ensure their products are digitally sound as well.  

'A computer on four wheels'

In 2015, a journalist from Wired – an American tech magazine – drove a Jeep down a public highway as two hackers seized control of the car. Music blared through the stereo, unbidden, the windscreen wipers went berserk and – as the journalist approached a hill – the accelerator stopped working. 

The incident was part of a ‘wireless carjacking’ experiment and the article that followed prompted a step change in security precautions, according to Damindu Jayaweera, a technology analyst at Peel Hunt. 

“Since then, all car makers have put security first,” he said. “The problem is that this is a fairly new area for manufacturers. They used to be all about the hardware – the mechanical bit – and not about the software bit.” But cars, he added, are essentially now "computers on four wheels".

Petrol and diesel vehicles can also be hacked, of course, if they have connectivity features such as internet navigation. The more electronics that are built into cars, however, the more exposed they become, and today’s cyber threats range from the weird to the terrifying. 

Andy Davis, transport director at NCC Group (NCC), a cyber security consultancy, argues that organised crime will most likely devote its resources to stealing data from within cars, or credit card details from charging points, as opposed to physically controlling vehicles. 

Andrew Tsonchev, director of technology at cyber security group Darktrace (DARK), echoes this, saying the “most realistic and imminent category of threat” is against charging stations. 

“It’s considered incredibly likely that we will soon see some kind of mass ransomware attack across EV infrastructure – particularly in the US,” he said. Such a situation, he noted, would resemble the Colonial Pipeline attack of 2021, which forced a temporary shut down of America's largest fuel network. 

Tsonchev says charging points could be used to attack the energy grid itself. Were the infrastructure to be hacked, he said, and erroneous signals sent to the grid, power supplies would be seriously disrupted. “People have shown you can quite easily launch a signalling attack, where you can knock out the grid because the automated systems stop responding to the signals.”

Such attacks are a major reputational risk for companies such as Pod Point (PODP), the stock market newcomer which develops and supplies charging equipment. Car makers will also be on high alert: Fiat Chrysler was forced to recall 1.4mn vehicles after Wired published the results of its experiment in 2015. Cyber security specialists are feeling somewhat cheerier, however.

“It is a massive source of growth for NCC Group,” said Davis, who works with car makers, component suppliers and infrastructure groups. “Car manufacturers would love to have internal cyber security teams. But there is a lack of cyber security skills. And the salaries of engineering teams are nowhere near aligned with those of cyber security consultants.” But precise figures on the extent of this growth opportunity remain hard to come by.

While the rise of electric vehicles has spawned a host of opportunities around customer safety,  however, it has radically stripped back the physical manufacturing process. An internal combustion engine (ICE) engine has hundreds of moving parts. In contrast, Tesla (US:TSLA) claims its electric motor has just one: the rotor. 

“The hybrid car is the most complex in terms of cabling,” said Sean McLoughlin, director of industrials and clean technology research at HSBC. “When hybrid peaks, input into the engine peaks, but then it starts to fade away again.”

“You have a whole ecosystem of suppliers that supply the automotive and truck industries with all the bits that go into the vehicles. Some are more challenged than others. The more you’re into the ICE part of the engines, the more you are existentially threatened by the move to electric.”

Nuts and bolts

Component manufacturers are urgently trying to get with the programme, but their fortunes highlight that simply cottoning on to a new trend does not guarantee success. Oxford-based TI Fluid Systems (TIFS) has at least made a good start: its fluid storage, carrying and delivery systems are in 37 per cent of battery electric vehicles (BEVs) launched in 2021, and it secured €427mn (£360mn) of ‘lifetime revenue’ bookings from BEVs in the first quarter of this year.

However, its ‘fuel tank and delivery systems’ arm – aimed specifically at petrol, diesel and hybrid cars – still generated 46 per cent of sales as of the end of last year, and revenue remains down on pre-pandemic levels. A turnaround story is certainly not impossible. But with inflation raging, freight disrupted and interest rates on the rise, it’s a very expensive time to rethink a manufacturing business. The company already has almost £1bn in borrowings, and investing for growth is not going to get any cheaper in the short term.

Castings (CGS) – which mainly makes iron castings for trucks – has the benefit of carrying no debt at all. It is also considering how to transition its business, albeit in a slightly different context. Its engine arm accounts for around a third of sales, but the company says some parts will still be able to be installed in electrical vehicles. Senior (SNR), which has a truck-product manufacturing arm that makes up a third of revenues, says similar. Both are also taking baby steps into different business lines. Castings is on the lookout for acquisitions to help widen the parts it can contribute to electric engines – but the company has little in the way of successful history when it comes to M&A. Senior has just signed its first contract to manufacture cooling systems for the motors of a commercial BEV for one of its suppliers.

But tensions between vehicle makers and suppliers are now beginning to rise, as higher costs start to bite at the same time as the industry starts to focus on electricification. At the end of June, Germany’s automotive industry association reportedly tried to broker peace between manufacturers and component suppliers after months of squabbling. The AlixPartners consultancy estimates that less than a third of the electric powertrain will be manufactured by existing suppliers in the future – with the rest done by new entrants to the market, or car makers themselves, seeking new work for employees and plants previously focused on ICE manufacturing. That could be a risk for the likes of Castings, whose customer base is relatively concentrated.

The balance of power is already starting to shift. AlixPartners suggests that while car makers have been able to increase their profit margins over the past two years, suppliers have seen theirs shrink, and the distribution of profits has been turned on its head. (See pie charts). 

For investors looking to cash-in on components, companies like TT Electronics (TTG), which has a fast growing ‘electrification & automation’ arm, or Volex (VLX) could be a safer bet. The latter – which makes plugs and cables – has shown particular promise. Its electric vehicles division almost doubled its organic sales year on year, and is now close to overtaking two of its larger segments. 

TT Electronics also operates outside of the car industry, working on power conversion technologies and ways to electrify military and commercial aircrafts. For, indeed, there is a world beyond automotives. Research by Deloitte found that a range of industrial sectors, from plastic makers to glassworks, want to electrify more of their equipment and fleets by 2050, spurred by regulation and internal targets. 

Canny consultants have realised that managers might need some help with this. Ricardo (RCDO), which started life as a designer of engines, now provides green consultancy services, and is striving to grow its environmental & energy division. Its strategy seems to be working: in the six months to 31 December, its eco order intake grew by 37 per cent year on year. The division accounted for 18 per cent of its total order book as of that date, up from 13 per cent the previous year. In keeping with its new focus, Ricardo last week sold off its software business, which mainly serves the ICE market.

For investors interested in this space, Inspired (INSE) is also worth a look. Inspired helps companies manage their power bills, quantifying their carbon output and selling energy efficiency advice. Growth has been solid so far, driven largely by its assurance arm, but energy ‘optimisation’ sales are starting to catch up, and are due to overtake assurance revenue in 2023. 

In the saddle 

While the heavy industry transformation happens behind closed doors, many electrification changes are already happening around us. In cities across the UK, cyclists are whizzing along unfeasibly quickly, powering up hills with suspicious ease. E-bikes – together with their unruly cousins, e-scooters – are in vogue. 

Strangely, however, cycling companies are not.

Birmingham-based Tandem (TND) designs, distributes and sells sports and mobility equipment. While its market data suggests demand for e-bikes is “set to grow significantly in the coming years”, Tandem is suffering from a post Covid slump. Across the group, revenue declined 31 per cent in the 24 weeks to 17 June 2022, with e-mobility sales falling by a quarter. 

Tandem’s larger rival Halfords (HFD) has run into similar difficulties. A weakening consumer outlook for bikes and cars has hit the retailer hard, and the group has forecast a fall in profits next year. Both companies have seen their shares fall steeply from pandemic peaks. 

It’s not all doom and gloom, however. Tandem’s e-mobility sales are still up 90 per cent compared with the first half of 2020. Meanwhile, sales of e-bikes, e-scooters and accessories at Halfords have risen by 74 per cent over the past two years. (EVs have also given the group a boost, with 140 per cent more electric cars brought to its garages for servicing in 2022 than 2021.)

Halfords remains popular with fund managers, too. In an interview earlier this year, Laura Foll, a portfolio manager at Janus Henderson Investors, singled the company out for its market-leading position, arguing that its size should aid future growth. With a forward price/earnings (PE) ratio of just 6.3 after a bruising six months – combined with structural drivers, including plans to legalise the use of privately owned e-scooters on public roads – it has its attractions.

Wheeler dealers 

E-bike retailers may be playing the long game, but car dealerships’ plans could be cut short by electrification – regardless of their current boom.

According to accountancy firm UHY Hacker Young, the profits of the UK’s top 20 dealership groups have risen more than sevenfold in the past year, from £105mn in 2019-20 to £764mn in 2020-21. 

This is reflected in the performance of several listed companies. Lookers (LOOK), for example, declared its first dividend payment in more than two years in April, while pre-tax profit at Vertu Motors (VTU) more than tripled in the year to 28 February 2022. Their success is largely a result of used car prices, which have been pushed up by a shortage of new vehicles, itself relating to a shortage of semiconductors.  

Going forwards, however, there’s a snag. “The automotive industry is trying to get a much more direct connection with its end customer,” said Neil Shah, director of Edison Group, an investment research and advisory company.

It started with Tesla – which sells directly to consumers – but more companies are turning to this model. In June, Ford chief executive Jim Farley told investors that all of its EVs should be sold online. “We’ve got to go to a non-negotiated price; we’ve got to go 100 per cent online. The vehicle…goes directly to the customer, 100 per cent remote pickup and delivery." Physical dealerships would come in useful for aftermarket services, he said.

HSBC’s McLoughlin noted a similar trend among heavy vehicles. "What we’ve seen is truck manufacturers talking directly to the customer, cutting out the middleman. Who might suffer? Well, the retail side. In cutting out the middle segment, [companies like] Volvo have a more direct relationship with the customer. But this middle segment may well need to adapt to new business models.”

US franchise laws make direct sales difficult for some car companies, and many believe that dealerships will remain an important touchpoint for customers. A survey by Bain & Co found 80 per cent of people still use physical dealerships when pondering what to buy.

There’s another problem, however. “Electric vehicles are far more simple in their make-up than a combustion engine and in terms of servicing them, there are far fewer requirements than a traditional vehicle,” Shah said. “So that’s the part of the business that the automotive dealers really need to think about.”

Analysis conducted by Investors’ Chronicle in 2020 found that aftermarket sales, such as car servicing and repairs, make up about 40 per cent of listed dealerships’ revenues, so this is no small problem – and no easy solution springs to mind.

Gridlock 

When you look beyond the obvious players, therefore, the repercussions of electrification are far-reaching – and often counterintuitive. While e-bike specialists endure bumpy terrain, companies like TI Fluid – which have spent years cooling petrol and diesel engines – are raking in new orders. But they too face plenty of threats, from rising costs to the risks of new competition. For investors, it is a case of weighing up the grinding force of change with the shape-shifting abilities of clever businesses.

There is something else to bear in mind, too: will we actually have enough electricity for all these eventualities to unfold? 

Demand for electricity as a proportion of global energy consumption is projected to rise rapidly in the coming years. McKinsey & Company predict that demand will more than triple, rising from about 83mn terajoules in 2020 to 252mn terajoules in 2050.

Last month, National Grid (NG) laid out plans for a £54bn upgrade to the UK energy network. However, according to reports, renewable energy developers are facing delays of up to a decade to connect new capacity to the grid. Elsewhere, even new housing developments are being thwarted by a lack of power. 

Shortages, a feature of so much of the modern corporate landscape, could still be with us in a fully electrified world. That, however, is a story for another day.