Picking the winners of the electric vehicle revolution

Global sales of electric vehicles (EVs) have slowly been taking off in recent years. While there were only around 17,000 electric cars on the world’s roads in 2010, this had swelled to more than 10m last year. Further momentum is likely to come as governments get more serious about tackling climate change. As they look to decarbonise road transportation, there has been a policy shift away from internal combustion engine (ICE) vehicles towards encouraging people to switch to EVs. For example, the UK brought forward its ban on the sale of new petrol and diesel cars to 2030, to help meet the country’s 2050 net zero emissions target.

Right now, global EV penetration remains low, accounting for just 4 per cent of new light vehicle sales last year. It was slightly higher in the UK at 6.6 per cent, although this was flattered by the Covid-induced slump in demand for petrol and diesel cars. Norway is currently the only country where sales of new EVs have overtaken those of conventional cars.

Moving forward, this looks set to change. Bloomberg New Energy Finance (BNEF) foresees an inflection point in 2037, when EVs will account for more than 50 per cent of new vehicles sold. While EV momentum has thus far largely been driven by China, European EV adoption is also set to grow considerably. The US has been a relative laggard, but impetus could come with a new administration in Washington. President Biden has promised to offer rebates that encourage consumers to switch to cleaner vehicles, and to create 500,000 more EV charging points by 2030.

Investors have previously been sceptical about the promised EV revolution, but there seems to have been a general acceptance over the past year that EVs are the future of road transportation. Amid the excitement over the prospect of consumers switching to EVs en masse, EV stocks have been soaring, and one company in particular has been doing very well indeed – Tesla (US:TSLA).

Tesla: Looking under the bonnet

Tesla is the biggest name in the EV space right now, ahead of both other pure-play EV makers and the traditional car manufacturers. Having put its “production hell” behind it, its vehicle deliveries reached 499,550 in 2020, just shy of its 500,000 target. This was enabled by the ramp-up of production at its new Shanghai plant and the launch of the Model Y.

The Allianz Technology Trust (ATT) has Tesla as its number three holding and the fund’s manager, Walter Price, points to the company’s six-year lead versus its competitors and efforts to drive down costs. “I think the thing that isn't appreciated about Tesla is the growing profitability of its new facilities,” says Mr Price. “By moving to China, [it has] gone from basically the highest cost plant in the world in Fremont, California, to one of the lower cost plants in the world, in Shanghai.”

But while Tesla has strung together five consecutive quarters of net profit, this has relied heavily on the sale of regulatory credits that helps less climate-friendly automakers meet their emissions targets. And then there’s a question of valuation. Tesla’s shares have defied gravity over the past year, partly fuelled by the enthusiasm of retail investors. Currently trading at a whopping 227 times consensus 2021 earnings, there are fears that it is in the throes of a bubble.

“When you're talking about valuation, starting points are important,” says Michael Pye, investment analyst at Baillie Gifford, which is Tesla’s third largest institutional shareholder. “I think that earlier on, the company was catastrophically undervalued, and then there was this belated realisation of the inevitability of electrification and Tesla's role in it. What you're seeing is the market kind of belatedly recognising that and saying ‘oh, wow, okay, this is really happening’.”

The market seems to be assuming a future where Tesla completely dominates the EV space, and that’s not assured as the competition ramps up. Indeed, this is the reason why Polar Capital Technology Trust (PCT) only has a “modest position” in Tesla. “We’re a little bit worried about the competition, which is starting to catch up,” says Paul Johnson, investment analyst at Polar Capital Technology Trust. “In Europe, if you look at the November sales data, the Renault Zoe, VW ID.3 and the Hyundai Kona actually outsold the Tesla Model 3.”

Still, right now, it doesn’t seem as though anything can bring Tesla’s shares down – not even issues with its vehicles. The company recalled nearly 50,000 Model S and Model X vehicles in China last year due to potentially faulty suspension and has also been asked by the US National Highway Traffic Safety Administration (NHTSA) to recall 158,000 vehicles due to possible safety issues with its touchscreen displays.

Consumer group Which? conducted a survey of almost 50,000 UK car owners last year and found that Tesla was considered to be the second worst brand for reliability behind Land Rover. Some models experienced “disastrously high fault rates and lengthy garage stays”.

But given what we have seen, it would be a brave investor who bets against Tesla at this point. For all the doubters, it is Elon Musk who is the richest person in the world right now.

An EV gold rush

Tesla is the apex predator of the EV world, but competition is hotting up, particularly in China, the world’s largest auto market. Tesla accounts for around of fifth of EV sales in China, but thanks to government support, we have seen the rapid emergence of many homegrown Chinese EV companies, including Nio (US:NIO), Alibaba-backed XPeng (US:XPEV) and Li Auto (US:LI).

Nio leans more towards the luxury end of the EV market and has seen a lot of investor enthusiasm over the past six months as people look to it as the ‘Chinese Tesla’. According to trading platform eToro, Nio surpassed Tesla to become the most popular stock among global retail investors in October.

Institutional investors are fans as well – the company’s top shareholder is Baillie Gifford, and Nio is the number five holding of the Scottish Mortgage Investment Trust (SMT).

“What you've got with Nio is a company that is effectively trying to create a premium Chinese lifestyle brand,” says Mr Pye. “They’re not just looking to produce a nice electric vehicle, they have a much broader vision around car ownership with battery swapping, insurance and access to so-called ‘Nio houses’ – a kind of members' club.”

But it is still some way off catching Tesla, having only delivered around 44,000 vehicles in 2020 – although this is more than double its 2019 total. The company has also yet to turn a profit, recording a $139m (£102m) operating loss for the three months to 30 September. Analysts are predicting that Nio will swing into the black in 2022.

It’s also worth noting that the company was in dire straits last year, teetering on the verge of bankruptcy. It received a $1bn cash injection from the provincial Chinese government in April and a $1.5bn credit line from six Chinese banks in July. Nio raised a further $1.5bn from a convertible bond offering earlier this month as it looks to fuel further growth.

Still, it is creating a buzz with its first saloon car, the ET7, which is promising an “extra-long range” of 620 miles. While Nio currently operates exclusively in China, it has set its sights on expansion into Europe.

Having listed in 2018, Nio does, at least, have some form of track record. But as fledgling start-ups look to ride Tesla’s coattails, there has been a flurry of new EV listings via so-called ‘special purpose acquisition companies’ (SPACs) – a sort of backdoor route to market that typically involves less scrutiny than a traditional IPO. EV companies that have used this process over the past year include Nikola (US:NKLA), Fisker (US:FSR) and Lordstown Motors (US:RIDE).

Investors have jumped on these SPAC listings for fear of missing out on the next Tesla. “You've got a real kind of hype cycle around electrification, and any company of whatever quality that's involved in that space sees an opportunity to take advantage of some of that capital and become a public company,” says My Pye. “That doesn’t mean there aren’t some high-quality companies, but I would be cautious about the asset quality of some of those businesses.”

Indeed, while many of these SPAC listings have seen their share prices take off, they are highly risky investments – these companies are typically lossmaking, burning through cash and sometimes yet to book any revenue. Investors are buying into a vision with no evidence that it will be turned into reality.

Nikola is a cautionary tale of getting caught up in the SPAC mania. The electric and hydrogen truck maker went public in June last year to much fanfare, but its shares came crashing down after a short seller report from aptly named Hindenburg Research alleged that it is “an intricate fraud built on dozens of lies”. The US Securities and Exchange Commission (SEC) and Department of Justice have since opened investigations into the company and founder Trevor Milton has stepped down as chairman – although he has disputed Hindenburg’s claims.

Fisker sounds promising, with its asset-light business model that focuses on vehicle design and outsources production. But it has yet to sell a single car and the first deliveries of its Ocean SUV – which is being billed as “the world’s most sustainable vehicle” – are not slated until the fourth quarter of 2022. Even so, it has a market cap of $4.1bn.  

It is questionable how much headway these new EV start-ups can make and whether they will be able to ramp up production quickly enough and at scale to be cost competitive.

“I think the EV market is going to be dominated by the large car companies and Tesla,” says Mr Price. “In my view, the small companies are very unlikely to be successful.”

The old guard hits back

Having built their entire operations around the internal combustion engine, traditional carmakers are now hoping to catch up with Tesla before it is too late. The fact that they are now urgently shifting their attention to EVs is perhaps a validation of investor excitement around this space. 

As it looks to leave the vehicle emissions scandal firmly in the rear-view mirror, Volkswagen (DE:VOW3) has perhaps been pushing the hardest. It intends to spend €35bn (£31bn) on battery EVs over the next five years and launch 70 all-electric models by 2030. According to data from EV-volumes.com, VW sold the second largest number of EVs behind Tesla last year, and its new ID.3 car was also one of the most popular EV models globally.

Progress in Europe has been encouraged by European Union (EU) rules introduced last year mandating that carmakers’ average fleet-wide carbon dioxide emissions do not exceed 95 grams per kilometre. Because companies can earn and trade emissions credits, sales of EVs are critical to balancing the emissions from their other vehicles. Government support was also helpful – as part of its Covid recovery plans, Germany doubled its EV subsidy, meaning consumers can now get a discount of up to €9,000.

Meanwhile, looking to usurp Tesla in North America, General Motors (US:GM) has increased its budget for EV development by more than a third to $27bn through to the end of 2025 and is aiming to bring 30 all-electric vehicles to market by then.

But can the old guard mount a serious challenge to Tesla, or has it left it too late?

“There are 100 auto companies in the world, so, chances are, some of them are going to be successful in making the transition to EVs because they understand how to make a quality car,” says Mr Price. “They're not catching up with Tesla in 2021. I think in 2022 you will see some of these companies start to catch up. My money is on the Koreans and the Germans. I think Volkswagen is super serious as well as Hyundai/Kia.”

Increased competition is good for the consumer, providing more choice and helping to drive down prices. David Harrison, manager of the Rathbone Global Sustainability Fund (GB00BDZVKD12), believes that the industry heavyweights’ experience should not be underestimated. “There’s a difference between doing low volume and doing it repeatedly well, and what the traditional automakers are very good at, which is once they introduce something new to their line-up being able to roll it out at an industrial scale around the world.” Mass production will be key to making EVs more affordable.

But it is likely that not all car companies will survive the EV transition, meaning there could be further industry consolidation. We could even potentially see Tesla acquire one of the incumbents. “We’re definitely not going to launch a hostile takeover,” said Mr Musk in an interview at the Axel Springer Award ceremony in December. “But if somebody said ‘Hey, I think it might be a good idea to merge with Tesla’, we’d certainly have that conversation.”

Look further down the supply chain

Rather than trying to predict which EV maker will come out on top, it is worth looking at investment opportunities elsewhere in the supply chain, particularly as the line between the auto and tech sectors becomes more blurred. With the proliferation of technology, semiconductors arguably now make the world go around and the auto industry is no exception – computer chips are essential components for everything from a car’s power steering to its infotainment system. German semiconductor manufacturer Infineon (DE:IFX) estimates that there is on average $434 of semiconductor content per ICE vehicle, rising to $834 per EV.

Infineon is a popular pick among funds such as the Allianz Technology and Polar Capital Technology Trusts. Thanks to the acquisition of fellow semiconductor maker Cypress, it is now the top automotive semiconductor supplier and its customers include major car parts makers such as Bosch (US:BOSCHLTD) and Continental (DE:CON). It is providing chips for several EV models that are ramping up production, including the VW ID.3.

STMicroelectronics (FR:STM) is another fund manager favourite thanks to its silicon carbide technology, which is being used by the likes of Tesla. “Silicon carbide is the next generation of power semiconductor technology and is suited to high-voltage applications like fast charging,” explains Polar Capital’s Mr Johnson. “The energy efficiency is significantly higher compared with traditional silicon, so it’s going to enable EVs to operate over longer distances and be more energy efficient.”

Mr Harrison prefers to hold semiconductor equipment maker ASML (NL:ASML) in the Rathbone Global Sustainability Fund rather than the semiconductor manufacturers themselves, as “from experience, the semiconductor cycle can be very volatile”. 

“We've owned ASML, the Netherlands-listed business for a long time,” says Mr Harrison. “We like that it supplies all the chip companies – Samsung, Taiwan Semiconductor – and they’ve got a 90 per cent market share in next-generation technology. We believe, and have for a long time, that the market drastically underestimates the opportunity set because it supplies all these companies.”

The car industry has recently been hit by a chip shortage, forcing automakers such as Daimler (DE:DAI), Honda (JP:7267) and VW to curb production. The supply squeeze comes amid surging consumer demand for phones, computers and videogames during the Covid-19 pandemic and as automakers made overly conservative estimates of their chip needs.

Original equipment manufacturers (OEMs) typically order semiconductors six to nine months in advance. Having underordered at the height of the pandemic when their plants were shuttered, they have now been caught out as demand has been a lot stronger in the fourth quarter than they anticipated. “That's beneficial for the likes of Infineon and STMicroelectronics because it means that their fabs are going to be fully utilised and they’re going to be able to get better pricing as well,” says Mr Johnson. “They're in a sweet spot at the moment, I'd say.”

But while he expects the supply squeeze to ease by the second half of this year, Allianz Technology’s Mr Price thinks the shortage will continue for longer. “I think to get out of the shortage, it's going to take probably two years,” he says. “So somewhere in 2022, even if you start adding capacity today.”

It’s not all about semiconductors. TI Fluid Systems (TIFS) is seeking to capitalise on the electrification of road transport. While it currently provides €50-€150 of products per EV, it is hoping to reach over €200 by introducing new thermal products that help keep components cool and increase efficiency. 

Meanwhile, one-stop testing shop AB Dynamics (ABDP) should find its services in higher demand as OEMs look to ensure that their EVs meet regulatory standards. With the industry’s largest digital library of the world’s roads, its simulation software should also be able to capitalise on the journey towards autonomous vehicles. 

Lisa Chai at Robo Global suggests looking at the EV manufacturing process as well. For example, the need for more inspection cameras to monitor product assembly should benefit machine vision business Cognex (US:CGNX). She also points to ABB (CH:ABBN) which “produces the robots that manufacture traditional cars. But you still need those robots to manufacture electric vehicles. They also have a robotic guidance control that's one of the best, and they work very closely with lots of the automakers.”

EVs are just one part of the story

Mass uptake of EVs will depend on more than just the vehicles themselves. As well as the cost of buying an EV, another key reason why consumers choose not to make the switch is ‘range anxiety’ – the fear of running out of charge mid-journey and being unable to find a nearby charging point.

Without sufficient charging infrastructure, EV ownership is impractical. It is a classic ‘chicken-and-egg’ dilemma – people are unlikely to purchase EVs if they don’t have reliable access to charging facilities when out and about, and companies will shy away from investing in charging infrastructure if there are too few EV owners.

According to the International Energy Agency (IEA), there were around 7.3m charging points worldwide in 2019, the vast majority of which were private, slow chargers situated in homes and at workplaces. Publicly accessible chargers only accounted for 12 per cent of the total.

In the UK, around 40 per cent of households do not have a driveway or access to off-street parking where they can charge their EV overnight. This means that they would be reliant on charging points in public places. According to mapping service Zap-Map – which is majority owned by Good Energy (GOOD) – there are currently 37,035 public charging points in the UK. But it is a postcode lottery with urban and more affluent areas typically enjoying better coverage.

While the number of charging facilities has been increasing, there is still a long way to go. SMMT estimates that at least 2.8m new public charging points will have to be built by 2035, costing £16.7bn and equivalent to 507 new charge points being added per day. The government has pledged to invest £1.3bn to accelerate the rollout of charging points – both public and private – across the country, but councils are dragging their feet, both due to lack of funding and expertise.

Research by Centrica indicates that local councils are planning to install an average of just 35 electric car chargers each by 2025, with more than 100 councils having no plans to install any new charging points by then. There is a clear regional disparity, with councils in the south of the country planning to install 2.5 times more electric car chargers than those in the north.

As well as availability, it is also a question of speed. The majority of the UK’s public charging points are currently ‘fast’ chargers, which aren’t actually all that fast – they can take anywhere from one to six hours to charge your car and can also suffer from compatibility issues. What is needed is more ultra-rapid charging points where the charging time can be brought down to as little as 20 minutes. This is still more disruptive to a journey than the short break needed to fill up a tank with petrol or diesel, although charging times could improve further as battery technology advances. Israeli start-up StoreDot is hoping that by 2025 a five-minute charge of its batteries will enable an EV to travel 100 miles.   

To make matters worse, there is also a lack of standardisation across the UK’s public charging points with the need for multiple membership cards or separate apps to use the facilities provided by different companies. Zap-Map is trying to increase accessibility by enabling drivers to use a single app to pay for charging across different networks.

The complicated set-up is due to the UK’s charging market being so fragmented. The largest provider is currently ubitricity – which has just been snapped up by Royal Dutch Shell (RDSB) – with a 13 per cent market share, followed by BP’s (BP) ‘bp pulse’ network, which is the UK’s biggest ultra-fast public charging operator. bp pulse is aiming to have 700 ultra-fast chargers installed across the UK by 2025, doubling to 1,400 by 2030. But this is a very small part of BP’s overall business, meaning there is little rationale to invest in the oil and gas major just to take advantage of rising demand for EV infrastructure.

There aren’t many opportunities to invest directly in EV charging. Mr Harrison is a fan of Dutch company Alfen (NE:ALFEN), which specialises in both smart grid technology and EV charging points. “It’s one of the businesses that we’ve found that plays into the EV infrastructure rollout story really well,” says Mr Harrison. “They’re the leader in Holland in EV charging points, and if you look at what they’ve done in Holland, they can replicate that around Europe. There’s going to be a lot more capital put into EV infrastructure over the long run.”

There could be another option to come as well. The UK’s number three player, Pod Point – which is owned by French energy giant EDF (FR:EDF) – is rumoured to be drawing up plans for an IPO.  

The race for battery supremacy

Batteries are the most expensive part of an EV and therefore the main barrier to producing a car that is as affordable and profitable as a comparable ICE vehicle.

“One of the things that troubles me the most is that we don’t yet have a truly affordable car, and that is something that we will make in the future,” said Mr Musk at Tesla’s ‘Battery Day’ in September. “But in order to do that, we’ve got to get the cost of batteries down.” As the company aims to more than halve the cost per kilowatt hour (kWh) of its batteries, it says it will be able to introduce a $25,000 vehicle in around three years’ time.

Tesla’s actual cost per kWh is a closely guarded secret, but energy consultancy DNV GL estimates that it is around $125/kWh. The company’s planned reduction would therefore bring this down to $55/kWh, which is well below the $100/kWh threshold at which EVs are assumed to reach cost parity with ICE vehicles.

Tesla currently purchases lithium-ion batteries from Chinese manufacturer Contemporary Amperex Technology (CN:300750), South Korean rival LG Chem (KR:051910) and Panasonic (JP:6752). But it is also shifting to making its own ‘tabless’ batteries in-house at its gigafactories, which it says will help bring downs manufacturing costs.

EV batteries are a work-in-progress, with some companies focusing on realising the so-called ‘million-mile battery’, while others such as QuantumScape (US:QS) and Ilika (IKA) are going down the solid-state battery route instead. This is a next-generation lithium-ion battery which uses solid electrolytes rather than the liquid ones found in conventional cells. They are much more efficient and offer the potential to lengthen the range of EVs and reduce charging times. But this technology is at the experimental stage, with potential commercialisation still some way off.

Battery boom round II

By the time it was clear EVs would eventually replace ICE vehicles – around five years ago – a mad rush saw prospectors scramble to get their hands on plots of land with the slightest hint of battery metals. The key materials for EV batteries are lithium, nickel, graphite and cobalt. Different battery styles use these in varying proportions.  

As the boom began in 2015 and 2016, old nickel projects with trace amounts of cobalt were held up as solutions to the world’s reliance on supply from the Democratic Republic of Congo (DRC), while tiny markets like graphite were overwhelmed because new supply came far too early. Former gold and copper explorers also swiftly jumped on the lithium bandwagon.

A few years ago, analysts predicted some or all of these metals would soon be in short supply. Miners reacted accordingly, and the prices for all of these metals bar nickel crashed. Cobalt went from $90,000 a tonne in 2018 to a third of that within a year – where it stayed – while new lithium mines in Australia were suspended or had production cut soon after opening because of the glut of supply. Investors in this first wave either picked the bubble and got out, or stayed for losses of around 80 per cent between 2018 and 2020. 

Some, like Pilbara Minerals (AU:PLS) and Neo Lithium (CA:NLC), have now eclipsed their 2018 highs, but others such as Bacanora Lithium (BCN) and Savannah Resources (SAV) on London’s Aim market are not there yet. The biggest casualty of the crash was Nemaska Lithium, a Canadian hopeful that drew in mainstream investors like SoftBank (JP:9984) but collapsed in 2019. It has since been taken private, but the process saw shareholders lose everything.

Now we are coming into the second ramp-up of the energy metals space. The company valuations could be more solid this time, given the increase in EV uptake and governments around the world bringing in bans on ICE vehicle sales. Lithium and cobalt prices have already picked up. Mining and refining company Sumitomo Metal Mining (JP:5713) predicts that the overall size of the battery materials market will go from around $20bn in 2019 to $36.6bn in 2025.

An EV battery with current ‘nickel manganese cobalt’ chemistry – called NMC 622 – requires just under 2 kilograms of metals per kWh, largely nickel and copper. A standard new VW ID.3 has a 58kWh battery, so these volumes are already significant.

It may not be a smooth ride to EV supremacy for the miners, however. Once they reach production, they become part of a complex supply chain that requires midstream processing and demand from battery manufacturers. The traditional route of juniors could also be at risk as midstream companies get more and more involved in the development process. Elon Musk has even said Tesla would build its own lithium mine in the US. 

The changing expectations of consumers also means supply chains will come under greater scrutiny than ever before. Savannah chief executive David Archer told Investors' Chronicle that this works in his company’s favour, given its proposed mine is in Portugal. 

“The real challenge for the cell manufacturers is securing a reliable, low-carbon footprint supply of battery metals and preferably from a supply source that has suitable provenance,” he said. 

“Producing lithium in Europe is a whole lot more appealing [for the European manufacturers].” 

But the midstream part of the industry, where the lithium is processed into the precursor chemical form needed by battery manufacturers, is not yet developed. Mr Archer said that by the time his mine is in production in 2023, there will likely be local demand. The company also needs to get through the difficult financing stage, where junior miners often see their share prices come down despite getting closer to production.

Finding the $100m or more needed – an updated figure will come in this year’s feasibility study – will be helped by possible new investor Galp Energia (PT:GALP), which this month signed a heads of agreement to take a 10 per cent stake in Savannah’s project, Mino do Barroso. 

Savannah is not the most advanced lithium company in London, but there is not a competitor far enough ahead that lithium production will come this year. Bacanora Lithium has had a project ready to build for some time, but was trying to raise its build costs just as the lithium market was tanking, and now Ganfeng Lithium (HK:1772) is redesigning its mine and plant in Mexico.

London’s lithium options are limited compared with the Americas, Asia and Australia. In the Americas, that means Albemarle (US:ALB) and Sociedad Quimica y Minera de Chile (US:SQM) – which is a top 10 holding of BlackRock Frontiers Investment Trust (BRFI) – and in Australia, the hard rock miners that flooded the market from 2017 include Pilbara Resources and Mineral Resources (AU:MIN). China, Japan and Korea offer more midstream and battery maker investment opportunities.

There are also some investment angles within the diversified majors. Rio Tinto (RIO) is working towards an investment decision on the Jadar lithium mine in Serbia, which would blow European demand out of the water. It would only be in production near the end of the decade, however. Glencore (GLEN) is in a powerful position through its cobalt production in the DRC, while its copper and nickel production are also critical for the energy transition.

Cobalt production in the DRC is one of the most widely known difficulties of the sector, because of child labour on the artisanal side of the industry. It’s not squeaky-clean on the industrial side in the DRC, either. In early 2019, a truck full of acid on its way to a Glencore mine crashed and killed 21 people. There are also the various investigations into Glencore behaviour taking place in the UK and US if an investor is keen to include environmental, social and governance (ESG) factors as part of an investment decision.

The stable, midcap, dividend-paying miners that are present in London in the gold and copper sectors just aren’t there for energy metal pure-plays. The safer option, then, is picking out a fund or ETF with overseas exposure and a high-risk, high-reward option is a dive into the speculative junior mining space.

‘The electric decade’

EVs may seem like just the hot investment topic du jour, but this is really a long-term trend that will continue to generate exciting opportunities for investors as it unfolds over the next 20 years or so – not just in terms of the EV makers themselves, but across a wide variety of sectors.

“What we'll probably see over the next three to four years is that electric vehicles will move from being justifiable to an enthusiast, to being an absolute no brainer for more people,” says Mr Pye. “I think we're really still at the beginning of what may be the electric decade.”