Could GM, Ford put the brakes on Tesla?

Buy growth, buy the future, or so the axiom runs. An investor’s ability to tap into growth segments of the economy is bound up with the risk profile of their portfolio. Naturally, some endeavours are inherently riskier than others.

Take one example: the expansion of self-storage was delivering outsized returns even prior to the pandemic, and the likes of Big Yellow (BYG) have now registered a share price increase of 139 per cent over the past five years. Yet the reasons behind the sub-sector's  impressive growth spurt are not difficult to appreciate; there isn’t so much of a blue-sky element and the lay of the land is clear enough.

Compare that to companies engaged in, say, the development of genomics or quantum computing. These are areas of research which could fundamentally transform the broader industries in which they operate, but it’s difficult to ignore the speculative element. Even if you believe the risk/reward balance is tilted in your favour, with research-driven businesses there is every chance that you will be asked to stump up further capital after your initial foray, or face stock dilution. Endless rounds of fundraising come with the territory.

All of this came to mind towards the end of last year, with the listing of electric vehicle (EV) start-up Rivian Automotive (US:RIVN) on Nasdaq. The California-based business initially priced its IPO at $78 (£57.64) a share. Expectations were high and by the end of the first day’s trading the shares were changing hands at around $107 apiece. A consequent valuation of $91bn surpassed that of both General Motors (US:GM.) and Ford (US:F.), marking Rivian as the world’s fifth-largest automaker by market cap even though it had yet to book one dollar in sales.

Most investors would entertain an enhanced degree of risk if they are ploughing their capital into alpha stocks, even if they’re in the development phase. And given the direction of travel (government mandates, net-zero, etc), it is not difficult to grasp the growth potential of the EV market.

Yet history points to a stark Darwinian logic in the automotive industry. Consider that around 3,000 automobile companies have existed in the US alone since the 1890s – and only a handful survived the Great Depression. Today, depending on which way you determine it, there are 3-4 dozen in operation, the majority of whom are global in nature. Many automakers have been subsumed within larger rivals, although we can say that the high rate of attrition in motoring’s early years is partly a reflection of the capital-intensive nature of the industry.

Indeed, the industry has previously been supported by various state-sponsored bailouts in the US, France and the UK. Even the mighty German auto industry has not been immune to wider issues. Last year, Berlin pumped in an additional of €3bn (£2.52bn) to bolster the country's ailing automotive industry, taking the aggregate level of support to €5bn.  

So, even if some of the world’s preeminent automakers have struggled, albeit in the face of unprecedented disruption, why have companies like Rivian and, of course, Tesla (US:TSLA) garnered so much support? You could say that both offer access to a variety of EV opportunities. It has been argued that companies engaged in infrastructure support are likely to benefit from more predictable revenue streams. Investors aren’t short of potential options on the charging front, with ChargePoint (US:CHPT), Blink Charging (US:BLNK) and Wallbox (US:WBX) leading the way across the pond.

The carmakers have their own side projects. Rivian is engaged in the development of two consumer vehicles (the R1T pick-up truck and the R1S SUV), but it is also expanding its EV charging network and is looking to fulfil an order for 100,000 commercial delivery vans for Amazon (US:AMZN), one of its principal shareholders. Tesla, of course, is associated as much with its advanced battery technology as it is with its drive trains.

Elon Musk’s brainchild recently reached a market cap of $1tn after Hertz (US:HTZ) announced it would purchase 100,000 vehicles from the EV maker through to the end of 2022. And yet Tesla’s sales are substantially lower than the other companies that have achieved this milestone, to say nothing of the extent of its debt and mandatory purchase obligations. Nevertheless, the group has been paring back its net borrowings and has just set a quarterly sales record by delivering 308,600 cars in the fourth quarter, bringing total sales in 2021 to 936,000, up 87 per cent from the prior year. This was achieved even though Tesla was forced to increase its prices in response to rising supply chain costs, together with the global shortage of microchips.

Perhaps the reason why EV valuations are defying gravity is simply because private investors envisage that national governments will be prepared to offer a commensurate level of support for EV manufacturers as they have for established automakers. How else to sustain a state-mandated transition away from the internal combustion engine?

But prospective investors in the sector should also question whether enough attention is being paid to the accelerated roll-out of EVs from the established automakers. We may eventually find out that 'first-mover advantage' is anything but in this space. Valuations for Tesla are largely predicated on the belief that it will hold a dominant position in the marketplace in the next five to 10 years.

For now, it holds 21 per cent of the global market, although it is facing intensifying competition from Chinese EV manufacturers in SAIC Motor Corp (CH:600104) and BYD (HK:1211), while Volkswagen (DE:VOW) and Hyundai (KRX:005380) have been expanding their ranges. They’re not the only legacy manufacturers to step up their capital allocations. Between them, Ford and General Motors have committed around $65bn to launch a minimum of 46 new autonomous and electric vehicles by 2025. Expansion plans are being welcomed by investors: Ford shares leapt 12 per cent on 4 January after the company doubled its production target for the F-150 Lightning electric truck next year.

It is certainly conceivable that automobiles fuelled by 'green hydrogen' could become the preferred means of achieving net-zero by 2030, or at least command a significant proportion of global sales. Toyota’s (JP:7203) hydrogen fuel cell technology is becoming ever more advanced. The Japanese auto heavyweight has been increasing hydrogen storage capacity in its Mirai range, while improving its aerodynamic characteristics. A new Mirai recently clocked a record 1,003-kilometre journey on a single tank of hydrogen, before it was refuelled, and ready to go again in just five minutes – that should get standard EV manufacturers thinking.

As things stand, it would be unwise to draw too many conclusions from recent developments in the EV market. If Tesla were to hold on to its current market share, the future is set fair given the projected expansion of EV numbers. Unfortunately, it’s a big 'if', especially given the growing influence of legacy manufacturers in this corner of the auto market.

The long-term outlook for EV and fuel cell vehicle adoption has brightened over the past couple of years, but EV/hybrid sales as a percentage of the overall global auto market, though rising rapidly, are still in single figures. And it is difficult to determine the extent to which the pandemic is linked to the gains recorded since 2020. At that point, you could pick up shares in Tesla for around $88 apiece – they’re now changing hands for $1,200. The current valuation has a lot of positive assumptions baked in regarding market share and the pace of the roll-out through to 2030. And it may also be partly based on Tesla successfully developed full self-driving technology. However, given relative valuations, you might be well advised to take a second look at the legacy manufacturers if you’re intent on gaining exposure to the EV market.