Mike Appleby

Long-term trends in the global automotive industry

Mike Appleby

This article was first published by Alliance Trust Investments on 18 July 2016.

Mike Appleby, investment manager explains how big changes in the car industry are informing where we see the best investment prospects in the sector.

In the ATI Sustainable Future team we try to identify developing trends in industries and sectors as this can help us to pick longer term winners that generate good investment returns. We think that there will be profound changes in the car industry over the next decade and this provides an interesting potential investment source.

The number of cars sold throughout the world is expected to increase significantly from around 75 million per year in 2015 to over 100 million by 2035, with the majority of growth expected to come from emerging economies. The total number of cars on the road is also expected to almost double; from 1.1 billion cars in 2015 to around 2 billion cars on the road by 2035 (1).

There are increasing fuel efficiency requirements for cars that manufacturers will find difficult to meet. Cutting emissions often requires significant research and development to engineer new car models that are significantly more fuel efficient. This regulation affects all major car markets including the US, Europe, Japan and China.

Emerging trends

We see a number of trends emerging in the automotive sector as a result of the anticipated rise in new vehicles on the road combined with increasing regulations around fuel efficiency. Fundamentally, cars will become more fuel efficient to meet with global regulations; however this increase in efficiency will not be as great as the increase in the number of cars on the road over the next decade.

We expect demand for fuel for passenger cars, which represents over half of total global oil demand from transport (2) , to continue to grow until peaking around 2025, after which growth in demand is expected to slow and be flat or falling by around 2030. Over the next decade the main offset of growth in oil demand from cars will be energy efficiency of the internal combustion engine, as opposed to substitution of electric vehicles.

The number of electric vehicles (EVs) will increase from the current low base and will take share from incumbent internal combustion engines. There is a significant variation in take up in different markets, with much higher adoption than the global average in Europe, slightly higher in China and lower in the US. We expect it will be 2025 before electric vehicles comprise a meaningful proportion of global car sales of around 10% or more.

Investment implications

By 2025 the vast majority of cars sold will still be based on the internal combustion engine – even under the most optimistic electric vehicle adoption assumptions. Existing car companies face a huge challenge to adapt their vehicles to meet more stringent global efficiency standards. This will involve them spending more money on outsourced specialist components to improve the efficiency of their engines. We expect this will create demand for specialist equipment and is positive for the likes of BorgWarner, Johnson Matthey and Delphi. We favour these specialist equipment manufacturers over the car manufacturers.

Electric vehicles present a big long-term growth opportunity (from a low base) and the increase in electronics content, particularly sensors and power management chips, presents an interesting growth area for the likes of Infineon, NXP Semiconductors, and Linear. We are also interested in finding companies with meaningful exposure to innovation in car batteries.

Fuel efficiency combined with substitution of the internal combustion engine for electric options means the growth in demand for oil for cars will peak around 2025. This is negative for the oil and gas sector which has enjoyed growth in demand for its products for many decades. Perhaps unsurprisingly, the industry expects demand to peak later than this analysis might suggest.

Electric growth

The incremental demand for electricity from the increased penetration of electric vehicles is meaningful, but perhaps not as high as we imagined. For example, in the UK (which has a relatively low proportion of total energy demand coming from electricity and where this incremental demand should make a bigger difference to total energy demand), a switch to 100% EV would result in an approximate increase in total electricity demand of about 25%.

Even if all cars sold were EV, it would take over a decade until more than 90% of cars being driven are electric and for this full incremental electricity demand to come through. This gives an idea of an approximate ceiling for incremental electricity demand from EV’s in the UK.

Of course it is difficult to predict numbers a decade or more in the future. We see some meaningful changes that need to be taken into consideration when making investments in the automotive industry and we anticipate the rate of change in the sector will be faster than widely expected by most investors.

Being positively exposed to structural change, for example increasing fuel efficiency regulation, increasing semi-conductor content in cars, or increasing electric vehicle penetration, is not of itself a reason to invest in a company. Further fundamental analysis is needed to determine what proportion of the business is positively exposed to these changes; however we will invest if the company is well managed and if we think the valuation is attractive.

Sources

1 Source: Bernstein / Navigant Apr-2016

2 Transport makes up around 55% of global oil demand with gasoline (from light passenger vehicles) accounting for 26% of total oil demand and diesel (mostly from trucks and freight) at 18%.

 

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Monday, July 18, 2016, 12:00 AM