At the Geneva Auto Show earlier this year we came face-to-face with a number of original equipment manufacturers and the challenges they face. While the car market has growth potential, due largely to technical innovations in the electric and autonomous car spaces, it is hard for traditional manufacturers to access these opportunities as technology companies enter the fray. Meanwhile, stricter regulations are making profiting from producing traditional cars harder.
Despite these challenges, traditional car manufacturers and parts suppliers could still see growth if they can adjust to the changing environment and create value.
The current regulatory environment is challenging for traditional car manufacturers. Multiple emissions scandals have led to a significant political backlash, with diesel-powered cars coming under the greatest scrutiny. New targets for CO2 emissions have been introduced in the US and the EU, while China is aggressively pursuing an electrification programme. The impact of these regulatory changes is already being felt; the presence of diesel in Western Europe is forecast to fall from around 50 per cent now to 20 per cent in 2025.
Car makers clearly cannot continue to rely on diesel car sales. Yet, rotating production away from diesel will require significant investment, with most global car manufacturers forecasting increased capital expenditure in the next few years.
Electric vehicles are taking the place of diesel cars. Governments are increasingly offering purchasing incentives for consumers, particularly in China, while the technology has evolved rapidly to become genuinely viable, most notably big cities. As adoption grows, prices will fall and the infrastructure required to support these vehicles will grow, expanding their potential market share further.
The challenge for traditional car manufacturers is that external players are dominating the electric vehicle market. Tesla, for instance, has proven it has both superior technology and the capability to build a compelling brand from scratch, without the weight of legacy assets.
Meanwhile, the connectivity and global systems required to develop autonomous vehicles are most readily available to global information technology companies. In this regard, companies like Google have a distinct advantage over legacy car manufacturers, although some are collaborating to develop ‘best of both world’ products, such as Samsung and Audi.
However, one segment of the established market may benefit from these shifts. Both electric and autonomous vehicles demand more components, such as much higher volumes of electric cabling for everything from satnav to connecting the car’s automatic pilot to the cloud. For the manufacturers of these components, this increase in demand from individual units presents a compelling growth opportunity. Indeed, auto electronics is the fastest-growing segment of the autos sector.
These technological developments are also driving an evolution in consumer behaviour. The pace of development means that technologies become redundant much more quickly, a disincentive for vehicle ownership. Ownership has also become more expensive due to congestion and parking charges, which are springing up in cities worldwide. Instead, consumers are moving towards shared mobility in the form of app-based taxi and car sharing services, a trend that will be further driven by autonomous vehicles.
A new route
While the manufacturers currently have very low valuations, the challenges they face indicate that caution is required. Similarly, the high valuations of the car industry’s disruptors should concern investors.
Instead, investors should look to the companies at both ends of the spectrum that are offering competitive advantages over their peers. Among the manufacturers, Subaru’s niche market positioning and unparalleled combination of quality and price is attractive. Ferrari’s brand strength and shrewd strategy of undersupplying demand has generated unrivalled pricing power. Opportunities can also arise from internal restructuring and M&A, as in the case of Peugeot.
Auto parts suppliers are particularly appealing. Companies like Plastic Omnium, Valeo and Nexteer Automotive sell products to a range of car makers, making their revenues more resilient and more of their products are needed in newer vehicles.
Lastly, the disruptors are the hardest businesses to value. A young deeply loss-making company like Tesla currently sells very few units and will face significant competition in the future. However, it already has a larger market capitalisation than Ford or General Motors. Tesla must be valued on the basis of its disruptive potential and it has a clear head start in the electric vehicle space. Meanwhile, the company has built a successful brand, while its batteries could become an important part for other manufacturers. While the risk is high, so are the potential rewards, making an investment in Tesla more reasonable than many market observers believe.
Roberto Magnatantini is head of global equities at SYZ Asset Management