Transportation is Evolving

Transportation is Evolving

Summary:

  • Macro trends signal a slowing picture for the automotive sector, from inventory-to-sales to production.
  • To fight the challenging macro, Detroit and others are doubling down on innovation in autonomous and alternative energy.
  • Investors can expect early adopters to step in as early as 2020.

The number of autonomous vehicle testing permits in California alone has increased 4X since September of 2015. Back then, only 9 firms had permits from the California Department of Motor Vehicles. Permit holders today include the major players; Apple, Google, Ford and many more. From indicators like this, our opinion is the automotive industry is pivoting.1

The electronic vehicle (EV) marketplace has also experienced substantial growth. Plug-in vehicle market share in the United States grew 37% in H1 2017 vs H1 2016. The absolute market share is still minimal (1.1% in H1 2017), but just like the aforementioned trend in autonomous driving, the growth is undeniable.2

The traditional automotive market is being disrupted by a technological revolution. The bulk of this attack is being driven by the world’s largest tech and auto companies. The ultimate goal is to make roads safer, more efficient, decrease barriers to entry (both from a user and technological point of view) and spur growth in the automotive industry. As such, your commute to work will likely drastically change in the coming years.

The Macro Auto Picture

From a high level, the automotive sector has beaten the market year-to-date (YTD).  A well-diversified automotive ETF (CARZ by First Trust) is up 19.5% while the S&P 500 is up 12.97% YTD. Last year, autos in aggregate had largely underperformed, down -4.6% when the market was positive 10%. Prior to Hurricane Harvey down South, autos were underperforming the market by about 4 percentage points, but hopes of refresh cycle from destroyed flooded vehicles have pushed the sector up of late. Within the ETF, investors have exposure to the big three automakers and many other manufacturers, spanning from Tesla to Volkswagen and Honda. According to Morningstar, the ETF is comprised of 99% consumer cyclical autos, we view it as a pure play and good read on the sector.

Macro themes have been driving poor performance of this sector, where numerous trends have held stocks back. First off, automotive sales are generally in decline. In the chart below from the St. Louis Federal Reserve, investors can see the lack of sales growth since 2016, nowhere near what was previously experienced during the expansion after the credit crisis.3

The lack of growth is also visible in the Auto Inventory-to-Sales Ratio, sitting near a seven year high.4

Lower sales travels down the supply chain…into lower production. This is supported by a 22% drop in production, from May 2015 to May 2017.5

Dynamic Detroit and Beyond

Traditional automakers are reinventing themselves in a big way to combat a more challenging macro environment. Through internal research and development plus inorganic growth, the big three and others are pushing into the future. Through General Motor’s purchase of Cruise Automation for $581M USD, they are enhancing their exposure in autonomous vehicles.6 “Cruise Anywhere” – the firm’s private release of its autonomous technology – is just recently now available to some GM San Francisco employees if they want a ride…still under the supervision of a back-up driver however.

Other players like Tesla are new to the automotive business and were founded upon a different strategy. The founding mission behind Tesla is to “to accelerate the world’s transition to sustainable energy” so it should not surprise investors they are striving to lead the automotive rebirth and be first on the new automotive frontier.

All this innovation comes at a cost however. According to Tesla’s 2016 10-K, Tesla made $7B USD in revenues, but spent $834.4M USD on research and development. This breaks down to be 11.9% of revenues allocated to R&D. Other auto manufacturers like General Motors spent a similar amount. According to General Motors 2016’s 10-K report, General Motors brought in $166B USD, but spent $8.1B USD on R&D (a 4.8% allocation). The same trend can be seen at Ford, according to their 2016 10-K report, R&D totaled $6.7B USD, while revenues totaled $151B (4.4% allocation).

On the topic of what Tesla’s future might hold, the company recently announced its Master Plan, Part Deux – or what they have in mind for the firm’s direction. Over the next decade or so, the green automaker will develop a number of projects…from expanding into more terrestrial vehicles types (like trucks) and advancing autonomous driving, enabling vehicles to make money via a ride-sharing network. These ambitious goals not only execute the company’s vision, but also take on some of the largest private startups in the world. Tesla’s future autonomous fleet of vehicles is particularly of concern to existing ride sharing companies like Lyft and Uber, who also hope to amass scale of autonomous ride-sharing vehicles. The opportunity to increase the supply of rides is material, because cars are only “in use by their owner for 5% to 10% of the day,” according to Tesla. The ability to earn cash back could also support a higher listing price for the vehicle, because of the added utility. Tesla hasn’t announced a specific ETA for such a ridesharing fleet, but Ford has!

According to a Ford press release, the company is planning on producing a fleet of fully autonomous cars by 2021.7 Innovation and accessibility like this puts Ford ahead of the curve and according to a Navigant research report, 1st amongst its peers in automated driving.8 Navigant suggests that Ford is most prepared for autonomous driving due to its investments in areas like mapping technology and light detection-ranging sensors, to its natural ability to scale car production when the technology is ready.

Another tectonic shift occurring in the automotive sector is the shift to renewable energy, specifically electric cars. While the idea of an electric car is not new, mass adoption is. Estimates by Morgan Stanley suggest that battery powered car sales (as a percentage of new car sales) will be 9% by 2025 and 16% by 2030 in their base case scenario. Their analyst team proposes that political pressure and emission standards will create a difficult climate for traditional combustion engines going forward. They also mentioned that combustion sales will peak soon or already have.

Driving range has been a consumer concern since the idea of a battery power car, but as Morgan Stanley emphasizes, “major auto parts manufacturers are launching plans for new electric vehicle [batteries] that have an expanded range of 300 miles.” 300 miles seems to be the goal for many, however Tesla is already beyond that benchmark

The Estimated Time of Arrival

So when will autonomous electric cars be in the majority of driveways? That depends. First off, the level of automation is a key variable to understand before suggesting an ETA. A majority of the first generation of autonomous vehicles are already here, like the BMW i3 Series or various Tesla models with Autopilot. These vehicles are between levels 2 and 3 on the National Highway Traffic Safety Administration scale of automation (partial /conditional automation to be specific). The graphic below explains these levels. A fully autonomous vehicle (level 5) is still on the horizon and ultimately the end goal.

Judging by various press releases, PR departments are preparing the public for self-driving levels 3 and 4 as early as 2020. For example, according to Toyota’s 2016 CES report, autonomous highway driving is expected to arrive from Honda and Toyota in 2020. Slightly more challenging metropolitan self-driving is not expected until later, Nissan for example expects urban driving by 2025. The aforementioned Ford ride-sharing service due in 2021 will be level 4.

Some companies are currently mulling over level 3 automation altogether however. Some firms suggest that level 3 might do more harm than good, because users might become too comfortable with the technology, despite the fact that they might need to still intervene for some situations. Companies like Ford, Volvo and Google have adopted such thinking…so there might not be a widespread ETA for level 3. Automation is coming, but it will be scattered.

Alternative Ways to Invest in These Trends

Other than the tech/auto companies mentioned, there are numerous ways investors can play this shift.

One of the “under the hood” ways to invest in the future of transportation is via Nvidia. According to the firm’s latest 10-Q, the automotive sector drove 7.2% of total revenues. Nvidia, for example, supplies the supercomputer and digital instrument cluster (aka the digital dashboard) for Tesla. Other players like Mobileye – who is currently in the process of being acquired by Intel- is pushing the industry forward with their EyeWatch and sensor technology that interprets hazards in real time for drivers.

Goldman Sachs recently published an equity research report in May 2017 which outlined all the big moves and investments by the major automotive players. Their positioning is displayed below.9

Conclusion

Automation has disrupted countless industries, but given the complexities and large stakes involved in autonomous driving, consumer facing progress has been slow to some observers. Behind the scenes, material progress is being made and a roll out from San Francisco plus Detroit and beyond will arrive in just a few years. Self-driving at a high level will be an available reality sooner than later for those who want to stay on the cutting edge.

Aside from consumer facing vehicles, autonomous trucks and even the recently proposed hyperloop mode of transportation will change the logistics of commerce too. These areas of innovation are also being attacked by the usual suspects and a few startups. An interesting development in the logistics game has been Amazon beefing up its transportation services. The $466 billion-dollar company has reportedly been working on an app that connects drivers with deliveries and put together a 12-person think tank to explore how the firm can leverage self-driving technology. Not only will your drive to work be changing, but so will your deliveries.

References

  1. California DMV Final Statements of Reasons. September 25, 2017.
  2. EV Volumes Report, Europe Plug-in Sales for H1 of 2017 + Updates for July and August.
  3. U.S. Bureau of Economic Analysis, Total Vehicle Sales [TOTALSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/TOTALSA, October 3, 2017.
  4. U.S. Bureau of Economic Analysis, Auto Inventory/Sales Ratio [AISRSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/AISRSA, October 3, 2017.
  5. U.S. Bureau of Economic Analysis, Domestic Auto Production [DAUPSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DAUPSA, October 3, 2017
  6. Levin, Doron. The Street. General Motors Discloses Why is Paid $581 for Cruise Automation. July 21, 2016.
  7. Ford Motors Press Release. Ford Targets Fully Autonomous Vehicle For Ride Sharing in 2021; Invests in new Tech Companies, Doubles Silicon Valley Team, August 16, 2016.
  8. Navigant Research Leaderboard Report: Automated Driving. Q2 2017.
  9. Goldman Sachs Global Investment Research, Equity Research Report, Rethinking Mobility. May 23, 2017.­­­­

Elite Wealth Management Team

Full Disclosures: http://elitewm.com/disclosures/
This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.  For a complete list of recommendations made within at least the past year, please contact us at (425) 828-4300 or info@elitewm.com.  Please Note: it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. Furthermore, we do not represent that the information contained herein is accurate or complete, and it should not be relied upon as such. Opinions expressed herein are subject to change without notice. Certain information contained herein (including any forward-looking statements and economic and market information) has been obtained from published sources and/or prepared by third parties and in certain cases has not been updated through the date hereof. While such sources are believed to be reliable, Elite Wealth Management does not assume any responsibility for the accuracy or completeness of such information. Elite Wealth Management does not undertake any obligation to update the information contained herein as of any future date.

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