March is Motor Show time in Geneva and it was fascinating to witness the shift in emphasis away from plug-in vehicles as European automakers highlighted their accomplishments in fuel efficiency technologies like HEVs, micro-hybrids and dual fuel drive trains that can switch back and forth between gasoline and compressed natural gas.
While there were modest displays for Tesla (TSLA), Fisker and other emerging brick-makers, and space was set aside for the obligatory plug-ins that most real manufacturers are toying with, the substantial majority of front-line vehicles at display entrances and halo cars on turntables were HEVs and micro-hybrids. As far as I could tell, this year's theme was The Revenge of the Internal Combustion Engine.
One of the most intriguing concept cars at the show was the "LC Super-Hybrid" from Controlled Power Technologies, which is really a super micro-hybrid. Instead of fooling with the expense and complexity of electric drive, CPT added longer gear ratios, a 2 kw belt driven starter generator, an electric supercharger and beefier electronics to a VW Passat with a 1.4 liter turbocharged gas engine. The changes cost less than $2,000, but the end result was a 50.5 mpg Passat with driving performance that rivals the 1.8 liter version while offering 23.4% better fuel economy. An associated presentation from the Advanced Lead Acid Battery Consortium summarized the value proposition in this table.
The logic is compelling because it cooperates with the law of economic gravity. Micro-hybrids and the LC Super-hybrid offer attractive fuel savings at a very modest cost. While it's technically possible to do more with increasingly expensive and complex mild hybrids, HEVs and plug-ins, the incremental cost for a percentage point of incremental benefit starts getting absurd as soon as you add electric power to the wheels. After several years of unrelenting hype from ideologues, advocates, reporters and politicians who can't see the forest for the ferns the message is finally sinking in – The green in a consumer's wallet will always outweigh the green in his cocktail conversation.
On Monday of this week Automotive News published a brief but highly informative interview with Alex Molinaroli, the president of Johnson Controls Power Solutions (JCI), the world's most successful battery manufacturer and the only global manufacturer with major commitments to both lead-acid and lithium-ion batteries. While EVangelicals may be distressed by Mr. Molinaroli's frank assessment that electric cars won't generate big sales for at least a decade, I view it as just one more confirmation of my long-held belief that cheap will beat the pants off cool in the transportation market.
To understand the relative importance of JCI's diverse battery manufacturing activities, you need to dig into the segment information in its Annual Report on Form 10-K. At September 30th, the power solutions segment accounted for 22.4% of JCI's assets, 14.4% of its sales and a whopping 35.4% of its income before interest and taxes. In the last three years, JCI invested $937 million in its power solutions segment, plus an additional $300 million that was provided by a 2009 ARRA Battery Manufacturing Grant to the JCI-SAFT joint venture. Planned spending of several hundred million over the next three years will increase JCI's AGM battery manufacturing capacity from a couple million units in 2009 to:
- 11.8 million units a year in Europe;
- 6.8 million units a year in North America; and
- 2.8 million units a year in China.
The reason is simple, AGM batteries generate twice the per unit revenue and three times the per unit margin of JCI's conventional flooded batteries. As its new AGM capacity comes online, JCI can expect its power solutions revenue to jump by $1.3 billion annually while adding about $500 million a year to operating income. AGM battery manufacturing is a key developing business segment for JCI and it's all being driven by automaker demand for better batteries that will be used primarily in micro-hybrids. A similar albeit less aggressive AGM battery manufacturing expansion is currently underway at Exide Technologies (XIDE) which is expanding its capacity to roughly 8.5 million units a year.
Of the two major battery manufacturers that are rapidly ramping AGM manufacturing capacity, I believe Exide presents the more exciting opportunity because its historic earnings were brutalized by restructuring costs and its stock has been beaten down to a point where it trades at 54% of book value and 8% of sales. If Exide's AGM manufacturing activities generate marginal profits that anywhere close to those expected from JCI, a $150 million boost to operating earnings could send the stock soaring.
Over the last year there's been an increasing amount of market noise as battery and supercapacitor developers hawk new systems for the micro-hybrid market ranging from enhanced lead-acid batteries to supercapacitors and even lithium-ion batteries, which proves once again that the whole world looks like a nail to a hammer manufacturer. Last month, SAE International published an important article on the micro-hybrid space titled "AGM battery takes primary role for idle stop-start in microhybrids" that explained the challenges of micro-hybrid applications with striking simplicity and clarity. I think it's a must read for any investor who wants to understand the space and the opportunities.
While I believe the SAE International article is too important to summarize, I do want to draw readers' attention to one key sentence.
The fuel-economy improvements vary according to car maker, but a BMW study estimates up to 4% overall for current systems, with the potential for 10% if a higher charge-acceptance-rate battery (over 100 A) were available.
The sentence is important for two reasons. First, BMW has spent almost three years and an immense amount of money testing the PbC battery from Axion Power International (AXPW.OB), an asymmetric lead-carbon capacitor that offers the charge acceptance of a capacitor and the power and energy of an AGM battery in an integrated hybrid device. A joint presentation from the two companies at the 2010 European Lead Battery Conference in Istanbul showed that alpha prototypes of the PbC offered sustained dynamic charge acceptance of 100 Amps through the equivalent of five years of simulated use under a testing protocol that was jointly developed by BMW and Ford (F).
Second, at this year's Geneva Motor Show BMW's front and center display space highlighted the new Series I; 116d EfficientDynamics Edition that launches this month and boasts CO2 emissions of 99 grams per kilometer, or fuel economy of roughly 62 mpg. Its turntable star was the BMW 6 Series Gran Coupé which will launch in June. Both cars are advanced micro-hybrids that share a novel BMW driver awareness system called ECO PRO Mode that helps drivers reduce fuel consumption by up to 20%. According to BMW's website:
As soon as you select the ECO PRO Mode using Driving Experience Control including ECO PRO, everything is geared towards maximum efficiency. Pedal recognition, gear recognition and the best point at which to change gear are optimised and the heating and air conditioning strategy is adapted intelligently. The control display indicates which BMW EfficientDynamics functions are currently operating in order to actively reduce the amount of energy being used, such as Brake Energy Regeneration or optimised temperature control. The driver also receives situation-specific ECO PRO info on fuel efficient driving, such as the optimal gear to drive in. The Bonus Range Display in the on-board computer shows how much further it is possible to drive thanks to the ECO PRO Mode.
When I start connecting the dots an intriguing picture begins to emerge. The ALABC presentation for the LC Super Hybrid shows that automakers are spending €35 to €100 for each 1% of fuel economy in their mico-hybrids. The SAE is reporting that the best the automakers can do with AGM batteries is a 4% improvement in fuel economy, but that a battery with higher dynamic charge acceptance like the PbC could boost efficiency into the 10% range.
When I factor in BMW's decision to showcase two advanced micro-hybrids with ECO PRO Mode, I have to think that BMW's found a solution to the dynamic charge acceptance issues they explained at the ELBC. These cars are promising fuel economy gains of up to 20% while providing real-time system performance information to the drivers. There's no indication that they've selected the PbC, but I have a hard time believing that a first tier automaker would introduce a new system that called drivers' attention to the dynamic charge acceptance degradation that all plagues all AGM batteries over time.
Now that the problems and challenges of electric drive are becoming increasingly obvious to the mainstream media and to politicians who need to think about elections later this year, I expect an increasingly difficult time for the developers of electric vehicles and their components. As Mr. Molinaroli said "A mass market for EVs is still a long way off. That's why we don't spend a lot of time talking about all this."
Investors with low risk tolerance who want meaningful portfolio exposure to an automotive mega-trend that's evolved quietly in the background while hucksters hype $100,000 toys for the 1% should take a serious look at JCI, a diversified dividend paying industry leader that's likely to be a dominant force in the micro-hybrid market for years to come. Those with a higher risk tolerance may want to take a good long look at Exide and consider what the market price might be with $150 million of incremental gross profit from AGM battery sales.
The lottery ticket in the bunch is Axion, which currently trades at an R&D market capitalization in the $32 million range. Since Axion just tucked $8.5 million away in the bank from an offering at $0.35 per share, the price isn't likely to fall over the next six to nine months. If one or more of its first tier testing relationships matures into a customer relationship, the possibilities are endless.
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.