One EV Revolution, 4 Likely Victors

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Includes: ALB, BHP, BMWYY, DMLRY, F, FCAU, FMC, FUJHF, GLNCY, GM, HMC, HYMTF, ISUZY, KIMTF, LGORF, NILSY, NSANY, PUGOY, RNLSY, SMTOY, SOUHY, SQM, TM, TSLA, TTM, VALE, VLKAF, VOLAF, VWAGY, WEICY
by: Henry Miles
Summary

Recent announcements suggest that demand for battery and fuel cell vehicles will soon rise significantly.

This mega-movement will favor dominant automobile and mining companies.

Toyota and Volkswagen, and Glencore and South32, are the odds on favorites in their respective sectors.

One of the challenges with information is that it comes in bites, known as items, that die a quick death in the short news cycle. Those of us who contribute to Seeking Alpha experience this with every article. On the one hand, we gather and interpret data, and submit copy carefully but quickly knowing that it is all becoming stale as we write. Post-release, we see in our page views the reality that the half-life of our contributions falls somewhere between 12 and 18 hours. None of this is conducive to gaining much perspective on deeper trends within the broader flow of information.

A Gathering Revolution

Nevertheless, every so often a collection of items indicates to me that something impressive is approaching; a gathering revolution, a major uplift in a developing mega-trend. Such has been the case beginning in March with Volkswagen’s (OTCPK:VWAGY) stunning announcement that it will boost electric vehicle production by 50% with 22 million BEVs by 2029. Less than two months later, Toyota (TM) followed with news that it too will mount a massive EV offensive:

  1. “…collaborating with partners as we strive to contribute to a better society",
  2. “…preparing a framework to respond thoroughly to the challenge, putting all the pieces in place, including the creation of new business models”, and
  3. “…focusing on vehicle development and the stable supply, improved durability, and reuse of batteries.”

Not long after this news hit, along comes former Audi executive and father of China’s electric vehicle movement pronouncing, “hydrogen is the future” as in fuel cells (it will come first for commercial, terminal-bound, vehicles, IMO).

Volkswagen and Toyota

Whether BEV's or FCEV's – and it will be the former, initially, on the "retail" side of things – having set their sights, Volkswagen and Toyota will come to dominate for three major reasons. First, their reach is truly global with Volkswagen/Audi being #1 in terms of vehicle sales followed closely by Toyota as #2. Secondly, among their offerings, the Germans are bringing forward a line of e-tron BEV's, while the Japanese giant prepares for EV production in China. (In the coming years, the mass and high-end markets will converge East-West, North-South.)

Thirdly, overwhelming financial strength is required to make all this happen. In an article that SA published not long ago, I proposed a simple metric to measure financial strength among comparable companies: (Revenue + Equity) / Leverage = Comparative Strength. This little formula reflects my belief that transformative change is best driven by those whose top line has found its way through the bottom line onto the balance sheet and isn't already "spoken for” to support existing liabilities / commitments. By this standard, Toyota and Volkswagen rank #1 and #3, respectively, with Honda (HMC) falling between them on half the sales base. All other automobile companies are well down the list.

R

E

L

Metric

2018 / USD

Revenue

% Tot.

Equity

% of Tot.

Leverage

(R+E)/L

VW/Audi (OTCPK:VLKAF)

$278B

14%

$120B

14%

3.6x

111

Toyota (TM)

$265B

14%

$181B

21%

1.6x

279

Daimler (OTCPK:DMLRY)

$197B

10%

$74B

8%

3.3x

82

Ford (F)

$160B

8%

$36B

4%

6.1x

32

GM (GM)

$147B

7%

$39B

4%

4.7x

40

Honda (HMC)

$139B

7%

$75B

8%

1.4x

153

Fiat/Chrysler(FCAU)

$130B

7%

$28B

3%

2.9x

54

BMW (OTCPK:BMWYY)

$115B

6%

$66B

8%

2.6x

70

Nissan (OTCPK:NSANY)

$108B

5%

$51B

6%

2.4x

66

Hyundai (OTCPK:HYMTF)

$88B

4%

$61B

7%

1.6x

93

Peugeot (OTCPK:PUGOY)

$87B

4%

$20B

2%

2.4x

45

Renault (OTCPK:RNLSY)

$68B

3%

$41B

5%

2.2x

50

Kia (OTCPK:KIMTF)

$49B

2%

$25B

3%

0.9x

82

Tata (TTM)

$49B

2%

$15B

2%

2.4x

27

Volvo (OTCPK:VOLAF)

$45B

2%

$14B

2%

2.9x

20

Subaru (OTCPK:FUJHF)

$28B

1%

$14B

2%

0.9x

47

Tesla (TSLA)

$22B

1%

$5B

1%

4.6x

6

Isuzu (OTCPK:ISUZY)

$19B

1%

$9B

1%

1.0x

28

Total

$1,994B

100%

$874B

100%

Avg 2.6x

Avg 71

I won’t speculate here as to which car companies will fall by the boards. However, it appears that those weaker financially are scrambling to merge or form alliances with fittest as in, “Survival of…”. In the M&A category, the on-again off-again deal between Nissan, Renault, and Fiat continues to play out. As to alliances, we’re hearing talk of product-specific, non-equity, collaborations as, for example, between Ford and VW for vans and pickups, and Subaru and Toyota for SUV’s. Investors should consider avoiding lesser companies that are not in on this action as it may signal that their stronger siblings are shunning them – Why, after all, acquire or ally with a weak partner when you can just take their market-share and be done with it?

The Metals Required

Let us not forget that ALL automobile companies participating in the electric vehicle revolution will require ores/metals essential for battery production. There are five such elements but competitive realities suggest to me that there are only two attractive investment opportunities among EV miners.

  1. Lithium – Right behind hydrogen and helium, lithium is the first metal on the periodic chart. In the past, the element was mined. However, it is now produced from “salars”, sunken, salt-encrusted lakes of which there are many worldwide as, for example, Bonneville. This is great news for a potentially burgeoning BEV industry needing a lot of Li; not so much for investors when production from these brine basins can be ramped up quickly meaning that it’s difficult for lithium extractors to maintain competitive advantage. No, Albemarle (ALB), Sociedad Quimica y Minera de Chile (SQM), and FMC (FMC) are not for me especially when considering China’s presence in this arena.
  2. Cobalt – Ah, but cobalt is another story where, among other uses, the metal is core to the thermal stability of lithium-ion batteries. On the supply side, most of the world’s cobalt sources from the Katanga and Mutanda mines in the Democratic Republic of the Congo in which Glencore (OTCPK:GLNCY) boasts super-majority stake-holdings. (I’m known to like global oligopolists.) Glencore has warts dating back to its founding by Marc Rich, born Marcel David Reich (I met him once or twice). And, as is true of any miner, it’s always dicey operating in third-world countries like the DRC with exposure to these (and even broader) counterparty risks.
  3. Nickel – And then we have nickel coming on fast given its importance in the production of BEV cathodes. If nickel mining were only more concentrated, I might be drawn to one of the majors. As it is, I’m avoiding Vale (VALE) that is plagued by safety and regulatory issues related to dam collapses, I’m not investing in Russia these days, MMC Norilsk Nickel (OTCPK:NILSY), and things trail off fast from there.
  4. Manganese – Known as a ferroalloy, manganese is yet another cathode metal that is experiencing near-100% growth according to Adamas Intelligence. More interesting to me is that Science Daily reports that, “Manganese Hydride-1 would enable the design of tanks that are far smaller, cheaper, more convenient and energy dense than existing hydrogen fuel technologies, and significantly out-perform battery-powered vehicles.” Lo and behold, here we find another global powerhouse with BHP Billiton (BHP) having spun-off its manganese interests into a company known as South32 (OTCPK:SOUHY) that is the world’s largest producer of manganese ore with operations in Australia through Groote Eylandt Mining Company and Tasmanian Electro Metallurgical Company, and, in Africa, via South Africa Manganese.
  5. Vanadium – And finally, we have vanadium. Remembering, that BEV’s need to refuel by plugging into something, i.e. an electric grid, vanadium is believed to hold huge potential in redox flow batteries that can store large amounts of electricity more-or-less indefinitely to “smooth out” power coming off solar and wind farms. Because the metal is widely found in the mining of other ores, I’m hard pressed to find a global oligopolist, e.g. in Glencore / Brazil’s Largo Resources (OTCQX:LGORF). (Sumitomo Electric (OTCPK:SMTOY) is a leader in vanadium redox flow batteries.)

Glencore and South32

So, for now, in the EV metals space it reduces to two dominant suppliers, Glencore in cobalt, and South32 in manganese. Before jumping into a few financials, I hasten to add that both companies produce nickel as a part of their operations, and Glencore also vanadium. In other words, these two miners each have both major as well as lesser positions in EV-critical ores.

2018 / USD

Glencore

South32

Total Revenue

$164.8B

$9.7B

Sales Growth

3.3%

5.7%

Gross Income

$6.8B

$1.7B

GI Growth

12.4%

-1.1%

Gross Margin

4.1%

17.7%

Net Income

$2.6B

$1.7B

NI Growth

-43.0%

5.3%

Operating CF

$9.5B

$2.2B

Op. CF Growth

107.9%

-22.4%

Free Cash Flow

$6.0B

$1.7B

Free CF Growth

234.6%

-31.8%

Liabs. to Equity

1.8x

0.4x

Current Ratio

1.1x

2.9x

Price/Earnings

15.2x

9.9x

Dividend Yield

5.8%

5.3%

As it is with most other companies in the extraction business, Glencore’s and South32’s activities result in unintended consequences. Everyone would hope that essential resources could be taken from the ground without adverse impact. But this is not the case – tailings, runoff, sickness, even catastrophes are consequences of mining. Troubling value judgments come with investing in such activities. For me, I accept the choice that investing in clean is often dirty. I expect that companies are minimizing the latter to help achieve the former – including through such things a sustainability / recycling programs – just as I expect that regulators and environmentalists will keep up the pressure on extractors to do what’s right.

Demand, Supply, Mega-Trends

I’m a broken record on this subject but, going to back to my very first article on Seeking Alpha, I have stated my core belief that, “… a more promising approach [to investing] begins with the study of big, developing, scientific, socio-economic, and political patterns and trends that have not yet been reflected in the price of related equities.” When, the two largest car companies on the planet announce massive EV offensives – with support of economies the size and stature of China, the EU, and Japan – we are about to witness a major trend of the kind that doesn’t come along very often.

If you’re concerned about lesser players in the automobile industry – as well you should be – then either focus on the top ones or avoid the sector altogether and turn your attention to major mining companies that will satisfy the mushrooming demand for essential EV metals.

Disclosure: I am/we are long GLNCY, TM, SOUHY, SMTOY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Always do your own due diligence in consultation with a licensed and competent financial adviser who understands your unique needs and puts your interests ahead of their own. Remember, there are added considerations in owning foreign securities including those associated with ADR sponsorship, buying and selling the pinks, foreign withholding taxes on dividends, and fees. (All my proceeds from contributing to SA go to charity.)