BYD (OTCPK:BYDDF) is the world's largest EV manufacturer and the world's best example of a vertically integrated new energy manufacturer.
Tesla (TSLA) manufactures the world's most popular EV model and has the highest profile of any EV manufacturer. Its vertical integration is increasing as it expands both its manufacturing base and its energy storage business.
Between them, the two companies supply 22% of the world's EV market:
Source: Times Now Group
This illustration shows the domination of Chinese companies. BMW (OTCPK:BMWYY) and Volkswagen (OTCPK:VWAGY) represent Europe. The absence of the U.S. auto giants is startling. As for the surge in battery manufacturing now going on worldwide, U.S. companies are notable by their absence.
Newly announced developments from both BYD and Tesla illustrate how they are set to dominate their market segments. Vertical integration will be a key element in this. It makes them strong Buys for the investor looking long-term for companies set to dominate new strategic areas of the world economy.
The EV revolution is here. For some time, there have been concerns there will not be sufficient battery production to match demand. This demand comes from both autos and energy storage. Asia, especially China, dominates production and will increase its dominance in the next few years.
In China, it is not just Chinese companies who are investing in battery plants. It is expected there will be 300 GW production by 2025 from a range of companies. By that date, the government wants 30% of new car sales to be EVs.
Europe is pouring huge funds into trying to meet demand. The "European Battery Union", of which Sweden's Northvolt and Volkswagen are major players, is pushing hard for huge investments to be made. Volkswagen itself is eyeing up an investment of 1 billion euros (US$1.15 billion) in a battery gigafactory in Germany. China's biggest battery manufacturer CATL (Contemporary Amperex Technology Co.) has just signed a contract to build a factory in Germany. Costing a massive 1.8 billion euros (US$2.03 billion), it will supply BMW and other German auto companies.
The big players in the new world of EVs such as BYD, Tesla, and Volkswagen are also looking at how to secure supplies of lithium and other raw materials. Again, the Chinese are way out in front in this regard. They have sewn up much of the world's potential supplies of key minerals for the future battery revolution. A big player in this is Ganfeng, for instance. They have long-term contracts with Volkswagen, Tesla, BMW, and LG Chem (OTCPK:LGCLF).
The USA is apparently lost in its fossil fuel past. It is not a player in what is a huge fast-growing strategic industry. Tesla's sales for Q2 just released show a bright picture. Total sales numbered 95,200. Sales of the Model 3 increased 50% from Q1 to reach 77.550 units. Sales of the Model S and Model X increased 46% from Q1 to 17,650 units.
In contrast, total vehicle sales for the 1st half of 2019 in the USA showed a decline. Detroit is unlikely to see much growth by pulling back from Europe and manufacturing pick-ups for the U.S. market. There is a reason why the PE ratios of General Motors (GM), Ford (F), and Fiat Chrysler (FCA) are 7.05, 11.38, and 5.71, respectively. It is hard to see where future growth will come from.
Tesla is the American exception to this. However, much of its future growth and capital investment is likely to be found in Asia and Europe.
It is not just the growth in EVs which is fueling battery demand. The demand for lithium-ion batteries is being boosted by the breakneck pace of demand for energy storage. Both BYD and Tesla are scrambling to become big players in this business. This was evidenced by Tesla's supply of the world's largest battery at Hornsdale in South Australia.
Both companies are predicated on the basis of the inexorable forward march of sustainable energy. As Elon Musk stated back in 2016:
"People think of Tesla as an electric car company, but the whole purpose of Tesla was to accelerate the advent of sustainable energy."
As I detailed in a recent article, Bloomberg New Energy predicts that there will be a 100-fold increase in battery energy storage in the next 20 years. This is an inevitable result of the world drive towards renewable energy. Bloomberg expects 50% of battery use to be lithium-ion batteries. The "holy grail" of competitive solid state batteries still seems to be a long way off.
BYD's Recent Moves
BYD began life as a battery manufacturer in 1995. This was specifically for mobile phones. Its founder and chairman and driving force, Wang Chuanfu is a battery man at heart. Indeed, the company has not exited that business. Earlier this year, they invested 4 billion yuan (US$58 million) in a new factory in Guangzhou. This will manufacture lithium-ion batteries for mobile phones, laptops, and computers.
However, the biggest investment now is for lithium-ion batteries for EVs. In February, BYD began work on a new factory in Chongqing at a cost of 10 billion yuan (US$1.5 billion). By 2020, the company will have 5 production centres in China with a total output of 100 GWh. Wang has predicted that China will need production of 1,000 GWh by 2030 to keep up with demand.
The scale of each factory's output and costs illustrate BYD's commitment to capital investment. This might scare away short-term players and traders but should encourage long-term investors.
It could be argued that BYD has been somewhat slow to ramp up this battery production. Like Tesla, they were supply-constrained for EVs in 2018, not demand-constrained.
This ramp-up of battery production will enable BYD to supply batteries not only for their own fast-growing EV production. They will be looking to supply to others once their own demand is met. For instance, it was recently announced they would supply Toyota (NYSE:TM) with batteries for the Japanese brand's products in China. A similar move for BYD to supply Tesla's Chinese production with batteries cannot be ruled out. This is a fast-changing scenario. Toyota themselves have a strategic partnership with China's largest battery manufacturer CATL. Toyota is targeting supplying 5.5 million EVs by 2025. Of these, 4.5 million would be hybrids or plug-in hybrids.
CATL is supplying a large number of the world's largest auto companies. It may have stolen a march on BYD. Wang Chuanfu believes he can catch up with CATL through his company's ongoing investments in battery plants. There are huge potential gains to be made. This is shown by the fact that CATL's value has tripled since its IPO on the Shenzhen exchange a year ago.
China is by far the world's largest market for both ICE vehicles and EVs. It is not surprising that overseas auto manufacturers continue to pour into the country. This presents a tremendous revenue opportunity for BYD's battery business.
It is not just auto manufacturers moving into China. The world's battery manufacturers are doing the same. LG Chem, Panasonic (OTCPK:PCRFY), and Samsung SDI Co. (OTC:SSDIY), for instance, are all investing substantial sums in new battery facilities in the country. The Chinese government has encouraged this by relaxing the rules for companies to build such plants.
As with Tesla, BYD has also moved into energy storage supply. It has a thriving export market in their "home systems" division. They have capabilities to supply through their overseas facilities. They have a close partnership in Europe with SMA Solar Technology AG. They have recently supplied substantial quantities of home storage products to markets as diverse as Germany, the U.K, Mexico, and Australia.
In yet another example of the advantages of vertical integration, BYD are instituting "second life" energy storage from their huge historical supply of e-buses. Such buses become less efficient after an approximate 7-year life-span on the roads. The batteries subsequently have another life as energy storage batteries for about another 7 to 10 years. With over 50,000 e-buses already supplied by the company, this gives a rolling long-term revenue source for them.
Tesla's Recent Moves
Tesla has always worked very closely with its partner Panasonic. At its GF1 in Nevada, Panasonic has made further investments recently. The facility has a total output at present of 24 GWh. In theory, this could be ramped up to 35 GWh. Tesla bears have recently speculated on a deterioration of the relationship between Tesla and Panasonic. They have seen this as a sign of Panasonic worried about the future of Tesla. This is not quite accurate.
The fact is that both parties need to diversify so as to avoid over-reliance on each other. This danger of over-reliance is actually a sign of the success of the partnership. Indeed, as long ago as January, Panasonic was already announcing co-operation with Toyota on batteries for EVs. The bears seem not to have noticed this at the time.
It was recently confirmed that Tesla are themselves researching prototypes and designs of new lithium-ion battery cells in a special facility in California. This should come as no surprise to anyone following Tesla's purchase of Maxwell Technologies Inc. (NASDAQ:MXWL) earlier this year.
At the 2019 Annual Shareholders Meeting, Elon Musk announced the company will be holding a "Battery & Drivetrain Day" in the 3rd quarter. This should be a very important and interesting event. It will show how far down the road Tesla has driven with new battery technology. Musk has stated they are looking for better performance and lower cost. The battery typically represents approximately 40% of the cost of an EV.
As I mentioned here, the Model 3 battery is already considered to be the best designed and lowest cost in the market. Tesla replaced the standard 18650 battery used in the Model S and Model X with the new and exclusive 2170 lithium-ion cells. Improvements have been effected by joint research between Tesla and Panasonic. Substantial improvements were made at both the cell and pack level. Far greater efficiency has been achieved in a variety of ways. The two companies have managed to increase the surface area of the battery material significantly. They have improved the energy density. They have effected a better cooling design.
In addition, manufacturing techniques at the Nevada facility have been improved out of all recognition. The resultant rapid assembly is key to Tesla meeting its Model 3 production and cost targets. Those Tesla bears who have stated that Panasonic are just a supplier to Tesla are mistaken. The success of the Model 3 battery is the result of joint research and manufacturing by two partners.
The battery improvements the two have effected are the central reason why the Model 3 is the best-selling EV in the world.
Apart from autos, Tesla has a fast-growing energy storage business. This comprises "Powerpack" commercial and "Powerwall" residential systems. In 2018, the company was unable to match surging demand with supply. This was due to a lack of product from Nevada and because the company gave priority to Model 3 production. For 2019, Elon Musk has predicted that the company's stationary storage business will grow by 300% over 2018.
Tesla has the ambition that energy storage products should match autos in terms of turnover. This can only be done if they can successfully ramp up battery production on a large scale.
Outsourcing from Chinese battery suppliers such as BYD is very possible. Previous rumours that Tesla had signed an agreement for their Shanghai production with local battery manufacturer Tianjin Lishen have been denied. However, both parties did state that discussions had been held.
The new Shanghai factory has risen at an incredible pace as pictured below last month:
The Tesla cynics who continuously stated the factory would not happen have been proved completely wrong. When the factory is up and running at the end of this year, its battery procurement strategy will be interesting. Musk has previously confirmed that battery modules and packs will be produced at the Shanghai plant. He also confirmed that the company would source from more than one company.
Meanwhile, Tesla is reportedly (and unsurprisingly) revamping its Asia Pacific infrastructure so that operations will be centralised in Shanghai.
The Investment Opportunity
BYD and Tesla are both innovative disruptors. Thus, they encounter plenty of opposition. This comes from entrenched interests in the fossil fuel industry and from political circles.
As with any stock, they have ups and downs in their stock price. They have, however, been great investments in the past for long-term "buy and hold" investors who take some profits on peaks and buy on dips. The two companies should continue to be even better long-term investments going forward.
BYD's 5-year stock chart shows its peaks and troughs:
Source: Charles Schwab
Famed investor Warren Buffett invested in 2008 and has seen over 500% upside through his long-term buy and hold strategy.
Tesla's 5-year stock chart shows similar trends:
Source: Charles Schwab
Long-term investors who bought the IPO at US$17 (of whom I am one) would have seen an over 1,300% upside through a buy and hold strategy.
As I detailed here, BYD's potential for hugely increased turnover and profit based on long-term capex is clear. Their long-term plan to become a US$150 billion company requires their battery business to increase revenues rapidly. Tesla's increased focus on batteries and move into China are very bullish signs. Their Q2 sales figures are a further bullish sign. Demand for their products is constantly increasing.
Both companies have invested substantially for their long-term future. The most recent, example, for Tesla is the Shanghai plant. For BYD it is the new battery factories. Last year, even without these, BYD invested about 17 billion yuan (US$2.5 billion) and incurred substantial depreciation and amortisation charges.
This year will see further important news on batteries from both BYD and Tesla. Batteries and sustainable energy are at the centre of what they do. They are not simple auto companies. As their battery business increases, increased revenue and profit should follow rapidly. Their auto businesses are also set to increase rapidly. Tesla's Q2 sales saw explosive growth. BYD's total auto sales for the first 6 months of the year only increased 1.59% to 228,072 units. However, their EV sales grew 94.5% to 145,653. That illustrates the strong direction the Chinese auto market is taking.
A good rule of thumb for long-term investments is firstly to find a company in a strategic growth industry, and secondly, find a company with a visionary leader. Renewable energy and EVs fit the first rule. Elon Musk and Wang Chuanfu fit the second rule. Investors should look at the big picture and not worry about the short-term noise.
The present situation represents a great buying opportunity for the long-term investor for both stocks.
Disclosure: I am/we are long BYDDF TESLA. 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.