The outlook for electric vehicles just got brighter with the U.S. Senate’s passage of the Inflation Reduction Act, which contains new spending to combat global warming and boost clean energy. It also contains tax credits that will promote the purchases of new and used EVs.
We checked in with Seth Goldstein, an equity strategist who chairs the electric vehicle committee at Morningstar, where one of his best bullish calls was on lithium rising from the lows in 2019-20. Today, he’s also optimistic about an array of lithium picks. Goldstein shared his expectations for these and other EV players in the condensed, edited conversation below.
Q: What does the Inflation Reduction Act mean for the electric vehicle ecosystem?
Goldstein: It should drive demand for EVs and plug-in hybrids, which should benefit the entire EV supply chain. However, an increasing proportion of battery materials like lithium and nickel must come from either the U.S. or its free trade partners. All EVs need lithium. I see Lithium Americas LAC being one of the biggest winners, as they are developing the largest lithium resource in North America. Other lithium producers like Albemarle ALB and Livent LTHM, who have North American and Australian projects, should also benefit. Downstream, I see semiconductor producers and auto powertrain suppliers as the large beneficiaries. BorgWarner BWA should benefit from more battery electric vehicles and plug-in hybrids, where it can win with its best-in-class powertrain technologies.
Q: We’ll talk more about the specific companies later. What’s the outlook for EVs?
Goldstein: EVs last year globally were 5% of new global auto sales. I’d expect there to be a higher adoption rate this year, as well as higher overall EV sales. As the EV becomes cheaper and more functionally comparable to an internal combustion engine vehicle, more consumers will realistically consider buying one. And as more EV models are released by not only Tesla TSLA but by the legacy automakers and new entrants, consumers have more options and more EVs will get sold. Even if we entered a global recession, EV sales would likely either remain flat or even move higher just due to more models being converted from traditional ICEs to EVs.
There’s a lot of secular growth in the long-term transition from ICEs to EVs. Automakers won’t see incremental profit growth from the transition to EVs. But in lithium or semiconductors or specialty chemicals or automotive components companies, there is a real opportunity to gain market share and see profits materially grow higher over time. In some of these upstream suppliers, we see real big opportunities regardless of recession. That leaves the EV sector in a much stronger place than perhaps most of the rest of the global market.
Q: Tesla is iconic in this space. What do you think of the stock?
Goldstein: The recent results were in line with our expectations. Given the COVID lockdowns in Shanghai and the ramp-up of the Berlin and Austin factories, we expected profits to take a sequential hit just due to extra costs and production issues. Any time a company opens a new factory, you’re not ramped up at full production yet, and it will cost more on a unit production basis until that factory turns profitable. These issues are temporary. We expect things will get better in Q3 and in Q4. Right now, I think the stock is slightly overvalued. Our fair value estimate is $760.
Q: Tesla is obviously controversial, not least because of a variety of labor issues, CEO Elon Musk’s tweets drawing the attention of regulators, and his stock sales to fund his Twitter bid. Tesla just had its annual meeting, where shareholders passed a proposal to increase their ability to nominate directors.
Goldstein: To the extent that Elon Musk continues to sell Tesla shares and reduce his ownership stake, it increases the chances that some of these resolutions could pass in the future. However, combined with his ownership stake, Musk will likely retain enough influence to prevent the supermajority of shareholders from being met, even if a majority of shareholders votes for initiatives such as reports on discrimination and mandatory arbitration. Either of the latter would help retain more key employees
Given where Tesla is today, Elon Musk is less important in terms of needing to be there 100% to make sure the operation runs smoothly. Tesla has very capable management outside of Musk. They are able to ramp up production, they’ve been able to implement the new batteries that they previewed at the 2020 Battery Day, the AI continues to progress. The strategy has been set. It’s all about execution. And so, there really should be no strategic changes right now. If Musk needs to spend more time focusing on Twitter or SpaceX, it really shouldn’t be a big deal. And I think also now Tesla has established itself as a brand that can stand on its own. It’s no longer Elon Musk tweeting about how cool Teslas are. Now, there’s a bunch of Tesla enthusiasts who tweet about their own cars every day, and the brand has really gained strength and has a favorable view among consumers, similar to other luxury automakers like a BMW or a Mercedes. So, I think, given that Tesla has developed its own brand strength apart from Musk, Musk becomes a little less important in his non-Tesla activities.
Q: How should investors add exposure to their portfolios?
Goldstein: We see opportunities throughout the EV supply chain. We like a lot of the traditional automakers like General Motors GM, Ford Motor Co. F, Volkswagen VWAGY, BMW BMWYY. They are in 4- and 5-star territory. We think they will be able to restore their profits, the chip shortage headwinds will be temporary, and they will be able to electrify their portfolios, and that will lead to transition to EVs, whereas the market is kind of assuming sales perpetually decline and lower profits.
We like traditional auto suppliers that are well positioned to supply the EV market. So, this includes BorgWarner and Continental CTTAY as they have leading EV powertrain portfolios. So, not only do they make the components for traditional ICE powertrains, they also make hybrids and EVs. So, no matter how fast or how slow EV adoption occurs, they are well positioned to grow profits.
If we move more upstream, semiconductors are an important growth market where EVs need two to three times more semis than a traditional auto. And so, a company like NXP Semiconductors NXPI is undervalued and well positioned to benefit since they have a more automotive-focused portfolio.
Q: How about these lithium companies you mentioned a moment ago?
Goldstein: Lithium Americas, Albemarle, Livent, and SQM SQM are all undervalued. Lithium is the energy storage component that works for a transportation battery. Lithium demand will be growing at an annual rate of 20% over the next decade. This will leave the market undersupplied. Some sell-side brokers have downgraded lithium stocks because of new supply. We think demand will be too strong.
Q: What would you avoid in this space?
Goldstein: Toyota Motor TM is fairly valued right now, and we have a little less optimistic view, due to the fact that they’re a little late to the party with their EV portfolio. They looked at hydrogen for years, but basically abandoned that plan and now are developing EVs. But unlike other automakers who have invested in developing technologies and powertrains for years, Toyota is having to do quite a bit of catchup. That could result in them not being able to maintain their market dominance.
Elsewhere, I’d stay away from the battery makers. It’s a no-moat industry, and not very profitable. They can build these big factories, but the battery makers are getting squeezed by higher raw materials costs like high lithium prices, and they are getting squeezed by their automakers and by automakers saying you need to reduce costs. It’s really difficult to establish a competitive advantage.
Q: Thanks, Seth.