Welcome to the "Industries in Motion" podcast from RBC Capital Markets, where we'll be exploring what's new and what's next in today's fast-moving markets and industries to help you stay ahead of the curve. Please listen to the end of this podcast for important disclosures.
I'm Michael Hall, head of European research at RBC Capital Markets in London. And in this installment of "Industries in Motion," I'll be speaking with Tom Narayan about his recent work on the outlook for European autos into 2022.
Tom joined us in London in 2019, and beforehand he covered the chemical sector in New York, having joined RBC in 2015 and had quite a long history on the buy side before that.
So, Tom, really great having you on board, and thanks very much for joining me today.
Yeah, thanks for having me.
Let's go right into it, Tom. Where are we then in the auto cycle?
Yeah, so auto sales really peaked globally in 2018 at 94 million vehicles and then, of course, fell all the way down to 74 million in 2020 with the pandemic. So we forecast 2022 to reach about 82 million units, still well below prior peak levels, but we don't expect this to return into peak levels until 2024 at the earliest. And the main cause of this is, of course, the continuing semiconductor chip shortage crisis.
Well, let's pick right up on that then, the semi shortage. How is that gonna impact the sector into '22 and beyond?
Yeah, this is probably the most important question facing the industry. The situation is fluid and changing daily, but for the most part, visibility is still quite poor. Volkswagen last week told investors that in 2022, it only expects four to 5% volume growth. IHS, a key third-party forecaster, is expecting 9% growth globally. And we think some of the caution on Volkswagen's part is just coming from a lack of visibility and conservatism as a result. We also saw suppliers like Faurecia and Valeo issue profit warrants in recent weeks, largely due to this uncertainty on chips. And this is because their OEM customers have been shutting down plants, starting them back up again.And this stop-and-go activity has created uncertainty on the visibility of the supplier group. Their current expectation for the industry, and we share this, is for a recovery to begin in the second half of this year. And our channel check suggests that it's more likely to be in the fourth quarter of this year and possibly even bleeding into the first quarter of 2023.
Okay, so look, we can't go into your specific recommendations here, but how do you think about investing in the sector given its inherent cyclicality and the various risks at play into 2022 and beyond?
Yeah, there's been a raging debate here on how do you really play this group, and it tends a very binary one. If you believe that the semiconductor chip crisis improves or normalizes quicker than the market is expecting, then the trade would be to own the volume OEMs and the supplier group. But the flip side of this trade, the one that's been working so far, is the opposite of that, which has been to favor premium OEMs and those with pricing power and not favor the suppliers, who are more volume-driven. We tend to think that the current trade, which we call the inflation trade, those companies that benefit from the chip crisis in some way because of they have pricing power, we tend to think that that trade will continue given the uncertainty, as we talked about, on chips. And this really benefits premium OEMs, premium car makers, whose customers really aren't as price sensitive. They benefited from things like a strong stock market, real estate, and, of course, low interest rates.
Now, even though these themes may be reversing a little bit, we still think that history's proven that premium car makers have been able to hold onto price even during deflationary periods. We also like the tire makers, who have also benefited from the chip crisis in some way because they're not really tied to auto production or new car sales. They're tied more to the replacement market, which is miles-driven determined. And if you're a tire customer, you don't really care as much about a 10 or 20 Euro price increase on the tires. You're buying a tire 'cause you need it, not necessarily because you want it. And it's usually somebody else telling you that you need to buy the tires. And tire makers have shown time and time again they've been able to not only push through price increases but definitely hold onto them, especially during, as this crisis kind of dissipates. Though we think they'll be able to hold onto the price.
Now we are most concerned on the supplier group, who are all volume-determined, and with the semiconductor chip crisis continuing, we still see pressure on volumes. And the other issue could be even as the semiconductor chip crisis normalizes, and we do expect it will over time eventually, there could be another problem looming on the horizon, which is a battery crisis. Namely, battery supply could be another supply crunch. We've already seen raw materials like lithium and cobalt and nickel escalate in their costs. And so even if chips normalize, there could be a battery crisis that looms right around the horizon. So even in that environment, we still think that you continue this inflation trade and prefer the premium OEMs and tires and are cautious on the suppliers.
Okay, that makes sense. And then turning to the question which has dogged investors for the last five-plus years, where are we in the new entrants versus the legacy manufacturers? Where are we in the new EV players, Tesla, obviously the notable leading example?
Yeah, this is the central theme that's emerged especially with these new EV players, notably Tesla, really sucking all the oxygen in the room, having a lot of market value and certainly getting credit from investors. And it does beg the question of, you have a fixed amount of revenues that go towards the entire autos ecosystem. If the new EV players are taking up the majority of it, it certainly suggests that investors may think that legacy players don't have a role in the future. So there's definitely a big question as to who is right. And to some extent, we think there is some truth to giving these new EV players credit. Autos is very competitive landscape. There's a fixed amount of vehicles sold each year, especially in mature markets like the US and Europe. So in this backdrop, if you have very well capitalized new entrants, like Tesla, who now don't have to transition from internal combustion engines to full electrics, like all these legacy players have to do, there's a reason to believe that this could spell trouble for the legacy car makers. And this is especially problematic when you consider how low the profit margins are for the legacy players.
The flip side to this argument, though, is that the legacy players aren't really just sitting on their hands. Will all of them survive these new threats? Probably not. But history is full of examples of situations when new competitive threats force these legacy players to react. In our "Imagine" series, we took a look at Volkswagen, who's facing a lot of these challenges and compared the automaker's electrification transition to that of Comcast, a company in the US cable industry, who in the 2000s faced competitive threats from a phenomenon called cord cutting, namely customers foregoing video subscriptions in favor of getting all their video content through the internet. And the cable industry, led by Comcast, was able to consolidate smaller players and survive the transition. And we could envision something very similar happening in autos, where some legacy car makers will survive, and others probably won't. We also do wonder if some of the valuations of these new EV makers are justified. And, finally, longer term, electrification could actually benefit some of these legacy survivors as battery prices could continue to fall.
You mentioned powertrain there, and it seems obvious that many or most of the auto manufacturers have already selected battery electric powertrains over the internal combustion engine. But you obviously got other renewable technologies. You've got hydrogen fuel cells, e-fuels. Is there an argument that we're gonna see other powertrains materialize and eventually win out?
Yeah, this is also a debate that you hear that comes up quite a bit. And certainly initially when a lot of the OEMs were talking about electrification, it was very controversial. But now we think it is basically a done deal that full electric, battery electric vehicles make the most sense for passenger cars. Weight is not really an issue, and the efficiency is the greatest for battery electric cars to transfer electricity to a battery, as opposed to hydrogen, which is the most often talked about alternative. Further, e-fuels, which is another one talked about, where you still use the internal combustion engine, that one has the worst energy efficiency. We did host a panel of experts, including the CEO of Hyundai Hydrogen Solutions, who did make a strong case for hydrogen, but this really applies to heavy-duty trucking where we see it making the most sense. With heavy-duty trucking, weight is very important. You're transporting cargo over long distances, and so is range. So, as a result, large batteries will cut into their bottom line, and we see hydrogen making the most sense for trucks. But, again, passenger cars, full electric seems to be the best way to go. You could charge your battery at home overnight, just like your phone. It's a lot easier. And at the end of the day, weight isn't as big of an obstacle, and it's the most efficient.
Gotcha. Final question then. Robo taxis, you talked about it in your research before, but there was obviously a lot of press on it post-Elon-Musk's comments on Tesla's result scores recently. Is there something going on here, something we need to understand and educate ourselves on?
Yeah, I mean the stock market definitely didn't like some of his comments. He seemed to wanna push near-term projects to the back burner in favor of these investments in robo taxis. I have to say, though, after attending CES this year, the Consumer Electronics Show, which arguably is the most important auto show, autonomous technology is very much a reality. We can put our tinfoil hats away. Science fiction is really becoming science reality. The problem with it tends, I think, really to do more with regulatory and policy roadblocks, not the technology. We don't expect to see shared robo taxi usage become mainstream for years, if not decades, but when this event happens, it will be transformational to the industry and arguably, to be quite honest, to society. It'll undoubtedly save millions of lives, increase labor productivity, save valuable real estate and city spaces. Shared AV usage could theoretically cut the amount of cars on the road by a factor of 20. It raises questions over what happens to these automakers. They'll undoubtedly need to shift from making cars to other parts of the auto value chain. Specifically, they'll have to pivot to more asset-light software models and compete with the entrenched and well capitalized software giants. Consumers, meanwhile, would probably benefit from lower transportation costs.
Now, while all of this is very far away, there are some near-term implications. Long-haul trucking will see real applications of driverless cabs within the next few years. And this is becoming an issue, especially now given the trucker shortage issue, which is structural in nature. So, bottom line, even though this may be some time aways, the technology is there, and we're gonna start seeing practical applications of it in trucking pretty soon.
Great, thank you very much for your time, Tom. It's been great running through the transition in the sector and thinking about the near-term problems but also the longer term dynamics. Really appreciate it. Look forward to hearing more as the year progresses.
You got it. Thanks a lot. Thanks for having me.
Cheers.
So what else lies ahead in today's ever-evolving markets and industries? We will be keeping track right here on "Industries in Motion." Make sure you subscribe to "Industries in Motion" wherever you listen to your podcasts. Thank you for listening to today's episode.
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