Investing principles for a new automobile era – Automotive News (subscription) (blog)

Traditional gasoline-powered cars and trucks are being transformed into sophisticated, technology-rich vehicles by automation, safety needs, electrification, data management and connectivity. Regulators, insurers and market forces are driving these changes.

But what is the industry’s evolution likely to hold from an investment standpoint?

As investment professionals, we see that more sectors than just automakers will be impacted as tidal waves of innovation wash over the industry, with far-reaching implications. A significant dispersion will develop between “winners” and “losers,” across numerous sectors, ranging from component suppliers to insurers to property developers — with one industry’s gain possibly another’s loss.

Tomorrow’s auto industry could look much like today’s smartphone industry, in which most assemblers make no money — but suppliers owning critical parts do. Already, some technology companies are cooling on becoming car assemblers, with growing emphasis on key components viewed as truly integral to future vehicles’ success.

The technology industry envisions future vehicles as giant smartphones on wheels — with mobility services such as navigation and entertainment likely accounting for more than a fifth of auto revenue by 2030, compared with virtually nothing today, according to consulting firm McKinsey. This is a must-win battle for technology and data industries faced with slowing smartphone and PC demand growth.

Considerable industry disruption will occur before well-priced, fully autonomous vehicles arrive — and applications of onboard technology and connectivity are already rapidly expanding.

For better or worse, many industries will feel the diminishing dominance of human-driven, gasoline-powered vehicles.

Take cobalt — key to the lithium ion batteries in electric vehicles. Cobalt could face a supply crunch, so some mining companies are planning to boost production, anticipating a demand surge. Already, cobalt prices have reached a near-decade high.

Utilities could benefit. Additional electricity demand from EVs could help offset overcapacity and falling demand in developed markets, while EV demand in emerging markets could complement rapid growth in renewable energy.

Insurers could see changing prospects over time: Advanced digital safety features could help improve road safety and benefit auto insurers by reducing claims. But ride sharing may eventually create a big enough risk pool for automakers or fleet owners to self-insure, eventually eroding the market share of personal insurers.

Meanwhile, auto fleet or leasing service operators will face falling values for outdated vehicles and the need to invest heavily in new-technology models.

Tomorrow’s vehicles will be rife with opportunity as well as pitfalls. Here are three principles that we believe will shape specific investment prospects:

1. Commoditization could damage value.

Commoditization could undercut the investment value of some products. For example, batteries are essential to EVs and today represent a chunk of EV cost. But their value may falter over time, with production costs falling as battery power grows. In the last fiscal year, the average profit margin of battery makers was 5 percent, vs. more than 20 percent for semiconductor and software companies. Traditional vehicle assemblers are challenged more than ever to adapt to changing demand — an expensive process. Safety accessories now part of high-priced packages will become standard and cheap, as did seat belts and airbags.

2. Intellectual property will be king.

Categories with significant intellectual property will become extremely attractive, with auto semiconductors an excellent example: Advanced driver assistance systems and autonomous driving need powerful chips. Software could also be lucrative. Long-term value will accrue to components with the most differentiated technologies and characteristics, as the rest of the vehicle becomes lower-margin.

3. It’s about more than cars.

Take real estate. Autonomous vehicles will likely impact profoundly the value of the built environment as well as raw land.

For example, shared autonomous vehicles may reduce demand for parking lots, which now cover more than one-third of some cities’ land area, says Eran Ben-Joseph of the Massachusetts Institute of Technology. Reduced parking demand could lower land values but also lead to redevelopment opportunities. Winners may include suburban apartment developers, because self-driving vehicles, by mitigating commuting pains, could help reinvigorate the suburbs.

Across different sectors and companies, the investment implications of the auto’s future will not be uniform. Opportunities and risks will constantly emerge and evolve, and only diligent analysis will identify which is which. But the road to this future should be well worth a careful and considered ride.