A historic industry transition is in process, and today's capital allocation decisions could prove critical to the success, relevancy and existence of legacy original equipment manufacturers (OEMs) moving forward. Looking to 2022-23, the disruptive potential of battery electric vehicles (BEVs) will likely become clearer as technological improvements in the EV supply chain result in cheaper, cost-competitive BEV products relative to internal combustion engine (ICE) vehicles.
Historically, industries have been ripe for disruption when facing both rapid technological advancements and broad policy support—which aptly describes the auto industry today. That said, the argument that legacy OEMs are “doomed” because they have “billions of dollars of PP&E and thousands of employees that may not be needed to make electric cars,” is principally flawed. For example, the basic stamping, painting, welding and interior assembly process is essentially the same for both ICEs and BEVs, and while BEVs don’t need a transmission, the roughly 10% of workers in those plants can be retrained to assemble electric motors—which also require precision machining and assembly. Engine and ICE component plants are at risk, but these facilities represent a manageable portion of the overall workforce (about 18% of hourly workers).
Contrary to the popular belief, we believe that legacy OEMs with “all-in” EV strategies will lead the transition to EVs with only limited margin dilution. To help navigate the near-term “noise,” we outline four factors that potential industry winners have in common:
- They’re taking an “all-in” approach to electrification, with diminishing capital allocation to legacy operations—effectively, running the legacy operations for cash.
- They’ve invested in a scalable, dedicated “EV-only” platform architecture. OEMs in this position have a first-mover advantage and an opportunity to gain market share as battery technology matures.
- They’re securing battery supply (e.g., through jointly owned plants). Battery access may, over time, become a core competitive advantage.
- Finally (and of key importance), companies need to have a cash-cow ICE business that helps fund these investments (or, in Tesla’s case, negative cost of equity).
While we think legacy OEMs leading on these parameters will thrive, laggards increasingly will lose market share and profitability as the electrification “evolution” accelerates. As such, we expect valuations to become increasingly polarized between structural winners and losers over the next 24-36 months. In our view, the sector is still highly investable and represents an attractive source of alpha potential.