Rublin, Lauren R.
Barron's (Online); New York (May 6, 2022).
We once thought the future of transportation meant George Jetson's flying car. Instead, we got Elon Musk's Tesla—the company and the electric car—whose twin successes jolted the global automotive industry and are speeding the (eventual) demise of the internal combustion engine.
One might think, from the stock market or Twitter, that Tesla and electrification are the only things that matter today in the world of transportation. But there's a lot more to the story, including autonomous driving, ride-sharing, robotics, and mobility technology, to name just a few salient trends. Plus, there are 300 million vehicles already on the road in the U.S. alone that still need care and repair.
What does all of this mean for investors? That's the subject of Barron's first-ever transportation roundtable, which explores the outlook for auto makers old and new, and the technologies shaping the industry's future. Our panelist include Gary Black, managing partner of the Future Fund, whose Future Fund Active exchange-traded fund (ticker: FFND) invests in companies capitalizing on "secular megatrends"; Pierre Ferragu, head of the global technology infrastructure research team at New Street Research; Abhijit Ganguly, managing director of Goodyear Ventures, the venture-capital arm of Goodyear Tire & Rubber (GT); and A. Carolina Jolly, senior research analyst at Gamco Investors (GBL).
Transportation Roundtable Panelists
* Gary Black Managing Partner,The Future Fund
* Pierre Ferragu Global Team Head Technology Infrastructure, New Street Research
* Abhijit Ganguly Managing Director, Goodyear Ventures
* A. Carolina Jolly Senior Research Analyst, Gamco Investors
The roundtable took place in mid-April. An edited version of the discussion follows.
Barron's: Let's start with an overview of this sprawling subject. What are the most important trends in transportation that investors need to follow and understand?
Gary Black: The No. 1 trend is that EV adoption is exploding. Battery-operated EVs were about 6.6% of total industry sales globally last year. We estimate they were 9% in this year's first quarter, and will be about 30% in 2025, rising to 60% by 2030. That is reshaping the competitive landscape, similar to the way Apple [AAPL] reshaped the mobile-phone landscape when it introduced the iPhone in 2007.
The No. 2 trend is autonomy, and it involves two factors: self-driving cars and robo-taxis. An industry will develop around summoning a self-driving car that will take you where you want to go, as you can do today in Phoenix and San Francisco. The global ride-hailing industry today is about $300 billion in revenue, including taxis.
Third, Tesla (TSLA) has developed a direct-to-consumer sales model within the EV industry. It avoids dealerships, and uses social media instead of advertising. That's a big trend that we have to pay attention to.
Fourth, as we take out gas stations and install EV charging stations, a lot of infrastructure will need to be built. Range anxiety is still the No. 1 reason why people don't buy EVs. We need much better infrastructure to enable drivers to go from New York to California without worrying about running out of juice. These are the four big trends we're watching.
Pierre Ferragu: To me, the most important trend is electrification. The first order of transformation is that an oil-consuming, polluting powertrain is being replaced by an electric powertrain, itself a monster evolution of a $2 trillion industry. Then, there is the spin that Tesla is bringing to it. Tesla is revolutionizing this market the way Apple revolutionized the $50 billion mobile-phone market. It is redefining the category and attracting a large number of buyers to a significantly more expensive, higher-value product.
Second, the gig economy and more autonomous mobility are transforming personal transportation. This means delivery eventually can become real-time, and cheap. We will be able to leverage technology to make customer transportation and delivery much more efficient.
A. Carolina Jolly: I want to talk about the vehicles we currently have, and how much we rely on them. I am focused on logistics: housing and servicing these vehicles, and warehousing parts, and how these segments of the auto industry will adapt to trends such as EVs, autonomous vehicles, and shared mobility. The supply chain is also important. As the industry trends toward EVs, how is it going to source components and raw materials? And, how is it going to educate technicians in the future? Many auto companies are being driven by great ideas, but for these ideas to fully penetrate the market, people need to learn to support them.
Abhijit Ganguly: We see three big plays from a corporate venture-capital-deployment standpoint. Robotics is intersecting with mobility, and at that intersection, we find autonomous driving. Advanced driver-assistance systems are improving.
We also see the connected car. More vehicle components are getting smarter, which creates opportunities for the automotive industry to onboard value-added products that improve safety and efficiency.
Then, we see contactless digital technologies that were pulled forward by the Covid pandemic. The convenience these technologies can deliver to end users will become a big deal. In our world, that plays out in a few different ways. Mobile car care is one example: People are choosing to have their cars serviced in their own driveways, at the airport, or elsewhere. Also, companies are starting to use sidewalk robots to deliver groceries, improving the last-mile delivery space.
Last, but not least, sustainability is becoming a big factor in mobility. Sustainability at Goodyear means we balance environmental, social, and financial demands without compromising the ability of future generations to meet their needs. We are stressing sustainability in our Goodyear Ventures investments by enabling electrification, accessibility, driving safety, and less congestion through tire-intelligence collaborations.
EVs represent about 5% of the U.S. market. Penetration is around 10% in Europe, and 15% in China. How will EV market share evolve?
Black: We call it EV adoption. Our numbers are a bit different: We estimate that EV market share is 4% in the U.S. and 16% in Europe, with China in the lead, at 17%. It just feels like it's a better product. You charge your car at night like you charge your phone. EVs' cost per mile is a lot cheaper than internal combustion engines, and is getting cheaper as gas prices soar. And, as the technology gets more sophisticated, EVs will drive themselves.
We are bullish on Tesla because it is the market leader. Tesla has about a 20% share of the global EV market. As the TAM [total addressable market] expands for Tesla—as the company launches its Cybertruck pickup, an under-$30,000 EV, cheaper versions of its best-selling Model Y—we think it can hold its EV market share. The TAM for EVs is growing by about 50% a year. Competition is coming for Tesla, but even if the company just holds its EV market share, it will keep growing by about 50% a year.
What are the key constraints to faster EV adoption?
Black: Tesla has to build a new manufacturing plant or two every couple of years. It just opened a plant in Berlin that has the capacity to manufacture 500,000 vehicles. The Austin, Texas, plant has the same capacity.
Both plants are in the process of expanding their initial capacity.
[Tesla Shanghai announced this past week that it will open a second factory with a 450,000-unit capacity.]
What is your price target for Tesla?
Black: Our target is $1,600 a share. We estimate total global SAAR [seasonally adjusted annual rate of auto sales] of 80 million vehicles a year by 2026. We estimate EV adoption at 36% by 2026, and assume that Tesla will retain 20% of the EV market.
That means Tesla will deliver about 6.2 million [vehicles] by 2026, versus 936,000 last year. We assume the average selling price stays about where it is, and the company's auto gross margin will grow to about 31.5% from 29% in 2022. We estimate that Tesla will earn about $55 a share in 2026.
We assume the stock will trade for about 45 times earnings, versus 75 times earnings today. That gives us a price of about $2,475. Discounting that back at a 12% cost of equity gets us to a $1,600 price target today.
Do you see any risk in the CEO spending more of his time on a company called Twitter [TWTR]?
Black: Elon Musk can handle many projects. He's also founder and CEO of SpaceX, and founder of The Boring Co. I am not a fan of the distraction caused by his pursuit of Twitter, but he's not using Tesla's capital to do so. If he acquires Twitter, he could easily install another CEO to run it. [Musk subsequently agreed to buy Twitter for $44 billion.]
Pierre, you're also a Tesla fan. Explain your bullish view.
Ferragu: Electrification is a dynamic system in which the more adoption you get, the more possibilities there are for people to buy new cars. At this point, demand for Teslas has vastly exceeded existing capacity. I am focused on supply growth. Today, Tesla has to increase prices almost every month to rein in demand and try to get away from a nine-to-12-month lead time. The company is rapidly increasing the cost efficiency of its manufacturing operation, and the cost of assembling a car is falling fast. The only constraint over the next five to 10 years will be manufacturing capacity.
If Tesla maintains the current pace of growth in its production capacity, it should be in a position to sell about 20 million units in 2030, versus barely one million last year. Between now and 2030, Tesla has what it takes to get there. Then there's the question of how fast other auto companies can ramp up their EV production. Recently, we heard from the CEO of Rivian Automotive [RIVN] that it is going to be tough. The battery market is competitive, and it is difficult to get the supply chain lined up. It is going to be a fascinating decade.
In the meantime, Tesla is leading the charge on the three most important fronts, which are on the demand side. Their cars are the most appealing; they have the best charging network, and the best visibility. On the technology front, Tesla innovates at an unheard-of rate. Tesla retooled its pilot battery-manufacturing line seven times in two years, which means almost once a quarter. The average manufacturer would do that every two to three years. Tesla is innovating eight to 12 times faster than anyone else in the world in terms of manufacturing.
The last aspect is that Tesla is accumulating scale. Even if some other companies manage to move faster in the early stages of EV development over the next few years, Tesla will still have a significant advantage related to its expenses and scale.
What is your Tesla price target?
Ferragu: My price target is $1,580. Between now and the end of the decade, Tesla will be a hypergrowth business. It can grow its cash flow by 30% a year. I arrive at my price target by applying a multiple of 75 times forward earnings, and I expect earnings that are 30% to 50% above the consensus in the next couple of years.
What happens once Tesla can make two million cars a year, but sell only 1.7 million? Also, unlike Apple, the company manufactures its own products. Is that an advantage, or a risk?
Ferragu: On the first question, I don't have a strong conviction that will happen over the next eight years. Tesla has an immediate addressable market today of less than 10 million units, limited by the number of people who can afford a car that costs nearly $40,000, or more. But it has already demonstrated that its effective addressable market is 2 ½ times that, because for every two drivers coming from this premium market, Tesla attracts three from the non-premium market who are trading up to Tesla.
There is so much pent-up demand coming from that trade-up. Tesla will need two to three years to meet that demand with cars at today's price points, and will continue to generate 30% gross margins. In three years, Tesla will have a car priced at $25,000, which will extend its addressable market to more than 50 million units per year. I don't know when the company becomes demand-constrained.
As for the comparison with Apple, the companies are more similar than you might think. Apple doesn't manufacture its own products—it has a symbiotic relationship with Taiwan Semiconductor Manufacturing [TSM] and Foxconn Technology [2354.Taiwan]—but it controls the product end to end, from the hardware to the software, service fees, and platform. That is also the Tesla model. Apple came into a world in which contract manufacturing was already mature. It didn't exist in the same way in the car-manufacturing industry. Apple had the possibility to leverage a flexible, efficient, third-party manufacturing system, and Tesla didn't.
Before this becomes the Tesla roundtable, where do the rest of you see investment opportunities?
Jolly: We foresee 35% EV penetration [of new car sales] in the U.S. by 2030. There are 17 million new cars sold in the U.S. in a normalized year, but there are almost 300 million vehicles on the road already. We focus on the companies that service and repair those cars. The average age of vehicles on the road today is 12 years. We like companies such as Genuine Parts [GPC] and O'Reilly Automotive [ORLY]. They generate over $1.5 billion in free cash flow per year from the distribution of aftermarket parts.
We also like Monro [MNRO], which has 50% exposure to tires. Lastly, Universal Technical Institute [UTI] trains technicians; automotive is a big part of their business. The industry is going to need technicians, especially as Tesla's Model S and Model Y come off warranty.
How will greater EV adoption impact traditional service providers, such as Genuine Parts and O'Reilly?
Jolly: We estimate that EVs will account for about 2% of the U.S. aftermarket, or vehicles more than six years old, by 2030. Those vehicles will require about 30% less work than traditional vehicles. EV adoption will be a small drag on aftermarket outfits like Genuine Parts and O'Reilly in the next few years, crimping demand by about 60 basis points [six-tenths of a percentage point] through 2030. The big four aftermarket distributors can double their market share in a bull case, going from 40% to 80%, as they have significant ability to invest in the future.
Ganguly: From our standpoint as a tire company, electrification is a tremendous opportunity. EVs demand very different performance characteristics. We also recognize the need to manage the duality in the near term—namely, the different types of vehicles coexisting in the marketplace. And, we see an opportunity in infrastructure, both in the software used in EV chargers and in putting chargers in the right places. We are investing in companies that make charging easier for end-users, whether consumers or fleets. We're studying the vehicle-to-grid intersection, and the potential for vehicles to return energy to the grid. These and other areas allow for new software-development opportunities. There are also hardware opportunities in the charging-station infrastructure.
Which start-ups in these areas should investors keep an eye on?
Ganguly: Revel is a Brooklyn, N.Y.–based EV-only ride-share company in our portfolio. It has installed its own charging infrastructure in Brooklyn, and is building it out in other places to support its fleet operations, which include 100% electric cars and electric mopeds. And, it has opened up the charging infrastructure to third parties.
We have also invested in AmpUp, which makes charging more convenient for users, fleets, and facilities managers. AmpUp's software allows for choice and control. For drivers, AmpUp offers a dedicated mobile app to locate chargers and schedule charging. For charging-station owners, it helps control who receives access to charging, provides analytics, and optimizes energy usage. For fleets and utilities, AmpUp can provide energy controls to deliver higher uptime.
These are two examples of companies facilitating the software/hardware combination required for EV charging to work broadly.
What is the revenue opportunity, or total addressable market, for EV connectivity?
Ganguly: There's a lot to be done once you put hardware in the ground. There are simple things, like remotely managing hardware and performing diagnostics. We envision a world of SaaS [software as a service] opportunities based on this installed hardware base.
On the connectivity side, we are still in the process of understanding the TAM. The connected car allows for new value propositions. Car components can be connected to the internet to provide better safety and efficiency and predictive maintenance. For example, an intelligent, connected tire can communicate tire health and, in the future, alert road conditions to drivers.
In addition, we are expecting blockchain-enabled smart contracts to help connected cars with unique VIN numbers make payments automatically for tolls, fuel, and such, and also interact with city infrastructure and other cars. Web 3.0 start-ups may also help allow connected cars to display vehicle data in a user-friendly way, and allow users to share data to help get services such as insurance tailored to their driving needs and styles.
We are extremely excited about connectivity—the ability to digitize the contact point of the car to the road, which happens through the tire. If you can do that, you can achieve much greater safety and efficiency.
We're almost an hour into this discussion, and no one has mentioned Ford Motor [F] or General Motors [GM]. They are spending tens of billions of dollars to develop EVs—and catch up to Tesla. What are their prospects?
Black: Ford and GM are going to struggle. Ford's new Mustang Mach-E [an all-electric Mustang] has gotten the most traction, but even then, the company can't produce enough. ICE [internal combustion engine] vehicles still account for 91% of industry sales. Ford and GM have deliberately tried not to cannibalize their base business. That's a mistake.
You have to go after the heart of your business and not be afraid to cannibalize yourself, recognizing that EVs at some point are going to be 100% of the market. We are starting to see that with the introduction of the Ford F-150 Lightning and Porsche Taycan. Traditional car makers will be more successful in the EV world if they bring out EV versions of their best-selling brands, rather than trying to launch new brands with an EV moniker.
Jolly: I might take the other side of that argument, even though I agree with some of Gary's points. GM generates about $150 billion of revenue annually. It has said it will double that revenue by 2030, including $50 billion in Cruise [autonomous] and $90 billion in EV. ICE vehicles will account for 65% of sales through 2030, but traditional auto makers also have dealership networks that provide parts and service. Currently, pure-EV manufacturers don't have this. GM generates significant cash flow, but trades for only a mid-single-digit earnings multiple. From an enterprise-value perspective, once you back out stakes in Cruise, the FinCo [finance company] book, and the net cash on the balance sheet, GE trades for one to two times Ebitda [earnings before interest, taxes, depreciation, and amortization]. To me, GM's stock could be a great value play.
Black: To continue the Apple analogy, who were the dominant players in mobile phones before the iPhone launched? Nokia [NOK], BlackBerry [BB], Motorola, and Samsung Electronics [005930.Korea]. Three of the four really don't exist anymore as mobile-phone companies. They couldn't compete with Apple. I put the iPhone in the same category as Tesla. From a technology standpoint, Apple didn't stand still. It kept improving the product, and that's what you're seeing with Tesla. I don't see GM and Ford out-innovating Tesla. Unless Ford and GM separate their EV businesses from their ICE businesses and build separate EV companies almost from scratch, they are going to have a hard time gaining traction in EVs in the same way that Motorola, Nokia, and Blackberry failed to gain traction, even though they had a huge head start versus the iPhone.
Ferragu: Tesla's Model 3 and Model Y are very competitive in price against an equivalent ICE Mercedes or BMW. But Tesla has a 30% gross profit margin. It costs a traditional auto maker typically $10,000 to electrify a car. This is an enormous challenge for them. How can they compete with Tesla if it makes electric cars more cheaply than their ICE cars, and they have to spend $10,000 more to make an electric car?
But Carolina is saying something important: You don't want to underestimate the economic momentum of the legacy auto makers. Also, the U.S. auto industry has enormous political support. I expect the industry to survive, but the next 10 to 20 years are going to be extremely challenging. These companies will need financial lifelines from their governments. In some ways, they are too big to fail, or too big to lose significant market share to new entrants.
How do non-U.S. auto makers stack up?
Black: Volkswagen [VOW3.Germany] has been pretty aggressive about going after the EV business. Toyota Motor [TM] is still the world's No. 1 auto maker. It has two best-selling brands: the Camry and RAV4. Toyota has been slow at adapting to the EV world. That could hurt them, so I would put them in the loser's box. The negative argument for Tesla is: Can they produce 10 million units per year by 2030 with only two models? No auto maker has been able to do more than about a mil-lion per year.
Autonomous driving is an alluring concept, but it hasn't yielded much yet in the way of real-world applications. What is the outlook?
Ganguly: We have made a few investments in the autonomous world. We are investors in Starship Technologies, a mobility company whose autonomous robots handle last-mile delivery of groceries and meals; last mile is the most expensive part of delivery. The robots operate on sidewalks, which eliminates many of the regulatory hurdles that come with operating on roads. On-demand ordering and contactless delivery saw explosive growth during the Covid pandemic.
We have also invested in Gatik, an autonomous trucking company working on middle-mile logistics—that is, business-to-business logistics for the retail industry. We are working on connected-tire technology. We see ourselves playing an important role in making autonomy safe and efficient. Focusing on point-to-point delivery seems a more solvable problem than full-scale autonomy. Both of these companies allow us to work on a subset of the autonomy problem, but there are people looking at this space through a much wider lens.
Are there attractive public companies in the autonomy arena?
Jolly: Our focus, again, isn't on who is going to win in EVs or autonomous vehicles, but which companies are going to benefit from these trends. Greater penetration of autonomous technology over the next five years means more-advanced sensors and sensor-based parts on vehicles. The addition of this technology means two things: People probably will be able to do less work themselves on their cars, so companies with exposure to repair will do well. Second, those sensors likely will require more frequent recalibration, so cars will go in for repairs more often than in the past.
In addition to Monro, Genuine Parts, and O'Reilly, we like Snap-on [SNA], which sell tools to repair shops. We expect them to make more-valuable tools as autonomous technology penetrates the market. We also like Copart [CPRT], which auctions salvaged vehicles.
As the market transitions to autonomous vehicles, new technologies, especially sensor-based tech, are driving up the cost and value of repair. Increasingly, it is more expensive for insurance companies to pay for the repair of these vehicles than it is to scrap and auction them out. This creates an opportunity for Copart.
Pierre, what are your thoughts on the future of autonomy?
Ferragu: We are making good progress on autonomous cars driving safely, but the real challenge is mission delivery: making sure the car does the job in finding the person to pick up and figuring out where to drop her off, for instance. Autonomous technology needs the right environments to flourish, meaning an existing infrastructure, with an existing fleet of human drivers already delivering a service, into which we'll be able to progressively introduce driverless vehicles.
When it comes to assisted driving—a car driving by itself but with the driver still behind the wheel, ready to take over and able to supervise—we are particularly bullish on Tesla. They have the best technology. For driverless services, we are bullish on ride-sharing leaders such as Uber Technologies [UBER], Grab Holdings [GRAB], and DiDi Global [DIDI], which are best positioned to introduce driverless vehicles in their fleets. We are more prudent on players like Waymo [a subsidiary of Alphabet (GOOGL)] and Cruise, which are trying to develop driverless fleets by themselves.
Black: Pierre, how much of your $1,580 Tesla price target reflects autonomy?
Ferragu: None of it. For now, I am forecasting 30% gross profit margins for Tesla, in line with their current performance. In the long run, autonomous might contribute to that level of profitability, or add to it. It will depend on how unique their technology is.
Black: We put no valuation on Tesla's autonomy offerings, either. Every innovation you've seen in the automobile in the past 60 years, whether automatic transmission, anti-lock brakes, or turbo-charging, has been copied by all companies. It is hard to say that any one company will gain significant market share.
Right now, the take rate on FSD [full self-driving] at Tesla is under 10% globally, and about 15% in the U.S. People will say that's because it doesn't work yet; it's only a Level 2 system [partial automation]. But even once Tesla gets to Level 4 or Level 5, other companies will reach the same point.
Practically speaking, how will autonomous driving roll out over the next few years?
Black: Elon has been promising it will be this year for at least five or six years, and we're still not there. First, we are several years away from the point where regulators will approve autonomous vehicles that don't require you to sit in the driver's seat and keep both hands on the wheel. Second, everybody in the industry is working on this.
Tesla believes in what it calls a generalized solution, meaning FSD beta features have all been perfected. Tesla can push a button and FSD will work everywhere. Other companies are using more of a geofenced framework, whereby they master one market and then roll it out to additional markets. It is hard to see how this scales quickly, so I struggle with it from an investment standpoint. More important, regulators aren't going to favor one company over another; they are going to try to give everybody an equal playing field. Hence, it is hard to value.
Ganguly: We are watching point-to-point applications, and expect those problems to be solved earlier than some of the broader, more challenging problems the AV industry is pursuing. We expect to see a lot happen on the sidewalk, including autonomous delivery of goods. We are also working with and watching robo-taxi-type applications. We see autonomy happening first in segments where safety can be assured more quickly.
Pierre mentioned Uber. Do the rest of you have favorites in the ride-sharing industry?
Ferragu: In ride-sharing and delivery, we see a strong network effect. It is a competitive market with no barriers to entry on greenfields. But as competition intensifies, scale becomes critical and only the largest two players survive. We call that natural duopolies, and natural duopolies usually result in very strong economics for the market leader, whereas the No. 2 will have a harder time. We like Uber and Grab, and we would like DiDi as much in a different political setup.
The pinnacle of that world is when you have the No. 1 food-delivery company and No. 1 ride-sharing player combined in one company, and that is the case with Grab. It is No. 1 in five countries in Southeast Asia in both delivery and ride sharing. Uber is No. 1 in about 40% of the world in ride sharing, and has exited other markets. In addition, in most of their markets they are a very strong No. 2—and sometimes even No. 1—in food delivery, as well.
Black: We like Uber, too, for the reasons discussed. Also, it is a reopening play. Uber is selling for less than two times enterprise value to revenue, and will be profitable in 2023. They have formed a duopoly with a lot of pricing discipline. We own Uber in the Future Fund.
Thanks, Gary, and everyone.
Write to Lauren R. Rublin at firstname.lastname@example.org
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Credit: By Lauren R. Rublin