Investment Thesis: Betting On ICE Engines
My latest investment for the HSEP is one that I've been thinking through and researching for some time. This will be one of the more high conviction ideas in the entire portfolio.
When we try to find legitimate multi-year investments, there a few things we want to look for in our ideas. We want companies that benefit from some sort of macro trend. We want companies that have staying power even through a recession. Dividends are great. And if we can find companies that border on contrarian, even better. That way we know we’re not just chasing gains that other investors have already made. Valuation is important. Especially if the easy-money era is indeed over. If we can find companies that check off every single one of these boxes, they’re probably major opportunities.
The Thesis: Vehicle Sales To Plummet
The investment thesis that I’ve been grappling with is the thought that auto sales broadly are going to fall off a cliff in the current macro/credit environment. The wrecking ball that has been the increasing cost of credit is going to do damage to the auto market in a big way in my view. History shows when rates rise, total vehicle sales fall shortly after:
The rate of change of these interest rates has not yet been processed by the broader economy. Like mortgage rates, higher fed rates impact auto loan rates. Here’s the average rate for a 5 year automotive loan over time:
Ouch. It’s now more expensive to finance a car than at any point in the last decade. This cost of credit trend actually suggests buying any automaker might be a poor investment choice if demand for the product is about to fall off a cliff. Especially considering many of the major auto makers are also in the financing game. After a brief spike up at the beginning, we’ve seen the auto industry’s inventory/sales ratio absolutely collapse since lockdowns:
How I interpret this data is that demand for vehicles was robust when rates were low - demand was so strong that inventory wasn’t staying on lots and finding cars was a challenge at the consumer end. Though a trend change is starting from generational lows, we’ve seen that ratio start to creep back up as the central bank started raising rates. I’m especially concerned about automakers going forward because of broader ESG initiatives.
The EV Problem
The focus from automakers has shifted to building out electric vehicles (EVs) over traditional gas-using internal combustion engine vehicles (ICE). And that brings us to EVs…
JP Morgan JPM 0.00%↑ has estimated ICE vehicles will maintain just 41% share of the vehicle market by 2030. Is this feasible?
Here’s a possibly unpopular opinion in the world of ESG investment, this big multi-year push to electric vehicles in the automotive sector is probably NGMI. At least for the time being but possibly even for a very long time. For those who lack the ability to decipher crypto-twitter slang, NGMI means “not gonna make it.” Why do I take that view?
First off, this is not a political idea for me. I really don’t care which duopoly party is supposed to like clean energy and which one isn’t. After listening to various opinions on the matter, I’m not sold that we have the ability to do what EV proponents have in mind without big improvements in several areas:
The podcast above is a really great listen and leads me to believe the widespread EV adoption estimates are likely irrationally exuberant. The podcast guest is Brian Gitt; a guy who very much believed clean energy is the future, pursued it as a career, and has since changed his mind. His skepticism on eco-initiatives seems to be shared by the now former-CEO of Toyota TM 0.00%↑ Akio Toyoda who said this back in December:
That silent majority is wondering whether EVs are really OK to have as a single option. But they think it’s the trend so they can’t speak out loudly…The right answer is still unclear, we shouldn’t limit ourselves to just one option
Naturally, in late January Toyoda was replaced. Yikes. Before we even get into the fun stuff, there are actually serious concerns that come with transitioning completely from ICE to EV for two crucial reasons:
The natural resources required for the energy storage at the individual unit level might not actually be sustainable
A large amount of electricity still comes from “unclean” energy sources, thus negating the entire point of moving to EVs in the first place
I’m a HUGE believer in innovation. I’ve personally been in a Tesla TSLA 0.00%↑ and felt how amazing it was - the torque is literally breathtaking. Super cool vehicle. I really do think that engineers will get this figured out at some point. But I don’t think the net benefit of swapping ICE vehicles for EVs in 2023 is a certain positive. And this concern isn’t even environmental - which is a valid concern regardless. I invest in things that are bad for the environment all the time. Gold mining, for instance, is terrible for the environment.
In my mind, the bigger issue facing widespread EV adoption may actually be the financial cost to the user - the upfront cost is more onerous than a traditional ICE vehicle that is of comparable quality. I think that’s pretty well understood.
Over the lifetime of the vehicle’s service, it’s a bit more debatable and likely matters tremendously where you are. Harsh climate? Forget about it. Moderate climate, maybe a better case for EVs. But even still, your comps and your input costs matter tremendously. If you’re comparing a Tesla Model 3 to a BMW 320i, the Tesla is cheaper after 4 years of ownership when you use the template defaults:
However, the moment you start making adjustments to the template it becomes much less clear. For instance, take out the EV purchase credit, adjust the energy source inputs to the more current $3.40 per gallon and $0.17 kWh levels, and then add in financing at current market rates over 60 months and it looks very different:
And again, this takes 4 years to get these savings. Many people swap for newer cars before 4 years. And most people I've encountered aren't building excel sheets to assess what their total cost of anything is - they're certainly not building models with 10 year time horizons for vehicle purchases. They're looking at the sticker. Those of us who do these things are weirdos. And some of us may be making assumptions that we shouldn't be making. For instance, here’s a user-generated model for the ICE F-150 vs the EV F-150 Lightning on a Ford F 0.00%↑ message board that is pretty hilarious. It assumes a kWh input cost that takes some liberty with reality.
Again, over the life of a vehicle, you could talk me into EV’s potentially being cheaper over a longer period of time. I really don’t know. Comps and inputs matter in a big way and the usage habits/vehicle choice of each consumer might produce a drastically different estimate.
But the larger point is if automakers are indeed shifting production to electric vehicles and EVs aren’t actually the silver bullet some believe they are, we’re probably going to have new auto supply problems. Furthermore, with higher borrowing costs likely hurting both the manufacturers and the consumers, my thesis is that we’re going to end up with a new ICE vehicle shortage. So how the heck do we make a bet on this setup and this thesis?
Keep reading with a 7-day free trial
Subscribe to Heretic Speculator to keep reading this post and get 7 days of free access to the full post archives.