By Cornelius Zeeman & Thembinkosi Kweyama,
Fairtree Portfolio Manager & Equity Analyst

The Evolving Vehicle Market.

 

From centuries of human reliance on walking and horseback riding, the 20th century brought the introduction of automobiles. Today, we are witnessing a rapid and profound transformation in transportation as we move away from traditional internal combustion engines and gasoline, embracing batteries and electricity as the new driving force.

Our previous article on China detailed the country’s incredible ascent in the manufacturing value chain. This article explores how China is spearheading the revolution in manufacturing New Energy Vehicles (NEVs). While the EU and the USA experience sluggish growth, China has surged ahead, with NEV (New Energy Vehicle) penetration surpassing 30% within the past 12 months (as seen in Graph 1 below).

Graph 1: NEV Market Penetration – China’s NEV S-Curve

Source: Fairtree, BofA, Morgan Stanley, EV Volumes

The accelerated NEV penetration, as seen in Graph 1 above, also reflects the substantial impact of government subsidies that incentivised Chinese consumers to purchase NEVs. Larger cities, often referred to as tier 1 and tier 2 cities, which suffer from traffic congestion, made it easier to get a number plate if you buy an NEV. Consumers choosing to buy an Internal Combustion Engine (ICE) vehicle had to go through a lottery process to obtain a license plate. This was a competitive endeavour, given the limited amount of number plates available.

In addition to incentives by Chinese authorities to promote the adoption of NEVs, there have also been major strides in technological advancements in battery efficiency and extended driving range, which has moved NEVs into mainstream popularity. With over 50% of NEVs now capable of travelling over 450km on a single charge and rapid charging capabilities achieved (for context, a single charge takes around 20-30 minutes from 10% to 80% battery level), Chinese Original Equipment Manufacturers (OEM) have emerged as pioneers in battery technology and NEV cost reduction strategies – an inflection points where adoption accelerates.

As depicted in Graph Set 2 below, premium BEV penetration has been higher vs the mass market due to factors such as relative affordability and model accessibility. China, benefitting from lower production costs, has introduced models tailored for mass market consumers, including the Wuling Hongguang Mini, Tesla Model 3/Y, and a few BYD Models. China’s automotive market emphasizes SUVs and sedans, with these categories boasting the highest number of models equipped with NEV powertrains. In contrast, the US vehicle market is dominated by trucks (referred to as “bakkies” in the South African context), which has limited availability of NEV models within this segment, thereby contributing to the sluggish adoption of EVs in this market.

Graph Set 2: BEV penetration: Mass vs Premium Brands – Global

Source: HSBC: EV-Volumes

Additionally, an intriguing aspect is the evolving consumer preference for immersive experiences beyond mere point-to-point transportation. Surprisingly, features such as Karaoke and large gaming screens are becoming key offerings in NEV vehicles. The positive reception by consumers underscores the unique selling proposition Chinese vehicle manufacturers offer versus traditional competitors. To date, only two vehicle manufacturers have the significant scale to produce more than 1 million units per year of electric vehicles, namely Tesla and BYD (Build Your Dreams). It is also important to note that close to 50% of Tesla’s vehicle production capacity is based in China.

Graph 3: BEV Sales by OEM

Source: Fairtree; Morgan Stanley; EV Volumes

Chinese Cost Leadership.

 

China’s manufacturing scale and technological advantage have placed it in a strong position as it looks to expand its export initiatives to other nations. They have illustrated a notable cost advantage over European vehicle manufacturers. For instance, in markets like Germany, a Chinese-manufactured BYD model retails at a 14% lower price than its European counterpart, even when factoring in import duties and freight expenses, which add an initial 32% to the ticket price.

Graph 4: BYD Seal China MSRP vs theoretical German MSRP (vehicles made in China, imported to Germany)

Source: Company data, UBS. Note: BYD Seal base version (not the teardown vehicle), including VAT

Graph 5: BYD Seal “margin-parity” German MSRP vs European BEVs German MSRP

Source: UBS (31 August 2023)

Anti-Dumping Probe.

 

In response to the competitive threat posed by Chinese vehicles, the EU has initiated an investigation into the subsidies involved in China’s manufacturing process. The “Anti-Dumping” probe is set to be concluded in the next 12 months and aims to assess its potential impact on EU-based Original Equipment Manufacturers (OEMs).

Meanwhile, in the USA, the government has introduced the Inflation Reduction Act, which serves as a policy to incentivise NEV purchases but comes with a few anti-China policies. Vehicles must meet the 50% local manufacturing or material content requirements to qualify, this has led to global battery manufacturers like LG Chem setting up bases in the country to comply with these requirements – echoing the ongoing conflicts within the semiconductor industry.

Impact on incumbents.

 

There is a lot of negative sentiment towards traditional vehicle manufacturers that are still skewed towards internal combustion vehicles, as well as the Platinum Group Metals (PGM) miners, who face declining demand for their metals. PGMs are a critical input into Internal ICE vehicles to lower tailpipe emissions. Historically, PGM demand has benefitted from the regulation of tailpipe emissions, which became more stringent throughout the years. While BEVs operate without using PGMs, PHEVs continue to use these metals, combining ICE and electric engines in a vehicle. This means that demand for PGMs is depends on how the mix of BEVs and PHEVs develops over time.

Currently, PHEVs enjoy popularity within European markets because they perform better in colder temperatures, whereas BEVs suffer from performance issues in extreme temperatures.

However, among OEMs, BYD stands out as the number one producer of PHEVs on a massive scale. Based on Bloomberg estimates for the next 5 years, BYD’s anticipated BEV and PHEV split is close to 50/50 and could still support PGMs. Notably, BYD is sold 1,44 million PHEV units in FY’23, and they have more than 35%-unit share in the PHEV market. We have also seen PHEVs grow faster than BEVs in the past year, which shows that there could be a world where PHEVs and BEVs can share the space in technology, and consumer preference is key.

Graph 6: Beyond Your Dreams (BYD) Vehicle Mix

Source: BBG and Fairtree

Different NEV technologies

 

The mechanics and raw materials differ between the powertrain technologies. The cost base of a battery electric vehicle is skewed to the cell and battery costs, and there is no powertrain. PHEVs, on the other hand, have smaller batteries, which are 20-35% of the size of a competing BEV model. If you put this into context, the maximum range you can get out of a BEV is between 415-605km, and PHEVs are above the 700 km range, including the additional power you get from the smaller battery. Range anxiety is still common and helps to explain the popularity of Hybrid vehicles. Another derivative to the NEV landscape has been the Extended Range Electric Vehicles, or EREVs in short, which have a larger battery size compared to a PHEV and can do close to 1000km in range on the back of the battery potential and ICE Engine duopoly with a 10% increase in the cost differential if you refer to the cost ladder in Graph 7 below.

Graph 7: Cost ladder from ICE to BEV to EREV

Source: UBS research, Company data. Note: This chart assumes an ICEV BOM cost of 100

Conclusion.

 

The Western world, notably the US, lags in transitioning to NEV and is now reacting by enacting policies to bolster demand and enhance competitive supply. The technology has evolved fast, and NEV prices are reaching parity with ICE vehicles in certain regions.

Traditional automobile manufacturers carry valuations of a declining industry, and the PGM companies are under pressure at the prevailing commodity prices. Pure play NEV manufacturers like Tesla, Li Auto, and Nio have been flying high over the last few years due to the excitement about exponential demand growth. However, their share prices have started to drift lower, and in some cases collapse, as the market realised that this would be a competitive landscape, thanks to the billions of dollars being thrown at the industry in the form of government subsidies and equity raises, on the back of elevated valuations. It is worth remembering that good growth does not always translate into favourable shareholder returns, as displayed by Table 1 below, where only three of these OEMs have shown positive returns since their respective IPO dates.

Table 1: Total Shareholder Returns for Select EV Manufacturers

Source: Fairtree, Bloomberg

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