Auto Industry- A Case Study in Disruption

  • Sep 30, 2023

Dear Investor,

Almost 50% of our domestic manufacturing is linked to automobiles and its supply chain. Today to say that this industry is undergoing disruption would be an understatement. In light of an old industry undergoing disruption, regulators struggle with finding a right mix of sticks and carrots to promote best technologies, product pricing goes haywire and consequently investors lose their ability to value assets in the space appropriately. Through this newsletter, we try to shine a spotlight on the transport transition pillar which is not only reshaping the vehicles on our roads but also redefining the market dynamics and investment opportunities.

Curtain call for ICE Vehicles?

India is the third largest energy consuming country in the world, although its per capita energy consumption is only a third of the global average. India is also the third largest global emitter of Greenhouse Gases (GHG) emissions, largely driven by the coal-dominated energy mix. India has committed to being net-zero by 2070, with a target to reduce the emission intensity of its GDP and meet 50 percent of its power generation capacity based on non-fossil fuel sources by 2030. India’s energy transition is anchored by three fundamental pillars – 1) grid decarbonisation, 2) industrial decarbonisation, and 3) transport transition.

It’s far easier to spot an electric vehicle in metros today either by their green number plates or EV scooters by their narrower form factors (yet the same weight!) and CNG vehicles by the queues outside CNG pumps!. It wouldn’t be far-fetched to call out that there is a sea change in the automotive sector – where vehicles powered by internal combustion engines (ICE) (since the 19th century!) are seeing a migration to hybrids/alternative fuels (CNG, biofuel, hydrogen, EV). It’s not that electric vehicle technology is new – its origins can be traced back to the ‘80s, however, environmental concerns, better economics and battery technology led to the commercial revival of electric vehicles (also in part thanks to a small Silicon Valley startup, Tesla Motors in 2006). It’s hard to tell what the medium term looks like for the automotive sector during this transition, but it’s clear electric vehicles hold a lot of potential for creating a more sustainable future.

Not so soon suggest EV numbers & ICE Valuations

EVs are surely growing by leaps and bounds – E2W touched 7,82,389 units and E4W at 54,297 units in FY23, both more than doubling over their previous base. The 2W and 4W industry sales for the same period were 15.8 mn and 3.8 mn respectively, implying penetration of electric vehicle sales still remains low. .

If the total cost of ownership of an EV was better than that of an ICE vehicle, we would have seen much better adoption. This shows there are still a few kinks viz. charger network, battery range, pricing etc. to be ironed out before EVs are more prevalent on Indian roads. This is where we see an irregularity in the market dynamics. EV penetration is a zero sum game – an EV would replace an ICE vehicle in a household or at best, be purchased as a second vehicle for city driving. In volume terms, while PVs just crossed FY18 highs in FY23, 2Ws still have not been able to. Thus for 2Ws, if the addressable market appears to have stagnated, and e2Ws are seeing exponential growth, ideally incumbents should have seen a de-rating, which has not yet happened. On the contrary these companies are trading at peak multiples, therefore not pricing in any risk from the rise of challenger new brands!

On an average, incumbents are trading at 50% premium multiples to their own history with the exception of Hero Motocorp.

Meanwhile in the unlisted space, unlisted e2W OEMs valuations are as bizarre if not more. Based on media reports, Ola Electric was valued at USD 6 bn, rivaling Hero Motocorp’s market capitalization despite selling just ~3% of its volume. And this is not a local phenomenon, we have seen this occur on the global stage as well as seen in the chart below.

Evs growth limited without government support

EVs have been dealing with challenges of their own. Government subsidies under the FAME II scheme did drive early adoption of e2Ws which is why we’ve seen volumes stagnate off late. But after the government stopped disbursals in the FAME II scheme due to alleged misuse and fraudulent claims of domestic sourcing by OEMs, some OEMs are petitioning the government to re-claim subsidies from customers! And before these issues are sorted, recent media headlines point to an eye-popping outlay ranging from Rs 40,000-50,000 crore under FAME III as compared to Rs 10,000 cr under FAME II which may be rolled out in the coming months. On the global stage, supply does seem to be in abundance given the supply chain disruptions are behind us. China is now by far the largest EV market and is also globally dominant in related industries. Pricing pressure in the Chinese market is intense, which has made exports an attractive outlet for them – possibly why Tesla has been cutting prices and offering discounts globally. The Indian government however has been hesitant about Chinese investments in India.

Too many unknowns?

Given that the waters are murky, economics are uncertain, and the path to profitability remains unclear, investors have to question the potential for positive returns on capital. For now, the market appears to be rewarding both sides of the spectrum – the incumbents and upstarts. We personally are of the view that it’s prudent to remain in the auto ancillary space where you have a well-diversified customer base and carbon-neutral product basket to capture growth wherever it may be. Our holdings in this sector are as such – one has MNC parentage and a host of process technologies which caters to the needs of its global customers. It has a well diversified clientele across PV, 2W, CV and off-road vehicles and has a clear focus on profitable growth while pursuing inorganic opportunities to add new technologies and customers. The other too has MNC backing and is focused on offering low pressure die-casting solutions to its global customer base. It is successfully diversifying away from its 2W customer base by adding customers in 4W, including India’s largest PV automaker, and defence as well. Last but not the least, this company is riding the LED-fication wave as vehicles become more energy efficient and premiumize. All of them are EV ready and sport order books for outperformance in the years to come.

As always, we thank you for your continued support and faith in us.We wish you and your family a very happy and safe festive season ahead!

Happy Investing!

Kenneth Mendonca and Sheetal Malpani