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The buzz around electric vehicles remains excessive

Elon Musk's Tesla is a leader in electric vehicles, but the company remains unprofitable and profits matter

by
Garry White

in Features

18.06.2018

Elon Musk is a world-class evangelist. The carefully-crafted cult of personality that surrounds the founder of electric-vehicle maker Tesla allows him to raise capital and enthuse investors in a way that most chief executives can only watch with envy. His quest to send humans to Mars, his canny marketing of flamethrowers and his near-Trumpian Twitter attacks on critics have helped cement his personal brand as one of the world’s most-famous entrepreneurs. However, it can be dangerous for investors to get mixed up in hype. Profits and cash flow ultimately matter more than an exciting story being told.    

One of the important rules of finance is to not get emotionally attached to any of your investments. The online reaction of some Tesla shareholders to any criticism of Mr Musk or his company appears to display the sort of emotion that should make rational investors quake. Whether the oft-made description of Mr Musk’s fandom as a cult is fair or not, these shareholders are certainly good examples of individuals with confirmation bias – the tendency to interpret information in a way that confirms one's pre-existing views. Confirmation bias should be regarded as the enemy of any investor that values rationality.

There is no doubt that global electric-vehicle penetration is going to rise and there could be substantial amounts of money to be made – eventually. However, the internal combustion engine will be around for quite some time to come and it is likely to remain predominant for many, many years. Electric vehicles are going to be an evolution not a revolution – do not let this fact escape you in the current buzz around the sector.  

BP sees only 15% of vehicles containing an electric engine by 2040. The nature of the oil behemoth’s business means it may be in its interest to low-ball this estimate, but it does not appear to have done so. It is in line with expectations from more neutral quarters. This week, Citigroup unveiled its forecast. Analysts at the US investment bank forecast global battery-powered electric vehicle penetration will hit 2% in 2020, 5% by 2025 and 10% by 2030. Its most optimistic case sees penetration hitting 14% in 2030, although this does not include hybrid electric vehicles. As a result, BP forecasts demand for liquids – petrol and diesel – to fuel vehicles will be essentially unchanged between now and 2040. Mr Musk and his ilk are a very long way from even denting demand for fuel from the global oil industry.

For traditional vehicle makers this presents a management challenge. The uptake of electric vehicles will continue to be driven by emissions legislation and incentives and it represents a substantial opportunity. Should the boards of these companies decide to make major investments in electric vehicle technology, rather than taking baby steps, their profit margins will be hit by all the capital spending. And investing in this cutting edge sector certainly requires a lot of capital – as Mr Musk is finding out.

Goldman Sachs has famously predicted that Tesla will need to raise $10bn in extra capital via new bond issues, convertible notes and equity by 2020. This is despite Mr Musk insisting the company will not need to raise any more cash this year. Goldman should probably have some insight into this, as a Bloomberg analysis this week found that the bank was the leading manager for share sales in the clean energy sector. The reason for this was the $2bn Goldman has raised to feed the Tesla beast over the last six years. The issue for investors in Tesla is that it is very likely that future new share issues will dilute your stake in the business. At least traditional car makers have significant profits and positive cash flow to use to invest in the development of new technologies.  

Tesla has built a $56bn market capitalisation based on its quest to make electric cars a reality and solve a global environmental problem. This is an admirable aim and, if successful, Mr Musk will be rewarded both in financial and reputational terms. However, it’s always a challenge for visionaries when they have to deal with reality – such as the production issues and build quality concerns which have slowed production of its mass-market Model 3 vehicle. Indeed, last year, Tesla only managed to manufacture 103,000 cars, which is a similar amount to that churned out by Toyota every single week of the year. Indeed, some form of reality appears to have hit home for Mr Musk this week, with Tesla announcing it was getting rid of almost 10% of its workforce to try and ease its cash burn. 

However, the future of electric vehicles is likely to depend on the development of better next-generation batteries. In the last fortnight, GM and Honda announced they were teaming up to work on new battery cell technology and Daimler announced it is forming an e-Mobility unit to speed up the development of battery-powered engines for use in buses and trucks. Chinese battery maker CATL, currently the world’s top manufacturer of batteries for electric vehicles, saw its shares jump by their maximum-allowed amount - 44% - in their market debut in Shanghai on Monday. It’s important to remember that the electric vehicle industry is not confined to Tesla alone, despite Mr Musk’s admirable evangelism and headline-grabbing stunts. And many of these other companies manage to make a profit too. That actually matters.     

A version of this article appeared in Friday’s Daily Telegraph.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

 

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