Mark Draper

Mark Draper

As Mayfair 101 investors can attest, there is no point chasing higher rates of income if it is not sustainable or results in capital destruction.  

Here are 4 key qualities that investors can look for when researching a company, infrastructure or property trust in order to assess the sustainability of income.

Dividend Payout Ratio

Hugh Dive (Portfolio Manager Atlas Funds Management) says that generally anything above 80% suggests that the current level of the dividend may not survive the inevitable variabilities in profits from the economic cycle.  Though this can be industry-specific, a regulated electricity utility such as Spark Infrastructure can handle a higher payout ratio due to greater certainty of earnings than a mining company such as Alumina.  Spark Infrastructure offers investors an income yield of around 6.3% based on the current share price.

Financial Health of the company

If a company is highly geared, there is a greater risk that the dividend may be reduced or cut to placate its bankers when economic conditions worsen.

Franked income = tax payments

While companies can make a range of aggressive accounting choices that can boost their earnings per share (and dividend per share), a company is unlikely to maximise the tax they pay to the government. Firms that pay franked dividends have significantly more persistent earnings than firms that pay unfranked dividends. It indicates that a company is building up tax credits by generating taxable earnings in Australia. This measure is not useful for companies such as CSL and Amcor who generate large proportions of their profits outside Australia and therefore cannot pay fully franked earnings.

Growing income

Roger Montgomery (CEO Montgomery Investment Management), sums it up by saying that the key is not the search for a high yield, but for a growing income.  There’s a very strong correlation between rising levels of income and share prices so investors who can put together a portfolio of businesses whose earnings march upwards over the years will find the market value will do likewise and they win twice.

SCA Property, a listed property trust with exposure to non-discretionary retail by owning 91 suburban shopping centres anchored by long leases to major supermarkets with low gearing, is an excellent example of an investment displaying these characteristics according to Dive.  Dive also points to packaging giant, Amcor as a sustainable dividend payer given it pays out 65% of profits as dividends and the nature of packaging earnings is stable. 

Montgomery highlights National Storage REIT, Waypoint REIT and Ingenia Communities as sustainable income plays.  He also suggests that Transurban and Sydney Airport will again provide high levels of sustainable income once the vaccine rollout becomes more advanced and economies reopen.

Listed investment companies (LIC), managed by high quality management teams with good performance track records should also be on the radar for yield hungry investors.  Many listed investment companies allocate profits from good years into a profit reserve account so that in poorer times, the dividend may be maintained.  The level of profit reserve account is freely available to investors in the financial accounts of the LIC published half yearly.  

Platinum Asia LIC and Perpetual Equity Investment Company LIC have rewarded investors with a 5% fully franked dividend in the last 12 months.  Both of these LIC’s have material profit reserve accounts established.

Care should be taken not to pay a premium for LIC’s which is relatively straight forward as most LIC’s publish their asset backing regularly.

Dive believes the biggest potential trap for investors is looking at a company's historical yield and making an investment decision based on this single measure. 

Telstra for many years paid close to 100% of its earnings as dividends and some years borrowed to pay its dividend.  This continued until the NBN blew a hole in earnings and Telstra cut their dividend from 31 cents per share in 2016, over time to 16 cents per share in 2019.  Those who invested in Telstra when it was around $6 in 2016 based on historical dividends have seen their capital dwindle in their blinkered search for income.

Better than cash yields are on offer in today’s market, but care needs to be taken to avoid the ‘dividend traps’.

 

Every month, Mark Draper (GEM Capital) writes for the Australian Financial Review.  This article appeared in the paper edition of the Australian Financial Review on Wednesday 24th February 2021

Wednesday, 27 January 2021 08:06

Investment themes for 2021

The latest IPO and tech company might be exciting, but there are more important themes investors should be paying attention to in 2021.

The dire predictions of 2020 that house prices would collapse, credit growth would fall by 8% and unemployment would reach levels not seen since the 1990’s recession don’t appear to have eventuated.

Instead, Roger Montgomery (CEO, Montgomery Investments) says “I expect property prices to rise.  Investors should know that the single most important driver for short and medium term property prices is credit availability”.

Hugh Dive (CEO, Atlas Funds Management) points to the ABS data released recently which showed credit growth in November 2020 was a record $24bn, up 5.7% from October.

Dive expressed that house price growth and credit growth leads him to select the banking sector as an outperformer in 2021.  He adds “banks are well capitalised due to asset sales and dividend restrictions and changes to the credit code in March will reduce the costs of lending”.  These set the scene for banks to report stronger than expected earnings in 2021 from higher operational profits and potentially writing back some of the bad debt provisioning.

Montgomery says investors should look for companies that generate annuity style income as they are likely to be attractive to international pension funds seeking higher returns than fixed interest.  

He adds “While an Australian investor might believe the shares of a company or REIT with a durable income yield of 5% represents fair value, an international pension fund might be content with a 2.5% yield.  Consequently, prices for stable income earners could jump.”

Nathan Bell (Head of Research, Intelligent Investor) is backing the theme around the reopening of the global economy through investments in Sydney Airport and Star Entertainment.  “Both will benefit as vaccine adoption increases, and as their respective revenues and earnings start getting back to normal, so will their dividend payouts” he says.

Warren Buffett once said “do not take yearly results too seriously. Instead, focus on four or five-year averages”.  The best investors are those who can imagine how the world is likely to be in the future, instead of how it is today.

The share market overall has showed great resilience to COVID, but there are some sectors that warrant great caution.

Nathan Bell suggests “taking profits on anything that relies on higher iron ore prices.  Eventually Brazil iron ore producer Vale will start getting production levels back to something more normal following a slowdown from COVID and mine safety issues, which is likely to bring down iron ore prices.”

There are plenty of signs of excessive excitement in the market including Bitcoin and Tesla valuations, Robin Hood and the frenzied activity in IPO’s.  Matt Williams (Portfolio Manager, Airlie Funds Management) highlights “In Australia this exuberance is manifested by the ever increasing number of companies joining the burgeoning buy now pay later sector and other tech focused IPO’s”.

Dive reminds us of the tech bubble of 2000 where Nortel had a market cap of $280bn and was 35% of the Canadian stock market (TSX), and other tech stocks such as Research in Motion (Blackberry) were larger than major banks such as the Royal Bank of Canada.  He says “one of the similarities between 2020 and 2000 is that investors are being told how all of these companies were going to change the world and not to worry about current valuations or risks on the horizon”.  

Dive completes the trip down memory lane saying that Nortel filed for bankruptcy in 2009 and Blackberry’s smartphone market share has dropped from 20% in 2009 to 0.02% today.

The buy now pay later sector is almost expanding weekly and now has a combined market capitalisation of $40bn.  This combined valuation warrants careful examination when compared to the overall forecast loss of $82m for the sector in 2021.

Buy Now Pay Later companies

Company Market Cap $M Expected profit in 2021 $M Dividend Yield
Afterpay 37,643 +26 N/A
FSA Group 135 +16 3%
Humm Group 540 +67 2%
Laybye 242 -16 N/A
Money 3 580 +3 N/A
Openpay 200 -22 N/A
Quick Fee 82 -4 N/A
Splitit 512 -45 N/A
Sezzle 748 -46 N/A
Zip Co 3,103 -60 N/A
       
Total 40,681 Loss of $82m 0.04%

 

The financial markets are currently presenting investors with a two tier market containing both very expensive and some reasonably valued opportunities.  This is a time for caution and well researched investing. 

 

This appeared in the Australian Financial Review on 27th January 2021.

Tuesday, 01 December 2020 08:42

Sydney Airport / Spark Infrastructure

The Investment Case

The four most dangerous words in investing are “this time it’s different” (Sir John Templeton).  The ghosts of the last tech boom, referred to as the dot-com bubble in 1999 seem to be restless, with some eerie similarities to today’s obsession with technology stocks and high valuations.

Douglas Isles (Investment Specialist, Platinum Asset Management) says “the current mania in technology stocks is not about the big names but about the breadth of companies trading on high valuations.”  This is seen in the table below which shows market capitalisation compared to GDP in the US share market, and compares the record level 170% to previous bubble episodes.  This valuation indicator has become popular thanks to Warren Buffett who in 2001 said “it is probably the best single measure of where valuations stand at any given moment”.

The cyclically adjusted price to earnings ratio, commonly known as CAPE, is another valuation measure applied to the US share market.  CAPE is defined as price divided by the average of ten years of earnings, adjusted for inflation. 

Isles says “the maths tells us in aggregate there will be considerable disappointment. But also, like 1999, the more interesting thing is the opportunity in companies that are not part of the mania. In 1999, the sectors being shunned were labelled the old economy.  Today the shunned sectors include emerging markets and cyclical stocks”.

There are of course differences in today’s technology stocks according to Nathan Bell (Head of Research, InvestSMART), who says “the dominant tech companies are perhaps the best businesses that we’ve ever seen and are extremely profitable.”  

Hugh Dive (Portfolio Manager, Atlas Funds Management) says that “Apple, Amazon, Facebook and Google are actually generating revenues and growing profits”.  He adds “what we haven’t seen in 2020 is the plethora of concept companies raising large amounts of capital solely based on having an idea that is similar to a hot theme”.

That said, the seven Buy Now Pay Later stocks trading on the ASX could arguably be described as an example of this phenomen.

Bell sees the flood of Initial Public Offerings (IPO’s) of untested business models where the business owners are selling heavily as a sign of a heated market.

Other ‘red flags’ that investors would be wise to consider include the record fund raising in the US into SPAC’s (Special Purpose Acquisition Company).  A SPAC is a company with no commercial operations that is formed to raise capital through an IPO for the purpose of acquiring an existing company.  Bell says SPAC’s are where investors essentially sign a blank cheque in the hope that management will find something useful to do with the money while Isles believes they look very much like the ‘cash boxes’ of the 1980’s.

Dive’s key red flag is “the re-emergence of novel valuation methods such as ‘price to revenue’ in order to value companies that are generating losses, and are expected to continue to generate losses for the near future before miraculously swinging into steep profit growth”.

Highlighting Dive’s point about the behaviour of investing into loss making companies, US investor Joel Greenblatt says “If you bought every company that lost money in 2019 that had a market cap of over $1 billion, and so there are about 261 of those, and you bought every single one of those companies, you’ll be up 65% so far this year”.

Similar to 2000, in 2020 we are being told not to worry about valuations either due to the effect of lower interest rates, or that companies have a long growth runway.  Dive highlights “the valuations of AfterPay (61x revenue) and even more mature and widely used companies such as Zoom (136 x forward earnings) assume both that current growth rates are maintained for numerous years, consumer tastes don’t change and that new competitors won’t emerge.  The lessons of the previous tech boom showed these assumptions to be heroic”.

Bell believes that “low interest rates can justify somewhat higher valuations than the past, but not 100 – 150% in my view.  Valuation still matters and very few tech stocks will justify current expectations over the long term”.

Microsoft’s peak share price in 1999 was US $59.97 which implied a price earnings multiple of 76.  The following year the share price fell more than 60% and it took until 2016 for the share price to trade above the 1999 levels.  Little wonder the ghosts are restless.

 

 

This article appeared in the Australian Financial Review during November 2020.

Bell Potter have produced a special report on developments of COVID-19 focussing on the virus itself with particular reference to Europe and the US.

The report looks at infection rates and death rates, comparing the first and second waves.

The analysis considers the likelihood of reaching herd immunity.  Complete with statistics and graphs the report is designed to assist investors reach their own conclusions about what may be in store for the world with COVID-19.

Download your copy of the report by clicking on the report below.

 

Friday, 04 September 2020 09:05

Best of the Best - August 2020

The Investment Team at Montgomery Investments have produced their bi-monthly "Best of the Best" report.

This edition focuses on:

- Why it's time to focus on quality businesses

- Optum - Hidden GEM in US Healthcare

- Nanosonics has a long runway for growth

- Three reasons we continue to like Woolworths

 

Download your copy of the report by clicking on the report below.

 

Friday, 04 September 2020 08:56

What we learned from reporting season

The only thing certain about the future right now is that the future is uncertain.  So as we complete one of the strangest company reporting seasons we have ever seen, investors should reflect on the company profit announcements to see what they can learn about what may lie ahead 

Matt Williams (Portfolio Manager, Airlie Funds Management) says that while overall profits were down 20% compared to the previous year, the dire predictions in late March proved to be too bearish and there are now more profit upgrades than downgrades.  He said “The economy has strongly outperformed the accepted bearish scenarios of late March, retailers have produced phenomenal numbers”.

“The COVID-19 pandemic has not been uniformly bad for all Australian companies.  Travel related companies and listed property trusts with shopping centre assets have had a tough 6 months, while electrical retailer JB Hifi, hardware and office retailer Wesfarmers, AfterPay and Domino’s Pizza all saw record revenue over the past 6 months, benefitting from consumers being quarantined at home” according to Hugh Dive (Senior Portfolio Manager, Atlas Funds Management).

Nathan Bell (Head of Research & Portfolio Management, Investsmart) picked up on the travel sector which saw airlines and travel retailers at the epicentre of the COVID-19 storm.  “You could hear the desperation in Alan Joyce’s voice as he pleaded for state borders to reopen after announcing a $4bn loss”.  Bell also highlighted the almost 100% drop in passenger numbers since COVID-19 emerged for listed Sydney and Auckland airports.  He is of the view that leisure travel ultimately recovers and even if business travel only recovers to 70% of past highs due to a permanent shift to online meetings, both airports represent good value at current prices.  “People are once again going on holidays in the northern hemisphere, which is another good omen for this pair of airports.  Vietnam, Taiwan and Korea recently reopened their domestic borders and passenger numbers are now 10 – 20% above 2019 levels, suggesting pent up demand” he adds in support of the investment case for a rebound in airports.

Food and alcohol retailers (such as Woolworths and Coles) reported solid results as they benefitted from changing consumer purchase patterns, but they now trade at huge valuations.  Their valuations suggest future returns are likely to be far more muted if not negative should the impact of Job Keeper payments and people raiding their super funds wear off.

Dive points to the fact that “cash flows from the government were a significant feature of the August results season, albeit one that was understandably not highlighted by management when they presented their results.  JobKeeper and higher JobSeeker payments have helped companies such as JB Hifi and Afterpay as cash flows from the Government have supported retail sales despite the significant rise in unemployment”.  Investors would be wise to resist extrapolating the impact of these Government payments over the past 6 months into the future.

While the Telco sector reported earnings hits from lower global roaming charges and reduced retail sales during lockdowns, the 5G networks will cover the majority of the population in the next 12 months which represents revenue growth opportunities.  More rational mobile pricing should also help the Telco’s.

Banks reported much lower profits due to a mix of low credit growth, low interest squeezing margins and increasing bad debts.  Bell says of the banks “the bull case for Australia’s largest banks rests on them trading at large premiums to book value despite reporting single digit return on equity figures.  If this happens, Australia will be the exception to the rest of the world.  We don’t see why Australian banks are an exception as more people deleverage in the years ahead and property investors look beyond property for large capital gains”.  Ultimately the loan repayment deferrals will also need to be bought to account as well.

Williams said that in his discussions with company management, the key themes about the future were:

-       What happens at the end of the Government stimulus where retailers would appear most exposed.  

-       Opening up of state borders

-       Economic reform

With around 70% of companies either not issuing future earnings guidance or withdrawing earnings guidance, coupled with some market sectors trading on extremely high valuations, the job of assessing investment value is difficult.  The best opportunities ahead are less likely to be found in this years’ reporting season stars.  

 

This article was published in the Australian Financial Review during the month of September 2020.

Monday, 10 August 2020 14:03

Sustainable returns from Telco sector

Telecommunication companies (Telcos) have been central to many of our activities during the COVID-19 crisis, ranging from virtual wine tasting nights with friends, working from home, Netflix binges or simply ringing family.

In recent years Telco’s have been challenging for investors with falling margins from mobiles and the NBN crushing broadband margins.  The worst of this may be behind the sector now and investors are now presented with an investment opportunity that may be COVID-19 proof.

An investment into a Telco company typically involves two main segments, infrastructure and retail/business operations which includes broadband, mobiles and services. .  

In Australia the three major players are Telstra, Optus and TPG which recently merged with Vodafone.  Telstra and TPG are listed on the ASX.

According to Andrew Peros (Deputy Head of Research, Ausbil) “infrastructure is probably the most attractive on the assumption that it can be successfully separated from the retail assets.  Telecommunications infrastructure provides a long term steady cash flow which is highly valued by the market.  Unfortunately, in Australia, there are no pure play communication tower investments.  Telstra’s communications infrastructure are currently part of the overall business and have not yet been demerged as a separate business, similarly with TPG’s cable infrastructure”

That may be about to change following a restructure announced last year which resulted in Telstra splitting its infrastructure assets into a separate business segment called InfraCo.  InfraCo consists of exchanges, ducts, data centres, subsea cables, fibre and 8,000 towers that host networking equipment.

Towers and other parts of InfraCo currently generate revenue from servicing Telstra alone.  If this division were separated from Telstra, these assets could increase revenue by servicing other Telcos.  A tower that currently services only Telstra could service all three mobile networks.  Competitors would have to supply their own networking gear, but the infrastructure owner could earn three times as much revenue. Mobile network towers are a natural monopoly and it makes little sense to duplicate a network once it has been constructed.  We don’t duplicate water pipes or electricity wires and the same can apply to mobile towers. This is an important opportunity for investors to grasp.

Annabel Riggs (Telco Analyst, Airlie Funds Management) is “attracted to the mobiles market, with the sector transitioning into a more rational pricing environment after a period of intense competition between network operators.  We are beginning to see evidence of a more rational market with Telstra lifting prices a couple of weeks ago across its post paid mobile plans.  This is positive for earnings and returns.”

5G is the next battle ground for the Telco’s.  Riggs believes that “network operators will selectively compete with the NBN in some areas by using a fixed wireless product.  The margins and returns on this product work if the customers are relatively low usage.  We have seen in New Zealand that about 20% of their broadband base is now on Fixed Wireless and bypassing their own version of the NBN.”

Peros adds “telcos are likely to hesitate on fixed wireless if competition between operators is expected to lower returns on capital, and there is a risk in Government support firming to protect the value of the NBN.”

Government regulation would seem one of the key risks to investing in the Telco sector.  The relatively high access costs the NBN charges the telco resellers for broadband is a good example.  Riggs points out that the NBN has improved its pricing model however the total cost of accessing the NBN for telcos is still much higher than the copper network.  The higher access costs to the NBN has put huge pressure on earnings of the telco sector.

The decision to ban Huawei from providing 5G equipment in Australia was another big decision.  Huawei was a lower cost equipment provider which will ultimately increase expenditure for TPG which was planning their 5G build around Huawei equipment.

Peros flags the economies of scale in a geographically large country with a small population as another important risk.  

Investors should also pay attention to some interesting new entrants.  Riggs points to Uniti Group who has recently acquired Opticom as having an interesting opportunity to challenge the large players in the fibre market.  Peros likes NextDC which owns data centres which will benefit from the increased demand for data now that a greater proportion of the workforce are working from home.

It would seem that Telco’s revenues are largely COVID-19 proof, but the growth story could come from the demerging of infrastructure and new entrants.

This article was published in the Australian Financial Review online on Monday 3rd August 2020

Note:  Mark Draper, Shannon Corcoran and their entities own shares in TPG and Telstra.

Monday, 10 August 2020 13:52

Sustainable returns from Telco sector

Telecommunication companies (Telcos) have been central to many of our activities during the COVID-19 crisis, ranging from virtual wine tasting nights with friends, working from home, Netflix binges or simply ringing family.

In recent years Telco’s have been challenging for investors with falling margins from mobiles and the NBN crushing broadband margins.  The worst of this may be behind the sector now and investors are now presented with an investment opportunity that may be COVID-19 proof.

An investment into a Telco company typically involves two main segments, infrastructure and retail/business operations which includes broadband, mobiles and services. .  

In Australia the three major players are Telstra, Optus and TPG which recently merged with Vodafone.  Telstra and TPG are listed on the ASX.

According to Andrew Peros (Deputy Head of Research, Ausbil) “infrastructure is probably the most attractive on the assumption that it can be successfully separated from the retail assets.  Telecommunications infrastructure provides a long term steady cash flow which is highly valued by the market.  Unfortunately, in Australia, there are no pure play communication tower investments.  Telstra’s communications infrastructure are currently part of the overall business and have not yet been demerged as a separate business, similarly with TPG’s cable infrastructure”

That may be about to change following a restructure announced last year which resulted in Telstra splitting its infrastructure assets into a separate business segment called InfraCo.  InfraCo consists of exchanges, ducts, data centres, subsea cables, fibre and 8,000 towers that host networking equipment.

Towers and other parts of InfraCo currently generate revenue from servicing Telstra alone.  If this division were separated from Telstra, these assets could increase revenue by servicing other Telcos.  A tower that currently services only Telstra could service all three mobile networks.  Competitors would have to supply their own networking gear, but the infrastructure owner could earn three times as much revenue. Mobile network towers are a natural monopoly and it makes little sense to duplicate a network once it has been constructed.  We don’t duplicate water pipes or electricity wires and the same can apply to mobile towers. This is an important opportunity for investors to grasp.

Annabel Riggs (Telco Analyst, Airlie Funds Management) is “attracted to the mobiles market, with the sector transitioning into a more rational pricing environment after a period of intense competition between network operators.  We are beginning to see evidence of a more rational market with Telstra lifting prices a couple of weeks ago across its post paid mobile plans.  This is positive for earnings and returns.”

5G is the next battle ground for the Telco’s.  Riggs believes that “network operators will selectively compete with the NBN in some areas by using a fixed wireless product.  The margins and returns on this product work if the customers are relatively low usage.  We have seen in New Zealand that about 20% of their broadband base is now on Fixed Wireless and bypassing their own version of the NBN.”

Peros adds “telcos are likely to hesitate on fixed wireless if competition between operators is expected to lower returns on capital, and there is a risk in Government support firming to protect the value of the NBN.”

Government regulation would seem one of the key risks to investing in the Telco sector.  The relatively high access costs the NBN charges the telco resellers for broadband is a good example.  Riggs points out that the NBN has improved its pricing model however the total cost of accessing the NBN for telcos is still much higher than the copper network.  The higher access costs to the NBN has put huge pressure on earnings of the telco sector.

The decision to ban Huawei from providing 5G equipment in Australia was another big decision.  Huawei was a lower cost equipment provider which will ultimately increase expenditure for TPG which was planning their 5G build around Huawei equipment.

Peros flags the economies of scale in a geographically large country with a small population as another important risk.  

Investors should also pay attention to some interesting new entrants.  Riggs points to Uniti Group who has recently acquired Opticom as having an interesting opportunity to challenge the large players in the fibre market.  Peros likes NextDC which owns data centres which will benefit from the increased demand for data now that a greater proportion of the workforce are working from home.

It would seem that Telco’s revenues are largely COVID-19 proof, but the growth story could come from the demerging of infrastructure and new entrants.

This article was published in the Australian Financial Review online on Monday 3rd August 2020

Note:  Mark Draper, Shannon Corcoran and their entities own shares in TPG and Telstra.

Wednesday, 08 July 2020 08:31

How to profit from electric cars

Australian investors would be forgiven for largely ignoring the prospect of electric cars in their investment decision making with only 6,718 new electric vehicles (EV) sold in Australia during 2019 (includes fully electric EV, and plug in hybrid EV).  For perspective, the total number of new vehicle sales in 2019 was 1,062,867.  Astute investors however, are aware of the electric vehicle tsunami that is coming and are positioning to profit from it.

Alasdair McHugh (Director, Baillie Gifford) highlights “that currently only around 1% of the global passenger car fleet of 1.4 billion vehicles are electric.  Therefore the opportunity for EV’s to replace the remaining 99% of passenger vehicles is substantial.  Even against headwinds of ride-sharing, public transport developments and cycling/walking to work, the shift away from internal combustion engine (ICE) vehicles to EV’s leaves a vast market to penetrate.”

Nick Markiewicz (Consumer Analyst, Platinum Asset Management) believes that the size of the EV market “will ultimately depend on the end goals of Governments and regulators, adoption rates of EV’s among consumers and how automakers choose to meet their targets”.  While there is a wide range of views from credible pundits and automakers about EV penetration rates ranging from 10 – 60%, given the automotive sector is USD $2 trillion industry by turnover, even small adoption will still result in a large, high growth industry.

The most sophisticated market so far is China, which accounts for 47% of EV sales last year.  The Chinese Government has a goal for 40% of all new car sales to be EV’s by 2030 according to Baillie Gifford.

The chart below shows new car sales by region over the past 15 years.

 

Elsewhere in the world France has announced a ban on the sale of ICE vehicles from 2040 and in the UK, the ban will take effect from 2035.  

Investors can seek to profit from the EV boom not just by owning high profile automakers such as Tesla, and Chinese automaker Nio, both owned by Baillie Gifford.

Markiewicz believes that traditional makers “like BMW and Toyota still have a relatively bright future, and do not deserve to trade at their current multiples.  Both have deep electric vehicle expertise, with Toyota producing its revolutionary hybrid in 1997, and BMW launching the i3 in 2011.  Unbeknown to many, BMW and Toyota are already two of the largest electric vehicle producers in the world”.

While the manufacture of EVs requires fewer mechanical parts than ICE vehicles, it does need many new electric and electronic components and batteries.  Baillie Gifford like Samsung SDI in the battery supply chain and Platinum like LG Chem, who are battery producers. It is also interesting that EV cars are heavier resulting in increased tyre wear compared to conventional cars.

Some opportunity exists in Australia in owning resources companies who produce nickel, lithium and cobalt, which are used in battery production, alternatively investors can invest in managed funds to gain broader exposure to growth in electric vehicles.

The biggest threat, according to McHugh, to investing in the EV industry “is the emergence of a new type of energy efficient ‘fuel’ that could power cars, for example ‘electrofuels’.  One possibility is hydrogen gas (H2) made with renewable electricity.  At the moment there are scientific barriers to entry for this technology; storing the gas within the bodywork of a car is difficult and could be dangerous, and therefore expensive”. 

Second order effects of EV’s that investors need to consider is the impact of EV’s on the demand for oil, and the oil price.  Markiewicz says that the impact is “likely to be at the margin – there are 1.4bn passenger vehicles in the global car fleet which account for 20% of crude demand today. EVs are only 2% of new vehicle sales, and the global fleet only turns over every ~15 years. As a thought exercise, even if EVs were 50% of all new vehicle sales today, it would still take 15 years to displace 10% of the world’s oil demand (0.7% demand destruction per year). At the same time, oil demand will grow elsewhere. Hence, even under bullish scenarios for EVs, changes to oil demand are likely to be quite small – impairing growth, rather than absolute demand”.

Owning EV manufacturers may be the obvious investment for this thematic, but investing in other related components in the EV chain may be just as interesting.

 

This article was written by Mark Draper (GEM Capital) and featured in the Australian Financial Review in July 2020.

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