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Electric Vehicle Acceptance: Beyond Eco Warriors and Early Adopters
Yet a point of Risk Looms Once Subsidies Roll OFf
- By Alexander Latter, CFA, Senior Associate, European Investment Grade Credit Research Team
- March 5, 2021
The growing share of battery electric vehicle (BEV) sales shows an acceptance beyond eco warriors and early adopters with a gas-guzzling SUV hidden in the garage. Global BEV sales hit 2 million in 2020 with total share reaching 3.1%, primarily driven by a share of nearly 5% in Europe (Figure 1) where tight new regulations and generous incentives are accelerating consumer acceptance. However, the looming sunset of these subsidies also shapes our credit preferences within the sector.
Figure 1: Europe Leads the Way for Global BEV Acceptance
We expect BEV market share to continue rising as emissions standards tighten further in Europe and with the U.S. likely to follow suit. This has created something of a mania in the equity valuations of pure BEV manufacturers, but has left traditional manufacturers, commonly known as OEMs, mired in concerns around weak BEV products and high costs.1,2
Clear Challenges, Underappreciated Positives
Electrified vehicles are expected to reach 50% of global sales sometime in the late 2030s, thus the demand for cars with internal combustion engines (ICEs) will exist for many years to come. Investing in a newly designed variant of powertrain whilst improving existing technologies amid tightening emission standards and potentially reduced economies of scale is expensive. The strains of maintaining these parallel investment streams has led to consistently increasing R&D costs—with capex and R&D now nearly 11% of sales (Figure 2)—which pressures profitability and cashflow.
Figure 2: The General Increase in Capex and R&D as Manufacturers Simultaneously Invest in Combustion Vehicles and BEVs
Another transition problem for manufacturers is the standalone profitability of BEVs themselves. In practice, due to battery costs equivalent to about $10,000 per vehicle, BEVs tend to be 20-30% more expensive than petrol cars and are still not particularly profitable relative to their conventional counterparts. Established legacy firms do not have the luxury of sky-high equity multiples or deep-pocketed investors, therefore, most OEMs hope to use the strong margins and cash flows generated from ICE sales to “pay” for lossmaking EVs. However, as the EV mix increases, the first ICE casualties will likely be in the profitable premium and SUV segments: it is easier to fit batteries in the large frames without sacrificing space, and the higher SUV prices can absorb the additional cost.
For the most advanced OEMs, the big spend in the first wave of electrification is complete. For example, in its rolling five-year, €150 billion investment plan, VW’s spending on BEVs between 2018 and 2020 remained relatively flat despite expecting to launch 27 BEV models between 2020 and 2025. Similar platforms are being rolled out at Daimler, Ford, and BMW where one platform, or “skateboard,” will accommodate BEV and ICE production, which will allow further economies of scale, possibly at the cost of reduced space and driving performance versus BEV-only platforms. Other OEMs have chosen to partner with competitors to share platforms—Honda will use GM’s Ultium architecture whilst Ford will pair with VW in Europe.
These platforms address the investment costs of BEVs and more efficient ICE offerings—via reduced engine variants and models—which will help protect cash flow amid fleet transitions. Additionally, in the short term, we are comfortable with EV profitability due to generous government subsidies. These allow OEMs to sell vehicles closer to normal levels of profitability despite the increasing BEV share. The improving outlook for automotive margins in 2021 and 2022 reflects the impact of government subsidies, particularly in Europe where France, Germany, and Poland provide subsidies equivalent to $10,000 or more (Figure 3). Outside of Europe and China, the EV ramp up will be slower with less acute pressure on profitability.
On the product side, legacy carmakers’ BEV offerings have been criticised as lacking range, style, and quality versus pure-play competitors. However, we believe this critique overlooks the pedigree of several legacy firms in BEVs, most notably Nissan with the Leaf and BMW with the i3, both of which have been in production for a number of years. Upcoming products from both these firms show ranges that are competitive with Tesla’s flagship models, and OEMs will continue launching products with up to 25 set to be unveiled in 2023 (Figure 4). Very soon, legacy OEMs will offer a much broader range of BEVs than is available from the big EV names, therefore, the legacy players cannot be counted out just yet.
Figure 3 and 4: Available EV Subsidies in Select Countries (in USD) and European OEM BEV Model Launches
Caution: Turns Ahead
Much has been said and written about the demise of traditional car manufacturers. But we believe that their strength of product offerings and ability to find efficiencies is underappreciated. The legacy OEMs will likely surprise observers with their resilience in 2021-2022, something already apparent in Q4 2020 results. Although government support for manufacturers has been key in the early years of electrification, notable challenges have also emerged. Many government subsidies—particularly the prohibitively expensive ones, such as the scrappage schemes in France and Germany—will begin to roll off in 2022 while profitability on BEVs will likely remain below target levels.3 Despite the potential for further BEV acceptance, the subsidy sunset is the point of greatest risk for legacy firms and underscores our preference for OEMs in the U.S. and Japan, which are under less pressure to electrify at speed as they wait for additional innovation to further reduce battery costs.
This material reflects the views of the author as of March 5, 2021 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.
1OEMs refers to original equipment manufacturers.
2The mania around pure-play BEV manufacturers is not apparent in their credit spreads as they generally trade solidly wider than the OEMs. In addition to the factors indicated within this post, stronger balance sheets, less volatility, and higher credit ratings, amongst other factors, contribute to tighter credit spreads among the OEMs.
3While tax incentives may continue, the cost of direct subsidies may be prohibitively expensive to continue for a prolonged period.
Alexander Latter, CFA
Alexander Latter, CFA, is a Senior Associate on PGIM Fixed Income's European Investment Grade Credit Research team, based in London. Mr. Latter joined the Firm in 2014 and covers the European banks and automotive and REIT sectors. Mr. Latter received a BSc in Economics from Bath University and holds the Chartered Financial Analyst (CFA) designation.
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