Across all sectors and regions, identifying company-specific change is fundamental in selecting stocks. The change that's important to identify would be something that, in the business or the operating environment of a company, is positive, material, but is not fully appreciated by the market.
Sometimes an entire industry is facing a structural change, and that creates opportunities for potential winners and threats for potential losers from such change.
One industry facing such change is the auto industry. It is facing potentially slowing markets in Asia and the U.S., long term disruption from car-sharing solutions like Uber, and ever more stringent emission standards.
The Volkswagen emission scandal had focused investors' attention on the pressure to improve engine emissions, and the challenges of adapting conventional internal combustion engine technology to the new requirements. Investors (and the industry itself) are still working out what is the solution to this problem — more powerful catalytic converters? Substitution of diesel engines for smaller, more efficient petrol engines with turbochargers?
An emerging option is the “electrification of the drive train” — a move to more plug-in hybrid or pure electric vehicles.
Our team attended the Detroit Auto Show in January this year, and had a number of conversations with automakers and component suppliers. We came away surprised how much of the car industry research and development and investment in focus is now on various aspects of electrification.
Tesla is the poster child of the electric car revolution, with a popular (albeit expensive) Model S. But it was interesting to see how its early success had catalyzed the rest of the industry into action.
Major car makers like Daimler's Mercedes Benz or Volkswagen's Audi brand are introducing electric or plug-in hybrid options in more and more of their model line-up. There is still a substantial price premium associated with electric or hybrid cars, and the battery industry is working hard to improve the cost-to-power ratio, investing in new technology and new manufacturing capacity. We will not be surprised to see more new entrants, including German chemical companies, to compete with established leaders in battery technology from Japan or South Korea.
But this trend is not just about replacing internal combustion engine with an electric motor. Electrification goes deeper than that.
A lot of functions now powered in the car by the main engine or hydraulics are switching to electrics.
Power steering, braking, oil and coolant pumps are increasingly driven by electric motors, increasing the complexity and power consumption of the car electrics. This in and of itself creates opportunities: Japanese manufacturer Nidec, the global leader in small electric motors, is one company that benefits from such opportunities. This increased power consumption necessitates the upgrade of the electric wiring in the car. Current car electrics are driven by a 12-volt circuit, but it's increasingly inadequate for these growing demands. Industry expects to move to a 48-volt system, which brings with it the need for more sophisticated electronic components that manage and protect the electric circuits. One consequence of this change is growing semiconductor content in car, in particular for so called power semiconductors.
A clear example of a beneficiary of this trend is Infineon, a German industrial and power semiconductor company. It is a supplier to Tesla, and to many of the world's leading auto OEMs. Infineon content per car virtually doubles as you move from traditional vehicle to pure electric or plug-in hybrid car, with almost $400 in semiconductor value per vehicle. While this may be some way off, a gradual electrification or even move to 48V is also a positive for Infineon's business.
Change that the auto industry is facing has generated some negative headlines. But even in adverse change there are opportunities — even though you may need to look beyond the auto industry, into — for example — German semiconductor sector, to find the potential beneficiaries of such change.
Electrification of the auto industry should challenge investors to think beyond traditional automaker companies when looking for growth investments. Of course, the examples noted above are for illustrative purposes and not to be construed as investment advice. They are however indicative that, given the recent market volatility and the structural shift in the industry, these changes create opportunities that investors can take advantage of.
Mikhail Zverev is head of global equities at Standard Life Investments.
