Who Will Be the Horse to Electric Vehicles?

Investing is not just about picking hot industries or trends. It’s about picking the right stocks in those industries or benefiting from positive long-term trends.

Take the auto industry for example.

At the start of the 20th Century, you didn’t have to be a genius to know the car was going to be big. But at the time, there were more than 2,000 auto companies.

Which one would you have chosen?

Odds are you probably would have lost all your money.

Just three of the 2,000 survived. That means your chances of picking an auto company that wouldn’t fall to zero were 0.15%.

Not exactly inspiring.

But that’s why Warren Buffett suggests to invert the problem. Instead of asking who will win among hundreds or thousands of competitors, why not ask who the losers will be?

Warren explained to students at the University of Georgia:

I’ve always said the easier thing to do is figure out who loses. And what you really should have done in 1905 or so, when you saw what was going to happen with the auto is you should have gone short horses. There were 20 million horses in 1900 and there’s about 4 million horses now. So it’s easy to figure out the losers, you know the loser is the horse.

Now here’s an interesting question. Who do you think will be the horse as the emerging electric vehicle (EV) industry takes off?

I believe it could actually be one of the biggest names in EVs today. You might not believe it yet, but the horse of EVs could be Tesla Inc. [NASDAQ:TSLA], a company who has helped build EVs from the ground up.

Why EVs might be inevitable

You’ve probably heard a lot about EVs already. Most of it, however, is probably hype.

Analysts love to give near term projections of EV sales and wide mass adoption. The truth is EVs are only a tiny portion of total auto sales each year.

In 2017, EV and plug-in hybrids accounted for about 2.5% of total auto sales globally. According to HIS Markit, consumers bought 94.5 million light vehicles in 2017.

That means car buyers bought only 2.4 million EVs and plug-in hybrids last year. While this number represents huge growth, in absolute terms, it’s still quite small.

What’s more, growth for EVs could decline a lot sooner than people think. For a long-time, government subsidies have increased the demand for EVs. In places like Northern Europe, subsidies for EVs were as much as 37% of the sticker price.

But how long can the government continue to prop up this market? When Denmark scaled back their subsidies, EV sales dropped 60% in the first three months.

However, there’s little doubt that we’ll have EVs all over the place in the future. Not only do they run on a cleaner source of fuel, it lessens our dependence on radical governments in the Middle East.

What’s more, as battery technology and electricity generation/storage improves, the case for efficient EVs only gets stronger.

If you just run the numbers, EVs have a long growing runway ahead. But as I’ve alluded to, mass adoptions might be over the next decade or two, rather than the next three to five years.

So how will Elon fall behind the pack? 

Tesla has one advantage, don’t ruin it Elon!

Tesla is one of those gravity defying stocks. Investors have ‘bought in’ to Musk’s vision. They see a future full of EVs, preferably Tesla EVs. And if you look at the current figures, you’d have to hand it to Elon and his crew.

In 2017, Tesla’s cars made up 38% of EV sales.

In 2017, Tesla’s made up 38% of EV sales. 28-03-2018


Source: EV Obsession
[Click to enlarge]

So how could such a dominant player today be the horse of tomorrow?

Well, consider that Tesla has no real production advantage. They can’t produce EVs at a far lower cost than their competitors. Tesla constantly misses deadlines, and they’re not exactly a leader when it comes to quality.

What helps Tesla sell more EVs than everyone else is their brand.

Much like Apple products, consumers like to buy Tesla because of their design. It also makes them feel like they’re a part of a club, Elon’s club.

To maintain their brand power, Tesla will need to maintain quality standards at their factory. But such a feat is hard when you adopt a reworking method.

I’ll let Bloomberg explain:

Throughout its history, Tesla has been plagued by poor manufacturing quality and missed production deadlines.

And now, CNBC’s Lora Kolodny has the scoop on Tesla operations tasked with “reworking” and “remanufacturing” poor quality cars and parts, illustrating a deeper problem than the poor quality itself.

By reworking vehicles after they come off the line at its Fremont, California, assembly plant at a dedicated remanufacturing facility in nearby Lathrop — and even reportedly in its service centers — Tesla is taking automotive manufacturing back to dark ages.

Once upon a time, this was the standard practice for Detroit’s automakers. Driven by logic derived from Henry Ford’s manufacturing system, U.S. automakers kept production cranking in order to maximize efficiencies of scale, and then repaired defective cars after they rolled off the line.

Though many factors contributed to the decline of the Big Three in the 1970s and 80s, the inefficiency and apathy entrenched in company culture by this approach to quality was one of the most important.

An alternative to the reworking method is the Toyota Production System (TPS). Henry Ford may have brought cars to the masses. But Toyota mastered the economics of manufacturing.

In the TPS system, the goal is to eliminate waste. Whether that is a waste of time or underutilised workers.

Founder of Toyota, Kiichiro Toyoda, originally got the idea for TPS from reading about supermarkets. A customer in a supermarket takes the desired amount of goods off the shelf to the checkout. Shelves are then restocked with just enough product.

Thus Toyota can make cars in small batches. Not only does this mean they’re quick to market. It also gives them a quality control advantage.

For example, Toyota installs a cord above every work station. All employees can pull the cord whenever they spot a defect. This brings the factory to a halt, while the defects are remedied.

Bloomberg continues:

This practice reflects the systematic approach of the TPS philosophy: rather than trying to more efficiently repair defects, which by their nature vary wildly and thus confound standardized processes, the Toyota way emphasizes fixing the cause of the defect.

Better to stop production until the root cause of the defect has been fixed than foster indifference by telling workers that defects will be fixed later by someone else.

Tesla seems either uninterested in or oblivious to the historical lesson here. On last quarter’s earnings call, chief executive Elon Musk told analysts that Tesla doesn’t see TPS as a model for his company, even as he reiterated his goal of “productizing” Tesla’s factories.

So how long will it be before Tesla’s brand power wains due to quality issues?

My guess is not very long. If Elon wants to beat Toyota at their own game (mass producing quality cars), he’ll have to innovate on the production line.

But until then, Tesla continues to look like the horse of EVs.

Your friend,

Härje Ronngard,
Editor, Money Morning


Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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