Will EV story be as electrifying as the market makes out to be?

In the short term, markets are all about stories. They make the markets exciting. Stories put the stock prices on steroids. Who would have thought a mature sector like technology would see a tectonic shift in valuation on the market’s successful spinning of super-digitization story. So is the case for new-age start-ups where stories are spun on the next super-apps. But the interesting thing is, stories cut both ways. It is not only on “hope” on which they are built. When they are built on “fear”, that is when, it gets more interesting for investors, esp. the ones who are focused on value.

Let us take the story of EV with a specific example. On one end of the spectrum, you have a core business (diesel engines for commercial three-wheelers) that is on a sunset with the prospects of slow death. At the moment, over 95% of the operating profits come from this failing core business. That has not stopped its stock price to move up by over 2X over the last six months. What did the magic do? It is from a successful spinning of EV story to the dying core business. It doesn’t matter that the e-two-wheelers they have launched will take decades to reach scale and profitability. All that matters is the “hope” that there is a big business out there in the future, however long and far it could be. That is a powerful hope story in the working. No prize for guessing the name of this company.

Now, let us turn to the other end of the spectrum. Here, you have a solid core business (engine lubricants) that is throwing free-cash-flow year after year with reasonable growth prospects. The business is a high-quality branded business with high return metrics. But there is a fear in the market that if EV becomes an electrifying story, then it might lose all its relevance. It is another matter that will continue to grow for decades (and throw free-cash-flows) even if the most optimistic projections play out for EV adoption. But, fortunately, or unfortunately, for the markets, “fear” is a good story compared to a decade-long free-cash-flows. It is not hard to guess that the stock price of this company has been languishing with no takers even at a steeply discounted valuation. That is a ferocious fear story in the working.

Now, here is an interesting question. What if there comes a new twist to the tale that has the potential to stall (or slow) the EV revolution? That will be a boon for the investors who took to high allocation in opportunities where fear-gauge was feverishly high on EV adoption. Surging lithium prices on global shortages have precisely come as a surprising new twist to the whole EV tale. Lithium prices are up by over 185% in the last six months (40% in the last month alone). Prices of cobalt and nickel, which go in the battery cells, have also been precarious on supply issues. Since these components constitute close to 50% of the cost of cells, a sharp increase in prices of these raw materials, as some estimates suggest, has the potential to increase the final battery costs by over 40%+. Since the cost of battery forms near 50% of the final EV product, it is fair to assume that the new-age EV players will soon have to contend with the difficult decision of either increasing the prices by over 20%+ or absorbing the hit.

Irrespective of how the EV players will handle this difficult situation, one thing is fairly clear. With the change in cost dynamics now, the timeline for mainstream adoption is going to be pushed farther away from the earlier estimates (which itself was for 2030). Anticipating these supply challenges for lithium to continue, some of the big entrants in the new energy game are throwing their muscles behind the alternates like sodium-ion. Reliance’s recent acquisition of Faradion for USD 135 mn is a case in point.

Sodium-ion is at the cusp of a commercial breakthrough. And Faradion — a company based in the UK, holds 21 patent families on cell materials, cell infrastructure and transportation. Reliance will also invest an additional USD 35 mn to expedite its commercialization agenda.

All these are not going to be good news for current stream of EV “hope-story” bulls as the mainstream EV adoption is not going to be anytime soon.

More so for India, given the insurmountable challenges like charging infrastructure, inadequate local battery manufacturing eco-system etc. Of course, while adoption could be faster in the case of three-wheelers and to some extent in two-wheelers, even there, one still foresees challenges because of the change in cost dynamics on surging lithium and associated materials like cobalt and nickel (Ola electric’s ongoing struggle to get its supply chain in shape is well documented)

As this story evolves, it may be time for value investors to screen those stocks that are badly hit by elevated EV fear for value opportunities that have the potential for a major re-rating. A lot could be found in autos, auto-ancillaries, battery makers (lead) and lubricant brands etc. Watch out for interesting times.

(The author, ArunaGiri N is Founder CEO & Fund Manager of TrustLine Holdings Pvt Ltd)