WHEB Commentary

Seb Beloe

Being a lightweight in the auto-industry

Body in white

The auto industry remains a potent part of the global economy. The industry still accounts for around 6% of the industrial output of most OECD economies[i] and employs nine million people directly, with a further 40 million in the industry’s supply-chain[ii]. It is also a highly cyclical sector with passenger car and auto parts production typically swinging higher and falling lower than wider industrial production across the economic cycle.

The financial crisis in 2008-2009 marked a particular nadir for the industry. In the US, light vehicle sales per capita nearly halved and the industry had to be rescued with emergency loans from the US government, ‘cash for clunkers’ and other special policy measures. Since then, however, the US industry has recovered very well with new vehicle registrations back above 15m units per year and the total number of vehicles in operation back above the 2009 peak of over 250m units[iii].

Monthly sales figures are not the main story

However, while much of the investment industry obsesses about the latest monthly light vehicles SAAR (seasonally adjusted annual rate), our attention is focused on more profound underlying trends affecting the auto industry. At the top of this list is the now relentless pressure on auto-makers to improve the fuel efficiency of their vehicles. In part this is driven by the still relatively high oil price, and consumer demand for lower fuel bills. Arguably more important though have been the raft of regulations around the world driving inexorable improvements in fuel economy. For example, in 2006 all major markets around the world allowed new vehicles to have an average fuel economy of 170g of CO2/km or more. In six years, no major market will allow this level of performance. In the EU, emissions will have to nearly halve to 95g of CO2/km.

Legislation driving a stunning shift in the industry

This is a stunning shift which will require a complete rethink by auto manufacturers of how to build and power cars including the basic materials that are used in their construction. Right in the firing line is conventional steel which, while cheap, is very heavy. Auto-makers are discovering that, by replacing conventional steel with lighter weight materials there is a compounding effect that means they can also use smaller engines, smaller gearboxes and lighter suspension systems. Ford became an early-mover in the industry when it announced that its best-selling F-150 pick-up truck will use aluminium to replace almost all the steel in its construction. All in all, it will weigh 700lbs less than the previous steel-based model[i]. Aluminium is of course not the only material that is replacing steel. Electric vehicles have a particular need for lightweight materials in order to maximise the driving range from the battery packs (and to offset the weight of the batteries themselves). BMW’s i3 for example uses carbon fibre which provides the same stiffness as steel at just 50% of the weight. However, the other critical parameter in this equation is cost, with carbon fibre costing almost six times as much as conventional steel. Aluminium meanwhile provides equivalent stiffness to steel at 60% of the weight and only 130% of the cost[ii]. It is for this reason that aluminium has been selected not just by Ford for the F-150, but also by Toyota for future editions of the Camry and is already the material of choice in many Audis, Jaguars and Land-Rovers (not to mention Tesla).

The use of aluminium in the auto-industry, and indeed the penetration of other efficiency technologies such as turbochargers, dual-clutch transmission (DCT) and stop-start technologies is however still relatively low. The DCT market, for example, is expected to double over the next four years[iii] with stop-start technology growing from 10m systems sold in 2013 to 40m systems in 2020[iv]. McKinsey estimate that aluminium sales to the automotive sector will grow by 6% CAGR from 2010 to 2030 equating to an increase from 5m tons to 17m tons of material used in automotive applications[v]. We believe that these strong secular drivers provide strong downside protection to any cyclical slow-down in the industry over the next few years.

How to invest in the auto sector

So how can investors get exposure to these trends? The FP WHEB Sustainability Fund has several stocks that benefit directly from the shift towards lighter weight more efficient vehicles. Borg Warner is primarily focused on developing and selling technologies aimed at improving vehicle fuel efficiency including dual-clutch transmissions, continuous variable transmissions and turbochargers. Johnson Controls too has a dominant position in stop-start technology, though overall this business represents less than 10% of the company’s revenues. Our preferred way of getting exposure to the growth in the use of aluminium in the automotive sector is through Constellium NV which also sells lightweight aluminium alloys into the aerospace industry. Together the automotive and aerospace industries represent approximately two thirds of company revenues.

[i] http://www.oecd.org/eco/outlook/48333701.pdf

[ii] http://www.oica.net/category/economic-contributions/

[iii] Morningstar analysis

[iv] CLSA analysis

[v] McKinsey & Company, ‘Advanced Industries: Lightweight, heavy impact’, February 2012

[vi] Morningstar analysis

[vii] http://wardsauto.com/sae-world-congress/stop-start-technology-faces-uphill-battle-north-america

[viii] Op. Cit. V

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