The EV Industry Landscape

Today, I will share part four of what has become a five-part summer letter to IMA clients. The letter is quite lengthy, so for easier reading, I have divided it into smaller parts. In the previous three parts, I discussed the economy, the Magnificent 7 and past booms and busts. In this part, I will discuss investments in EVs, spurred by the following question from a client:

Question: I've read Vitaliy's thoughts on EVs. As a Rivian owner, I agree they'll upend the auto industry once battery, charging, and cost issues are solved. How can IMA invest to benefit from the EV industry?

In the remaining part, I will cover AI, as well as the impact AI will have on the economy.

In these client letters, I am not selling anything; they are written to IMA clients, who have already bought into what we are doing. I don't like sanitizing my letters (rewriting them into articles), as I don't learn anything from doing it, so I am leaving them as I wrote them.

Investment Strategies in the Age of EVs

When we see a new trend in the economy, we think about how to benefit from it and, crucially, how to not get run over by it. The key is not just identifying the "wind" but finding good businesses that will ride the wind, and as importantly, making sure that these businesses are undervalued.

This was the case with our investments in defense stocks. We saw building global tensions and found defense companies that met our quality and valuation criteria.

The EV Industry Landscape

You can also listen to a professional narration of this article on iTunes & online.

Now, let's talk about EVs.

We could play EVs by buying traditional companies. Making cars is a very difficult business with high fixed costs and very cyclical revenues. Cars are expensive and need to be financed, and thus affordability is impacted by the level of interest rates. Also, this business has been fundamentally broken by unions. I've written on this subject in the past, so I'm not going to belabor this point here, but unions have a call option on these companies' future profitability. As automakers start making profits, unions strike and demand to share the spoils. Shareholders are unlikely to make much money investing in these businesses.

Also, managing the transition from internal combustion engines to EVs will be very difficult for these companies.

Of course, there is a more obvious choice to participate in EV transition – Tesla.

I wrote a small book on Tesla and the EV industry in 2019. At the time when I wrote the book, Tesla was losing money and had a pile of debt. I wasn't sure if Tesla would be able to reach escape velocity and profitability. It has. The stock went up a lot and became very expensive.

History cements only one path of what has taken place, but there were many other high- and low-probability alternative historical paths for Tesla, and they were mostly not as glamorous or rewarding as the one that played out. Even Elon Musk confessed that Tesla was on the verge of going bankrupt a few times.

I have smart (a number of them are brilliant) investment friends who are both long and short the stock. Most Tesla bulls recognize that, as a car company, Tesla is overvalued or at best fully valued. They believe today's investment case in Tesla is future cash flow streams from AI, semitrucks, robotaxis, the charging network, and robots. I hope my bull friends are right about Tesla's success in these areas, as that would benefit society as a whole. But at this point, most of their investment thesis is based on hopium. 

Out of all these businesses, the only one that actually exists and is making money now is the charging infrastructure – but Tesla has announced significant cutbacks to the expansion of its charging network.

Then, my friends who are short the stock will point to Musk's flawed ethics, his distractedness with his growing business empire – I keep losing count of how many Sci-Fi companies he is running now. They'll point out significant competition from Chinese EVs (which many argue are superior to Tesla's current offerings). And, though Tesla would like you to believe otherwise, it is still a cyclical car business. By the way, those Chinese EVs are also a potential threat to traditional automakers – GM and Ford sell a lot of cars in China. And Chinese EVs are making their way to Europe and Latin America, too.

Also, up to this point, Tesla was able to escape unions because it gave out stock options to its employees – the stock went up, so employees were happy. But a stagnating – or, God forbid, declining – stock could send employees into the arms of unions, who are constantly camping outside of Tesla HQ. I don't want to write another book about Tesla; but at this valuation, which still exceeds that of the US and European automotive industry combined, it is not of interest to us. At a much lower price, we'd be willing to give it another look.

Then there is Rivian, which is losing tens of thousands of dollars on every car it makes. We have little insight as to whether this company will be around tomorrow or not.

We have a small position in Dowlais (a spinoff from Melrose Industries), an automotive supplier that makes transmission components and motors for EVs. They are number one or two in the markets they compete in. It's a very profitable, conservatively managed business that is currently on the wrong side of the automotive cycle (the industry is struggling from post-COVID hangover). The company is trading at an extremely undemanding 3–4 times earnings – it could potentially double or triple from its current level. The transition to EVs is a net positive for Dowlais, but it is just icing on this undervalued cake. We keep this position intentionally small – we like the company; we are not fans of the industry.

Energy Infrastructure and EVs

The adoption of EVs and AI will both result in high electricity consumption. 

The world is coming to terms with the fact that we'll need to use more nuclear energy, but this transition will take decades. One of our companies (Babcock International) has exposure to nuclear. Modular nuclear reactors may actually be the future, but we have not found a good way to invest in them.

In the meantime, most incremental electricity will be generated by natural gas. We own two stocks (in most accounts where we're allowed to own them) that are positioned to benefit from increasing demand for natural gas: Blackstone Minerals (BSM) and Kinder Morgan (KMI).

BSM is a royalty trust structured as a master limited partnership (MLP) for tax reasons. It is one of the largest mineral rights owners in the US. Energy (oil and gas) companies drill on its land and pay BSM a quarter of their revenues for this privilege. About one-third of BSM revenues come from natural gas. KMI operates a large network of (mostly natural gas) pipelines. Both companies are paying handsome dividends while the transition to higher natural gas consumption takes place.

We have looked into energy infrastructure and found a lot of good companies, but we were unable to find stocks that meet our criteria (everything is very expensive). We have a few of them on the watch list – a code word for we'd like to own them but at lower prices.

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I'd love to hear your thoughts, so please leave your comment and feedback here. Also, if you missed my previous article "Lessons from History’s Technology Booms", you can view it and leave a comment here.

Below is my latest Youtube video:

Hymne à L’Amour

Today we are going to take a rare detour from classical music into more popular music and explore “Hymne à L’Amour” (“Hymn to Love”), but I promise there is something for classical music and opera lovers. This detour was triggered by Celine Dion performing it at the opening of the Olympics in Paris. Russian culture was significantly influenced by French and Italian music, and I remember hearing this song when I was a child and falling in love with it.

The song has a tragic history.

Edith Piaf wrote it (lyrics) for her lover, French boxer Marcel Cerdan, in 1949. Their illicit love affair made huge headlines – Marcel was married and had three kids. Piaf first performed the song in New York City in September 1949. Cerdan died in a plane crash a month later; he was on his way to see Edith Piaf in NY.

My favorite performance is by Mireille Mathieu. I have to admit I had a small crush on Mireille as a child.

Click here to listen.

Here’s a wonderful performance by a Bulgarian soprano: Sonya Yoncheva.

And here is a cello solo version.

Click here to listen.

Vitaliy Katsenelson, CFA

I am the CEO at IMA, an investment firm that designs all-terrain portfolios that survive the worst markets and thrive in good ones. (Get our company brochure in your inbox here, or simply visit our website).

In a brief moment of senility, Forbes magazine called me “the new Benjamin Graham.”

I’ve written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. (But you can learn the basics of my approach to investing by reading the 6 Commandments of Value Investing.

My first non-investing book, Soul in the Game, is available to order here. You can get 4 entirely new chapters (not found in the book) by forwarding your purchase receipt to bonus@soulinthegame.net.

And if you prefer listening, audio versions of my articles are published weekly at investor.fm.

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