The Deflation Enablers:
Cost pressures should make companies accelerate investments in automation and productivity-enhancing technologies.
Many of these technologies are inherently deflationary.
Within this note, we provide a shopping list of “deflation enablers.”
Persistent inflation in areas such as labor, supply chain/procurement, and energy give rise to transformational investment across industries.
While cyclical forces tend to deter investment in an uncertain macro environment, we believe structural changes in demographics, energy policy and security, and an aging capital base make technologies focused on cost reductions and productivity more valuable.
Focusing on stocks that enable this productivity and cost reduction through automation, efficiency, or their own declining cost curves while maintaining strong barriers to entry and attractive equity risk/reward
Specifically, we identify 4 key drivers of deflation in autos, improving the payback period relative to today’s mobility model:
1) Dramatically increased scale in battery manufacturing. Today’s global battery manufacturing capacity stands at approximately 600 GWh (0.6 TWh) ( Exhibit 16 ).
2) By 2040, we estimate the amount of battery capacity required to supply the global BEV market, as well as related stationary storage end markets, could approach a scale of 20 to 30 TWh, as much as a 50x increase in total battery scale ( Exhibit 17 ).
Given the capital intensive, heavy manufacturing element to battery manufacturing, investors can anticipate improvements in scale economies that could approach that of the polysilicon/solar industry ( Exhibit 27 ).
3) Improvements in battery technology. Today’s Li-ion battery technology has historically delivered annual cost downs of 5 to 7% per year (prior to recent raw material spikes), but is still largely unchanged on a fundamental basis over the past 20 years.
Battery companies, auto companies, and governments are investing hundreds of billions of $ into advanced battery technology over the next 5 to 10 years to improve all aspects of the battery (cathode, anode, separator, electrolyte), as well as attempting radical new technologies to improve energy density by 2 to 3 fold (i.e. solid state) that could significantly drive costs down. Tesla’s battery day presentation identifies a range of design improvements to drive battery cost reduction on a $/KWh basis down as much as 56% by mid-decade ( Exhibit 24 ).
4) Improvements in vehicle manufacturing and infrastructure. One must consider a range of technological improvements outside the battery cell itself that can improve energy efficiency (vehicle range or miles per kg at the car level). The software defined vehicle in a clean-sheet approach offers OEMs the opportunity to reduce the complexity of their vehicles and reduce the variability of SKU, driving dramatically higher volume per model and lower price.
Elon Musk specifically targets innovations such as the 4680 tabless architecture, structural battery pack, and giga-casting to reduce parts count and to integrate the battery into the structural integrity (or fuselage) of the car itself. Additionally, improvements in charging infrastructure (including charging station ubiquity, density, and DC fast charging) may render today’s large 1,000lb+ batteries a thing of the past, driving even more deflation in the cost of an EV. Finally, there is the lower cost of ownership of EVs vs. ICE vehicles from lower fuel prices and lower annual maintenance costs (AAA) ( Exhibit 9 ).
5) Autonomy. While we believe the journey to full L5 autonomy may take far longer than many investors realize today, gradual improvements (followed by dramatic improvement later) will drive high vehicle utilization, improved safety, and reduced driver expense. Today’s ADAS technology can reduce accident frequency and severity significantly, driving lower repair cost, social costs, and lower insurance premiums over time.
Payback periods from removing the driver completely can be measured in months, not years. Autonomy in autos drives deflation in miles traveled from $1/mile to as low as $0.10/mile in some scenarios of super high utilization vehicles.
While we remain bullish on the long-term adoption of EVs, we are particularly concerned with the FY24/25 to FY30 time horizon. • In the US, we currently forecast EV penetration to more than triple from 4.2% in FY22 to 13% by FY25 and to rise a further 2.5x to 32% by 2030. These assumptions were made in a pre-inflation/pre-Ukraine world. • Globally, the team’s current forecast is for EV penetration to hit 18% by FY25 (vs. 7% in FY21), rising further to 43% by FY30.
While we believe many geopolitical and economic and technological forces will drive higher EV penetration over time, we feel there may be material room to ‘push down the curve’ for the near term to allow for a necessary re-architecture of the supply chain and expansion of capacity to bring EVs to the price point required to fulfil the higher penetration scenarios.
Our global auto team sees two main areas of innovation that should bring component costs down: (i) advances in battery technology, which should help reduce battery costs to close to US$100/kWh in the coming years; and (ii) silicon carbide chips within EV powertrain components, which could save US$1,000/car, or 8% of the average cost of an EV. Together, we believe these two areas could see EVs approach parity with ICE cars on component costs by around 2025. As ICE emission costs continue to rise, EVs are becoming the cheaper option.
Cost savings like those targeted by TSLA mid decade, coupled with range increase, could help spur even more demand for EVs as payback period decreases, or even creates a situation where a comparable EV is cheaper than its ICE counterpart (seen below).
Additionally, upon reaching L5 AV, the cost per mile significantly decreases as utilization increases dramatically.