- Automotive industry demand, particularly for electric vehicles (EVs), is declining, leading to challenging pricing conditions.
- Used vehicle values in the United States have started to decrease after reaching extraordinary highs during the pandemic.
- China is the largest EV market and is putting pricing pressure on EVs, making exports attractive.
- With supply chain disruptions in the rearview mirror, EVs are now readily available for purchase, leading to potential oversupply and deflation.
- Investments in the green transition, particularly in EV production capacity, may lower returns on capital for automakers.
- The rise in the risk-free rate and inflation risk premium is increasing required return expectations, reducing the value of future cash flows and valuations.
- Investors need to consider whether expectations for the green transition are too optimistic and whether enough investment risk is factored in.
The automotive industry, including the electric vehicle (EV) sector, is facing several challenges that could potentially impact profitability. The demand for EVs, primarily driven by wealthier customers during the COVID-19 pandemic, is declining, especially for premium-priced second vehicles. The mismatch between supply and demand has led to increased pricing for EVs.
US EVs, on average, cost around $11,000 more than equivalent internal combustion engine (ICE) vehicles. However, this price difference is expected to decrease as additional supply hits the market, and Chinese EV manufacturers with spare capacity enter the global market.
One potential indicator of automotive market weakness is the used vehicle market, which has already started to show signs of declining values in the United States. Despite limited supply during the pandemic, used vehicle values reached extraordinary highs but have now started to decrease.
China is now the largest EV market and is putting pricing pressure on EVs, making exports an attractive outlet. Chinese automakers have made significant investments in EVs and are expected to lead in automotive exports. Ford’s Mach-E electric crossover, for example, is priced significantly lower in China compared to the United States.
The availability of EVs has significantly increased as supply chain disruptions have been resolved. However, this could lead to potential oversupply and deflation in the automotive industry. Chinese automakers have pivoted towards EVs, and their excess capacity, combined with global distribution capabilities, may lead to them dominating the EV market.
Investments in the green transition, particularly in EV production capacity, may result in lower returns on capital for automakers. The US government’s Inflation Reduction Act (IRA) and other funding initiatives provide significant support for the EV industry. However, automakers, including Tesla, are expected to face challenges in achieving positive returns on capital due to the immense capital requirements and intense competition.
The rise in the risk-free rate and inflation risk premium has increased required return expectations. This reduces the value of future cash flows and puts pressure on valuations. Investors need to consider whether expectations for the green transition are too optimistic and whether enough investment risk is factored into their assessments.
Overall, the shift towards sustainability in the auto industry poses potential risks to profitability. Challenging pricing conditions, oversupply concerns, and the need for significant investments may impact the financial performance of automakers. Investors should carefully evaluate the risks and returns associated with the green transition.
