Vehicle Electrification – a Bird in the Hand
Since I'm frequently chastised for holding old fashioned views when it comes to vehicle electrification, I'll start this article by quoting one of the oldest known versions of a common English proverb, "A byrd in hand - is worth ten flye at large." While this theme is not always clear in my writing, it's never far from my thoughts. In fact it's the foundation of my conviction that manufacturers of cheap energy storage products are better investments than developers of cool energy storage products and batteries are great at minimizing waste but miserable at replacing fuel tanks. Just for this week, I'm going to take the debate down a notch and focus on what I see as a bird in the hand in the energy storage sector.
I've written about new European standards that will require automakers to reduce CO2 tailpipe emissions to 130 g/km by 2015. I've also written about new U.S. CAFE standards that will require automakers to achieve an average fuel economy of 35.5 mpg by 2016. While I've never written about the rest of the world, many governments are jumping on the bandwagon and adopting emission standards based on the European model. The following chart from Tenneco (TEN), a global leader in automotive fuel efficiency and emission control systems, provides a summary overview of the current global regulatory landscape.
For the last couple of years, a huge amount of hype and media attention has focused on a new generation of plug-in vehicles that automakers plan to introduce soon. What these stories invariably fail to recognize is that one or two million plug-in cars may contribute to the cause, but the overwhelming bulk of the progress must come from efficiency gains in the 48 million cars that can't be built with plugs because the world can't make enough batteries. From my admittedly stodgy perspective, the 48 million cars are a plump bird in the hand while one or two million plug-ins are, at best, wild geese on the wing.
In mid-February, I wrote an article, Exploring Energy Efficiency in the Automotive Sector, that included the following summary table of efficiency technologies for cars without plugs:
|Hybrid Electric Technologies||Gain|
|Prius-class strong hybrids with idle elimination, electric-only launch, recuperative braking and acceleration boost.||40%|
|Insight-class mild hybrids with idle elimination, recuperative braking and acceleration boost.||20%|
|Direct Fuel Injection (with turbocharging or supercharging) delivers higher performance with lower fuel consumption.||11-13%|
|Integrated Starter/Generator Systems (e.g. stop-start systems) automatically turn the engine on/off when the vehicle is stopped to reduce fuel consumed during idling.||8%|
|Cylinder Deactivation saves fuel by deactivating cylinders when they are not needed.||7.5%|
|Turbochargers & Superchargers increase engine power, allowing manufacturers to downsize engines without sacrificing performance or to increase performance without lowering fuel economy.||7.5%|
|Variable Valve Timing & Lift improve engine efficiency by optimizing the flow of fuel & air into the engine for various engine speeds.||5%|
|Automated Manual Transmissions combine the efficiency of manual transmissions with the convenience of automatics (gears shift automatically).||7%|
|Continuously Variable Transmissions have an infinite number of "gears", providing seamless acceleration and improved fuel economy.||6%|
While all these efficiency technologies are important, the only ones I'm qualified to write about are stop-start systems, mild hybrids and full hybrids.
In a presentation at last fall's IAA Investor & Analyst Conference at the Frankfurt Motor Show, Dr. Wolfgang Bernhart of Roland Berger Strategy Consultants predicted that automotive powertrain electrification would become a critical efficiency technology by 2020 and forecast high scenario market penetration rates as follows:
While some may find the distribution surprising, it actually fits nicely into the concept of the standard bell shaped curve that we all learned about in grade school when report card time rolled around. A few buyers will underperform and continue to buy vehicles with internal combustion engines; most average and above average buyers will buy vehicles with stop-start and HEV systems; and a few truly committed souls will buy vehicles with plugs. As an investor looking to minimize risk, I prefer mass-market certainty to early adopter potential.
The biggest impediment to the widespread adoption of stop-start systems is that stopping and restarting an engine several times during a typical daily commute is very hard on flooded lead-acid starter batteries. While stop-start systems don't need an exotic chemistry like NiMH or Li-ion, they do need a better grade of absorbed glass mat, or AGM, battery that can withstand heavier cycling. Where automotive OEMs have historically paid about $55 each for starter batteries, advanced batteries for stop-start applications can cost from $150 to $250 each. The price difference may be pocket change in the price of a car but it's a huge revenue opportunity for the companies that can make starter batteries for millions of stop-start vehicles.
Building top line revenue in any business is hard and the only ways I know are to sell more products or to sell higher value products. The same is true of bottom line profitability where the only options are to improve margins or cut costs. A business that can build revenue by increasing unit prices and simultaneously increase profits by selling at a higher margin is rare, but that's the direction the lead-acid sector is heading in. Assuming a modest price differential of $100 per vehicle, the incremental revenue to starter battery producers should be on the order of a billion dollars within five years and three billion dollars within ten years. Since the revenues will come from product upgrades rather than increased volumes, the stresses on capital spending budgets, supply chains and distribution networks should be significantly lower than they would be with a new product. The net result should be higher revenues and profits, which are always good things for low-priced stocks.
No matter how the stop-start market ultimately unfolds, starter battery manufacturers will thrive. If the OEMs bite the bullet and buy better starter batteries, revenues from original equipment sales will soar. If OEMs don't upgrade their starter battery specifications when they introduce stop-start systems, revenues from replacement battery sales will soar. It's just an updated version of the old Fram Oil Filter advertising campaign, "You can pay me now, or pay me later."
The three publicly traded U.S. companies that stand to benefit most from the widespread implementation of stop-start systems are Johnson Controls (JCI) Exide Technologies (XIDE) and Axion Power International (AXPW.OB).
JCI and Exide are global competitors in the OEM battery space and they each book billions in annual revenue from the starter battery business. JCI's Varta unit is selling batteries for over a million stop-start vehicles annually. Exide is using the proceeds of a $34 million DOE battery-manufacturing grant it received last August to build a new factory that will make batteries for up to 1.5 million stop-start vehicles per year. Both companies truly are bird in the hand investment opportunities that are certain to see significant revenue and profit growth over the next few years from market mechanisms that are already in place.
Axion is a more speculative microcap company that spent the last six years developing a lead-carbon battery technology that's ideally suited to the extreme cycling demands of stop-start systems. During the R&D stage, Axion's prototype PbC® batteries withstood over 1,600 cycles at a 90% depth of discharge while top quality AGM batteries made by others failed after 300 to 500 cycles. After entering into a worldwide supply agreement with Exide last April, the two companies sent pre-commercial PbC devices to several first tier automakers early last summer. Ten months later, the testing continues to yield positive results and negotiations are apparently in process for road testing of PbC batteries in pre-production stop-start vehicles. If the testing turns into orders, Axion will be able to leverage Exide's global manufacturing base by providing carbon electrode assemblies for co-branded products. It's not quite a bird in the hand, but it's a lot closer than the flock of wild geese.
I'm a former director of Axion and a big stockholder, so I'm clearly cheering for my home team. That being said I know several of Axion's directors well enough to feel confident that they wouldn't have closed a $26 million down-round financing in December if management wasn't preparing for a major capital spending program. I expect that we'll hear a good deal more about Axion's short-term plans when its annual report is filed at the end of the month. The one thing I can say for certain is that I feel much better about my risk/reward profile today than I did in October 2006 when I bought the bulk of my shares at a price that's within spitting distance of the current market.
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and has a substantial long position in its stock, together with a small long position in Exide Technologies (XIDE).