Barron's Streetwise - Electric Vehicles Just Hit Critical Mass

Episode Date: April 9, 2021

Plug-in cars have taken off in Europe. The U.S. is next, says BorgWarner CEO Frédéric Lissalde. Learn more about your ad choices. Visit megaphone.fm/adchoices

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Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard is Friedrich LaSalle, and he's going to tell us about the future for electric cars, and plug-in hybrid cars, and gasoline and diesel cars, and trucks. Fred knows about the future for these things because he's the CEO of BorgWarner, which makes car components like transmissions and turbos and increasingly electric drive systems. That gives him years of advance notice about what car makers are doing and buying. Plus,

a top investment strategist at Deutsche Bank Wealth Management will tell us what's next for U.S. stocks and why he likes emerging market bonds. It's a jam-packed episode. You know what? I think I might be winded already. Let me just take a knee for a minute. Listening in is our audio producer, Metta. Hi, Metta. Hi, Jack. You know, I thought about you this past week. I went to CVS for my first vaccine shot and it was super efficient. I didn't even cry. And after you get the shot, they ask you to sit for like 15 minutes before leaving.

So they sat me in front of the soda cooler and I looked up and I saw the most radioactive looking flavors of Mountain Dew. One of them looked like transmission fluid and one of them might have been glowing. And I remember, you know, there was that phase you went through last spring when you were drinking all of the extreme Mountain Dew flavors, like one a day. And then over summer you switched to hard kombucha. I still don't even know what that is. And so now I'm wondering, Meadow, what are you drinking now? I'm drinking a magnesium supplement that tastes like lemon. You put it in water and it dissolves.

It's pretty good. What does that do for you, magnesium? It's good for like restless legs. Did the Mountain Dew give you restless legs? Is that what's happened here? It was all the mountain biking I had to do because I've been drinking the Mountain Dew. Oh dear. Let's talk about the

stock market. I understand we have a listener question. Yeah, we have a question from Chris. I think he's from Texas. Let's hear it. Hello, Jack. I really enjoy listening to your show. It is my Saturday morning ritual. I listen to it when I'm working out or working around the house. My dad turns 80 this year. I remember growing up reading Barron's Magazine and charting stocks by hand on graph paper before it was so easy to do and follow on computers today. My dad and I have a question. It looks like the PE ratio of the S&P 500 is skyrocketing through the roof, and if you chart it over time, normally it falls just as rapidly as it has rose. Is this time different with all the government money that's in the market? How long does this party last? And when do we think,

or where do we think, the P-E ratio of the S&P 500 will stabilize to? Thank you for your insight and the excellent show. And hello, Meta. It's a good question, Chris, and thank you. Last week, the top stock strategist at B of A Research, Savita Subramanian, told us that she's forecasting a slight decline in the S&P 500 through the rest of the year. But she said that doesn't mean long-term investors should dump stocks. I wanted to get you a fresh perspective, Chris, so I called Deepak Puri. Welcome, Deepak. Thanks for making a few minutes to speak with us. Absolutely. My pleasure. Thank you for your time. Deepak is Chief Investment

Officer for the Americas at Deutsche Bank Wealth Management. I asked first about the stock market. It looks expensive. Is it too expensive? The house view at Deutsche Bank is that the S&P 500 is headed to 4,100 soon. Based on its recent level, that's not a decline, but it's a barely perceptible increase. You have a fiscal stimulus that is much more bigger than we initially expected. So that's going to help risky assets. And then you have the reopening of the economy. You know, all this has really helped bridge this gap between the economies of stoppage versus where we are most likely going to be, where you're going to see some eye-popping

numbers come in for economic growth come the middle of the year. OK, so the news is all good for stocks. There's a lot of government spending. The economy is reopening. We're getting vaccines. It's a lot of government spending. The economy is reopening. We're getting vaccines. It's a restless legs economy. But what about the possibility that we're reaching peak good news right now? I mean, what is there that can still surprise us to the upside later this year?

Deepak says there might not be much, but that the TINA argument is still valid. TINA, of course, stands for there is no alternative. It means bond yields are so low that stocks, even though they're more expensive than usual, still look attractive relative to the other choices for investors. Deepak says that even though the 10-year treasury yield has climbed recently, it's still in the bottom decile of where the yield has been over the past half century. And the Federal Reserve doesn't look likely to do much to change that. So they're not going to preemptively raise interest rates. And that's great news for the markets.

So, Chris, you asked about the price to earnings ratio for the S&P 500. In other words, whether stocks are expensive. Deepak says that even if the price to earnings ratio doesn't rise any further, it might not fall either. In which case, stocks can push higher on earnings growth. So I feel the PE expansion theory might have a limiting impact. So we're not really suggesting that the P.E. is going to expand. But now the next leg of the market is really going to be driven by earnings where we feel you're going to start to see some really good numbers. I asked Deepak, how do we know inflation will stay low? And he said, we don't. It's a key risk for the market. Some of the forces that have held consumer prices down over the past decade, like globalization, might not help as much going forward.

But even though Deepak thinks inflation might shift to a higher level, he doesn't expect it to get out of control. I asked Deepak what specific recommendations he's making for stock investors, and he said a barbell strategy. And I thought, my upper body strength isn't what it used to be. But he was talking about a metaphorical barbell where the weights on one side represent companies that have kept growing right through the pandemic, like the tech giants. And the weights on the other side represent companies that haven't fared as well, but which might make better money going forward, like banks and industrials.

but which might make better money going forward, like banks and industrials. Deepak says to avoid the speculative, aggressive growth companies that don't have much earnings, as well as companies with deeply depressed shares, but also business models that might not be relevant in the post-pandemic economy. And he says for the tech giants to keep return expectations muted compared with the past decade. Okay, fair enough. But what about bonds? If the only reason stocks still look good is that bonds look worse by comparison, would investors be better off with something else for safety like cash? Do we still need bonds? You need bonds, but maybe not the same kind of bonds that one is used to. You know, to give you an example, you know, 20 years ago, you had a million dollar euro retiree and you're looking at $60,000 of income. You didn't have to do much. Then you get your 6% coupon.

You fast forward it to today. There is nothing that's going to give you 6%, right? You need to take exorbitant amount of risk. percent. Right. You need to take exorbitant amount of risk. To Deepak's point, a million dollars put into 10 year treasuries today gets you an income of just under $17,000 a year, which doesn't sound like the sort of income you'd think a millionaire would have. Deepak says that just like investors have gotten more comfortable with emerging markets for stocks, they should start looking there for bonds. I asked, should you use active management or an index? Deepak says active management is best so that there are people keeping an eye on political developments in each country. I asked, should your favorite dollar-denominated bonds or ones denominated in local currencies. He says bonds issued in dollars are preferable, so you don't add too much currency risk to the risk you're already taking by venturing

into emerging markets for your bonds. Lastly, I asked, what's the payoff? How much of an income can I generate with emerging market bonds right now? Can I get 5%? Here's Deepak. You know, I would say where you're not taking over exaggerated risk, where the risk is still somewhat, you know, palatable for that particular asset class, you're looking at three and a half to 4%. So a little bit less than what you just said. Having said that, there are certain funds out there, and here you're going very long on the duration side. You start to take interest rate risk on top of the credit risk. And here you can get closer to that 5% return,

but keep in mind that you are taking a lot more duration risk than what we would recommend at this point. Whoever thought we'd be in a world where 5% sounds like forbidden fruit. Careful about this one over here. He's offering 5%. You know, that's gotta be trouble. Meta, I think I might need another car. Do you have problems with the minivan?

No. Our family has only one car, and Meta, I know I've been a passionate advocate for minivans for years, but I just switched to an SUV because we moved to a house in the hills where we need the all wheel drive. And my daughter said minivans aren't cool. I mean, she's wrong, but okay. So it'll sound strange to some listeners that we make do with only one car, depending on where you live. But we lived for many years in New York City where that's normal. And then we moved to a house in the suburbs within walking distance to a commuter train to the city, so we still didn't need a second car. But now we're pretty far from the center of town and we're not walking distance to anything. And Little League season is about to

start and I'm an assistant coach, which is a big responsibility. And there's a scheduling conflict between my son's Little League practices and my daughter's basketball. You with me? Yeah, it was a very much longer answer to my question than I expected, but thank you. I know that you want all the details. I'm trying to be thorough here. So the time has come to become a two-car family. And I'm wondering, our other car uses gasoline, so should this one be electric?

Should I get a Tesla? I mean, my daughter tells me those are very cool. Only, I wish I knew what was going to happen with this infrastructure bill. Fresh off the victory of his $1.9 trillion American Rescue Plan, President Biden is on to his next priority, building stuff. Fresh off the victory of his $1.9 trillion American Rescue Plan, President Biden is on to his next priority, building stuff. President Biden's $2 trillion infrastructure proposal unveiled Wednesday includes a suite of measures to fight climate change, including billions to transition to electric vehicles, retrofit buildings, replace lead pipes, and modernize the nation's electric grid.

There's already a $7,500 tax credit for electric cars. It brings the cost of them down to the cost of regular cars. Only it phases out for companies that have already sold 200,000 electric cars, which means Tesla and General Motors no longer qualify. But there's a movement afoot to remove the cap, meaning Tesla and GM buyers would still get the $7,500 tax break. That could help decide which car I buy or even whether I buy electric. But there's even more at stake here than my little league assistant coaching professionalism. Electric vehicle sales are going bananas in many parts of the world. In Europe, sales of electric vehicles more than doubled last year, while sales of gasoline and diesel vehicles fell by a third.

Toward the end of the year, new registrations for electric vehicles made up 23% of the market. That includes plug-in hybrids, which are electric cars that burn fuel for backup. In Norway, electric vehicles topped 50% of the market last year. The country aims to stop selling cars that run on gasoline or diesel by 2025. Now in the U.S., electric vehicle market share is only around 3%. Tax incentives explain a lot of the difference in demand from region to region, but there also could be a critical mass effect at work. Once a lot of buyers go for electric vehicles, others have to wonder about the resale value of gasoline cars. When I got my SUV, I leased it so the residual value would be somebody else's problem, and I assumed I'd replace it with an electric vehicle in three years. Now that I

suddenly need a second car, I might make the move to electric sooner than I expected. To learn more about the shift to electric vehicles, I reached out to someone who sells components for pretty much all types of cars, no matter what makes them go. Hi, Frederic. It's Jack Howe from Barron's. How are you? Good morning, Jack. I'm doing really, really good. I hope I'm saying your first name properly. Frederic? Oh, yeah. Perfect.

Frederic, who also goes by Fred, is the CEO of BorgWarner, one of the world's largest auto suppliers. The company, ticker symbol BWA, is nearly a century old. It's so old that one of the people it's named for, Charles Borg, originally sold machines for making wagon poles. His son George got him into making clutches for horseless carriages. Today, Borg Warner still makes clutches, which are used to change gears. Its Dualtronic clutch system is designed to make automatic transmissions just as fuel-efficient as stick shifts, and to make shifting between gears almost imperceptible for the driver.

The company also makes turbochargers, which help little engines punch above their weight so that fuel efficient cars no longer have to be wimpy. There are many more products besides these. Electric vehicles don't need multiple gears, which means they don't need clutches. And they certainly don't need turbochargersgers which work by blowing more oxygen into the cylinders where the fuel is burned because there are no cylinders and no fuel and no burning. So for electric vehicles BorgWarner makes other components like electric drive modules and intelligent battery management

systems. I asked Fred about electric vehicle adoption. It seems to have hit an inflection point, has it? As an auto supplier, we have all the cars, right? We see all customers around the world. It has certainly accelerated. Over the past, I would say, 16 months, and I think it has become more of a societal bottom-up wish, where people want to be moved from point A to point B in a cleaner and more efficient way. Fred says BorgWarner began

preparing for this moment back in 2013 by creating some products for electric cars in-house and buying some others. He says the goal was to be ready once demand hits, but also that it could be expensive to prepare too far ahead of market demand. In an investor presentation last month, Fred projected that 45% of company revenue will come from electric vehicles by 2030, up from less than 3% this year. I asked, how do you balance the need to focus on products that are making money right now with the need to invest in future money makers in different categories?

That's what's fascinating to manage this company and any company that has to manage the present that funds the future. Now, the product line turbo is still growing for the foreseeable future because the first way of electrification jack is going to be hybrids. And with any good hybrid propulsion architecture, it is usually turbocharged GDI downsized gasoline engine. Fuel efficiency has been a big focus for BorgWarner for years. What happens to all that know-how once there's no fuel? Fred says it's still important. So for electric cars, efficiency in a battery electric vehicle

is as or more important than the fuel efficiency. Why? Because it touches the range or the cost of the vehicle with the size of the battery pack. Efficiency of moving the electrons from charging stations to moving the wheel is going to be extremely important. I did have just a couple random matters of transmission curiosity to ask Fred about. My last minivan, it had a nine-speed automatic transmission. There were paddle shifters behind the wheel. Is there like a secret minivan racing circuit I'm not aware of?

Fred said all those gears are just a tool to better manage the gear ratio in order to improve fuel efficiency. There's no minivan racing circuit, or at least not one he was willing to tell me about. I asked, does anyone still drive stick shift? He said about one quarter of the world still does, and it's going down, but not very fast. Meta, did you ever drive stick shift? I have, yeah. My mom and dad drive stick shifts. Everyone in Denmark, most people in Denmark stick shift? I have, yeah. My mom and dad drive stick shifts. Everyone in Denmark, most people in Denmark I should say, drive that. Really? Not in America.

You know why? Because it's better for eating. You can't shift with one hand while holding a McGriddle in the other. I mean, that's not safe. That's the can-do spirit. I did talk with Fred a little about our first cars. What was your first car when you were a kid? My first car was a 1980 Volkswagen Rabbit with a diesel engine.

Stick shift, of course, manual, everything. It topped out at maybe, I think, 60 miles an hour or something like that. But it got maybe 50 miles on a diesel. What was your first car? It was a Peugeot 206. I think 60 miles an hour or something like that, but it got maybe 50 miles on a diesel. What was your first car? It was a Peugeot 206. I think it was a small diesel stick shift, right? And I put a lot of money on that car.

That car has been around Europe for a long time, I tell you. Borg Warner competes with other component makers, but also with car makers who might be tempted to bring certain component manufacturing in-house. I asked Fred, what keeps BorgWarner competitive? He said constant innovation and scale. He gave the example of a German company called Akasol, which makes battery systems for electric commercial vehicles. In February, BorgWarner announced it's buying Akasol. One of the things Fred liked is that Akasol's management is committed to launching new products every 18 months. As he puts it, their third generation products won't launch until the end of the year, and they're already halfway through developing the fourth generation. There's suddenly a lot of investor

interest in the car industry, and not just for Tesla stock. Ford and GM shares have both more than doubled over the past year. BorgWarner shares are up about 80% over that stretch. They still trade at 11 times this year's projected earnings, which is unusually cheap, especially for a company that's expected to grow earnings by double-digit percentages for years to come. But analysts are pretty evenly split on the stock. One bear is Adam Jonas at Morgan Stanley. He gives management credit for addressing once-in-a-generation changes in the car industry, but he views the runoff of the company's highly profitable combustion engine portfolio as inevitable and the profitability of its electric

portfolio as unproven. On the other hand, James Piccariello at KeyBank Capital Markets is quite bullish. He views Borg as well- well positioned for content per vehicle gains, meaning it could end up making more from electric vehicles than it now makes from ones with combustion engines. Last question for Fred. What is his view of customer order books tell him about the pace of electric car adoption? In 2030, we believe that 30% of the vehicles that will be produced on that year will be fully battery electric vehicle. So one out of three. The other one out of three will be hybrid. Actually, 37% will be hybrid and the rest will be combustion.

We also see about 15 to 20% of the commercial vehicle being electrified. It makes a lot of sense. Buses, right? Cities will want those buses clean, right? When the cars are going to be clean, the buses are going to be clean. Medium duty vehicles, light duty vehicles, delivery last mile, all that's going to be electric. Thank you, Chris, for sending in your question.

And everyone, please keep the questions coming. Just tape on your phone, use the voice memo app, and send it to jack.howe at barons.com. Thank you for listening. Metal Lute Soft is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, please write us a review. If you want to find out about new stories and new podcast episodes, or if you just want to see a picture of my epic self-haircut fail from this past week, you can check in with me on Twitter. That's at Jack Howe, H-O-U-G-H. See you next week.