Developed Markets Autos Race towards electrification

Equity Research 16 July 2021

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Sector update

Developed Markets Autos –

Race towards electrification

Global Equities

Research Team

Investment highlights

• Ongoing challenges from global chip shortage should improve gradually, but supply capacity issue will

likely persist beyond 2021, constraining the extent of volume growth recovery in the sector.

• Electric vehicles (EV) adoption should drive further structural industry disruptions and fuel multi-year

demand growth, which offers both opportunities and disruptions within the value chain.

• Prefer a more selective approach for new entries following the auto sector’s out-performance year to

date, which has been driven by the faster developed markets’ economic re-opening and rotation

towards cyclical sectors.

• Remaining sector ideas with double digit potential upside to fair values, provide exposure to the structural

EV growth story and decent ESG performance include Bayerische Motoren Werke (BMW GY), Borgwarner

(BWA US), Continental AG (CON GY) and Honda Motor (7267 JP). While there is still potential upside to fair

value for Volkswagen (VOW GY), one of the traditional auto-maker leaders in battery electric vehicle

(BEV) model introductions, investors should be mindful of its higher ESG risks.

• ESG considerations - Increasing focus on EVs will continue to tackle the sector’s rising emissions footprint

driven by rising vehicle demand. Myth that EVs are emissions-free (it is more appropriate to view the

segment as lower-emitting). It is also important to consider sources of energy mix for EV charging, which

will influence the emission levels generated from different countries/regions’ grids.

Developed market (DM) auto picks featured on our focus list this year (such as General Motors, Borgwarner,

BMW and Honda Motor) have delivered solid double-digit gains, as the sector benefitted from earlier

developed markets economic re-opening and ongoing rotation into cyclical sectors this year. Tactical

investors who have followed our earlier calls may wish to lock in some profits on General Motors (GM US),

which we have previously taken profit within our research focus list due to limited upside to fair value and

prefer to accumulate fresh positions on pullback instead.

Exhibit 1: Preferred DM Auto ideas

Sources: Bloomberg, Morningstar, Internal estimates


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Within this report, we have provided key updates from our recent webinar with Morningstar’s developed

markets auto analysts and ESG considerations to provide a more complete perspective when approaching

the sector. Due to more extended sector valuations, we advise a more selective approach for new entries.

Key highlights of our recent webinar with Morningstar

As the global recovery theme continues to gather strength and following the solid gains in the sector, we

recently invited Morningstar’s developed markets auto analysts to discuss the outlook of the sector,

investment opportunities and disruptions in the value chain as the industry shifts towards higher electrification.

U.S. Autos

• 2020 full year auto sales fell 14.4% to 14.6mn. 1H21 U.S. auto sales -1.3% yoy.

• Demand is present for most expensive vehicles (pickups, SUVs) but production has been hampered

by chip shortage (as of 12th July 2021, Autoforecast Solutions estimated the industry’s lost production

was about 1.9mn units).

• Chip shortage holding back GM and Ford (in particular the latter). Ford has been a laggard in terms

of recovery, although guidance should improve when it reports 2Q results in early August.

• Keeping an eye on lowering inventory levels – As of end of June 2021, U.S. inventory estimated at

1.397mn units, down 46% from June 2020 and down 64% from June 2019 (source: Wards).

• Firms are guiding for gradual recovery in semiconductors, worst of chip shortage should be seen in

2Q21, but full normalisation is not expected this year and may extend into 2022-2023.

• Fleet age averaging a record high of 12.1 years. Used car prices has surged but ultimately are not a

substitute for new cars.

• ESG updates - In 2021, GM raised its BEV and autonomous vehicle (AV) spending for 2020-25 to $35

billion from $27 billion and said it seeks 100% of its 2035 sales to be ZEV, Ford raised electrification

spending to over $30 billion for 2016-25, unveiled the F-150 Lightning BEV (due in 2022), said 40% of its

global sales volume will be BEV by 2030 and 100% of its passenger vehicles in Europe and 2/3 of

European commercial sales, Lincoln’s first BEV due in 2022 and 50% of brand’s global sales will be ZEV

by mid-decade, created a battery research center called Ion Park, and formed a JV with SK

Innovation to make 60 GWh of cells by mid-decade and pack costs to $100/kWh by 2025 and below

$80/kWh well before end of decade.

• Morningstar no longer considers Ford to be behind GM in BEVs, it just needs more of them.


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Exhibit 2: Used Vehicles Index

Source: Morningstar

Exhibit 3: U.S. Inventory for rest of 2021


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Europe Autos

• Light vehicle outlook for EU & UK – forecast to see 4-8% increase in 2021 light vehicle demand, with

unit registrations between 13.8-14.4mn.

• Trailing 12-month light vehicle demand grew 4.2% to 14.8mn as of end May 2021.

• 2H21 to become more challenging due to higher base effects and chip shortage supply chain

disruption continues to be a concern.

Exhibit 4: Europe Light Vehicle Registrations

Japan Autos

• Light vehicle outlook – forecast 2-6% increase in 2021 light vehicle demand.

• 2H comps to be relatively favourable until October this year (market started to recover in 4Q20).

• Toyota has been stockpiling chips since 2011 earthquake but inventory has been down more due to

faster demand (not able to replenish dealers after sales fast enough).

• ESG considerations – Increasing BEV focus by Japanese automakers, who have seemed behind GM

and the Germans. Toyota has announced that by 2030, it will have 8 million electrified annual unit

sales with two million of that ZEV (BEV or FCEV) and 15% of 2030 Toyota USA sales ZEV. Toyota also

announced plans for 15 BEVs by 2025 under the new bz series name with 7 of those having the Toyota

brand. This is why although Toyota also said this year that it favors HEV and PHEV for this decade, we

think it could catch up on BEVs quickly if it needed to as it’s not ignoring them.

• New Honda CEO Mibe said in April that Honda globally will be 100% ZEV (BEV & FCEV) by 2040 and

will start testing GM’s Cruise Origin AV in Japan.

• Denso has been consistently showing signs of improvement over the past year, in terms of adapting

to the CASE trend (especially electrification) and improving operations. The company’s electrification

systems business already has higher operating margins than companywide level, and their advanced

driver assistance systems (ADAS) business also turned to profitability ahead of schedule. Also, a key


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component of Toyota’s latest fuel cell vehicle (FCV) model, “Mirai”, includes Denso’s power control

unit, which deal with the control of power generation/motors in various EVs (FCV, battery, hybrid,

etc.). Considering their product development and track record with new CASE technologies, it is likely

that Denso will be able to adapt to the “once in a century” change in the automobile industry, and

also undergo operating margin expansion from selling newer, higher value-added products. Because

of these factors, there has been very strong momentum for Denso’s shares, so current share prices are

above Morningstar’s fair valued estimate at the moment.

Sector challenges & disruptions faced:

• Vehicle production has been limited by ongoing chip capacity shortage, which has exacerbated

already lower inventory levels (reduces availability to consumers, unfortunately coming at a point

when demand is recovering).

• OEMs have re-allocated limited chip supply towards higher margin products, which has helped to

partially offset margin contraction due to higher material costs.

• Chip shortage in 2Q hardest hit – Texas winter storms shut down three chip fabs, Renesas shut down

a Japanese plant due to a fire while Taiwan’s semiconductor production was affected by drought.

Overall Japan was least impacted, while U.S. and China were harder hit than Europe.

• Chip shortage will persist into 2022, problem should modestly abate in coming quarters.

• Watching margin pressures from higher raw material costs and increasing launch of new battery

electric vehicle (BEV) models by traditional OEMs.

• Medium term outlook/Opportunities – OEM margins may temporarily expand as BEVs are less costly

to manufacture (lower powertrain parts required), but margins will likely return to normalised levels

due to heightened competitive pressures over time.

• Increasing EV focus globally provides both opportunities and challenges across the value chain.

Morningstar has an above-consensus forecast for global EV adoption to reach 30% (vs consensus

expectations of 21%).

EV adoption to drive historic multi-year demand growth

• Currently, EVs are “not yet there” and will need time to bridge the gap with traditional internal

combustion engine (ICE) vehicles in terms of cost and key functions (metrics include: driving range,

charging time, charging infrastructure, mass market appeal).

• Morningstar believes EVs and hybrids could reach two-thirds of new auto sales by 2030, driven by

assumptions of EVs reaching cost and functional parity with ICE vehicles by 2025.

• EVs alone may reach 30% of global annual sales by 2030, from 3% in 2020 (note that Morningstar

forecast is above consensus of 21%), with potential penetration rates as follows: China – 35%, EU – 50%

and the U.S. – 30%.

• Challenges remain for the time being on cost and functional parity (to traditional ICE vehicles), but

this gap should be increasingly closed from 2025. Pricing of EVs (entry level sedans and commercial

use vehicles) are currently more expensive than ICE, although luxury sedan EVs are cheaper already.


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• Current EVs range has a wide dispersion of around 100-400 mile range in the market, (median

estimated range of ~250-mile) but this is improving. Morningstar believes the majority of EVs may offer

at least a 300-mile range by 2025.

• Charging duration gap should narrow, driven by continued improvement in batteries and higher

voltage chargers.

• Charging infrastructure – Regions are taking a different approach to building charging infrastructure,

however major countries such as China, the E.U. and the U.S. should see a continuous growth in

infrastructure to support greater EV growth and be able to add sufficient infrastructure to support

greater EV growth by 2030E.

• Non-autos EVs – adoption should also increase in time for motorcycles, city buses and commercial

delivery vehicles, supported by lower cost and improving functions.

Exhibit 5: EV supply chain - opportunities

Source: Morningstar (as of June 2021)


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Exhibit 6: Global EV and hybrid number of vehicles sold in millions (left) and % of sales (right): 2016-2030E

Exhibit 7: EV Charge Times


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Responses to key questions raised from the webinar

• Why is Morningstar’s overall EV growth forecasts more bullish than street, but is below consensus on

its Tesla fair value? Please share your thought process behind this.

When assessing Tesla’s volume assumptions, Morningstar believes they should grow 10x over the next

decade from 500k last year to over 5mn units by 2030 but we just think that the global EV market will

grow even faster than the company. What that could result in is Tesla could lose market share over

time, with increased competition in the Chinese market will lead to it not doing as well as consensus

currently expects, which leads us to below consensus. For fair values around $700 or $570, we see the

primary difference as due to difference in volume growth assumptions.

• We see every region taking a different approach to building charging infrastructure. Can you

comment how you see developments on issues such as charging infrastructure evolving in different

geographies. And other than the technical functional parity aspects, can you elaborate on the policy

backdrop/ incentives that need to be increased before EVs will see faster mass adoption?

The U.S. has taken a state-by-state approach, where some states, such as California and New York,

are funding the buildout of charging stations by allowing utilities to build them, or providing public

grants for private companies to build and operate them. However, not every state is doing this, so

there are currently disparities among states, which is why we see the lack of charging infrastructure

currently holding back EV adoption in the U.S. There are major companies, such as Tesla, Electrify

America (unrated), ChargePoint (unrated) etc. who are building chargers across highways.

Additionally, President Biden and the Senate recently agreed to an infrastructure bill that would fund

the buildout of 500,000 EV chargers along highways. This should help the U.S. build enough chargers

to support its fleet.

Europe has taken a more unified approach, providing grants to fund charging stations. Additionally,

countries such as Germany and France included the requirement for gas stations to build EV chargers

as a condition to receive COVID stimulus funds. The EU has also awarded additional grants to build

EV chargers as a part of general COVID stimulus. This should result in Europe having a sufficient

charging network to support its fleet.

Japan’s utilities have been building charging infrastructure mostly in cities. So far, the government has

done little to support building EV chargers. As a result, the number of chargers is somewhat lacking.

This has led to greater hybrid adoption and lower EV sales in Japan as consumers cite lack of charging

infrastructure as a hesitation to buying an EV.

China has taken the approach of having government entities, such as the state-owned utility State

Grid, build charging points every 50km along highways. The central government has also encouraged

local governments to build charging infrastructure throughout cities as a way to alleviate consumer

anxieties of finding chargers. As a result, China has built the largest charging infrastructure in the world,

which is sufficient to support its fleet.

As far as what governments can do to accelerate EV adoption, Morningstar thinks the buildout of

high-powered chargers as the best long-term driver of higher EV adoption. Until EVs reach cost

parity for entry level sedans, government subsidies can help drive higher consumer adoption, but

building chargers will go a long way to alleviate road trip anxiety and ease consumers fears of

buying an EV.

• Which companies are the leaders in the autonomous vehicle (AV) space?

In the medium- to long-term, automakers may benefit from autonomous vehicles as they have laid

the foundations for autonomous ride hailing services or ‘Mobility as a Service’ (MaaS). BMW, Daimler,

the Renault-Nissan-Mitsubishi alliance, Stellantis (unrated), and Volkswagen have all set up entities


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that address the MaaS market. Each company has talked about Level 4 technology for fleets being

available from about the mid-2020’s onward. This may begin to translate into consumer available L4

products later in the decade.

Morningstar forecasts truly autonomous driving (AD) L5 vehicles coming to market in 2030 but, again,

as with L4, automakers will probably start with MaaS fleets first and make the technology available to

consumers later. Volkswagen already tried to launch an L3 Audi A8 in 2018 but could not activate

the technology in markets outside of Germany due to the lack of road laws governing autonomous

driving. Besides Volkswagen, BMW and Daimler are considered as leaders in adopting advance

driver assistance systems (L1-L2+, ADAS-Advanced driver-assistance systems and AD (L3-L5)

technologies. In the near-term (today through 2025), suppliers will benefit the most from L5 precursor

technologies for L1-L2+ ADAS and L3 AD systems. Morningstar forecasts a 20% annualized growth rate

in the total addressable market for suppliers’ ADAS/AD technologies from 2015 to 2040.

In terms of total revenue from ADAS/AD technologies, Continental currently leads the suppliers, with

Aptiv and Magna (in descending order of total revenue). Even so, in terms of materiality, Veoneer

(unrated) is the nearest pure play for investors that want exposure to the ADAS/AD theme, followed

by Aptiv, Continental (proforma for the Vitesco spinoff), and Magna (in descending order).

• Do you think we could one day see Tesla making software for other automakers, who may evolve to

focus more on the physical manufacturing aspects of the process? Can Tesla become the largest

battery supplier to other auto makers, and what do you think of its partnership with Panasonic?

We consider Tesla to be a market leader in AVs, but they are by no means the only one. Tesla’s AV

continues to improve, but we would classify it as Level 3 at best.

Tesla’s software works using its camera-only system. As a result, it would likely not work for other

automakers who use LIDAR and radar in addition to cameras for their AV systems. As such, we do not

envision Tesla selling their AV software to any other automakers unless the automaker goes the

camera-only route with their hardware. Should this occur, then it would be possible, but our forecast

does not assume this happens. As far as batteries, we think Tesla will continue to source them from

Panasonic (6752 JP) and LG Chem (051910 KS). In order for Tesla to meet its stated growth plans, the

company will likely need to keep its own batteries for use in EVs and energy storage systems and

would likely not have any remaining to sell to other automakers.

• Which are the main companies the large auto makers are buying semi chips from (e.g. NVDA, TSMC,

INTEL, AMD)? How much has semi chip prices for the auto players risen generally this year?

This question is better directed to the technology sector analysts. On the auto side, we have not heard

any of our OEMs complain about rising chip prices, they have only mentioned rising steel and how

cost mitigation efforts can take time to implement.

• With the race towards electrification and more stringent emission standards, can you talk about the

general trends you are seeing in terms of auto makers’ margin and capex plans?

On Tesla, as a pure-play EV producer, their plan has not changed due to regulations. They will

continue building gigafactories around the world to increase battery and vehicle manufacturing

capacity. In our view, Tesla’s drive to reduce vehicle manufacturing complexity and to reduce the

cost of its battery cells, combined with the company’s move to sell add-ons, such as AV software and

insurance, will drive gross margins higher over time.

We think that, as a percentage of revenue, most of the spending for electrification is already at peak

or behind the automakers as heavy launch schedules for BEVs are now taking place. They will

continue to spend on the technology but begin to pull back on spending for ICE vehicles as OEMs


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consolidate into fewer ICE powertrain families and generate revenue from BEVs as additional BEV

models (on already launched platforms) will be introduced.

There has been a ton of BEV spending announcements this year as well as BEV mix targets given. It

shows how much more the industry is focused on this, even the Japanese auto makers who long have

said they prefer hydrogen. We think it also shows how Tesla has disrupted and moved the global auto

industry forward.

We are beginning to see some automakers increase their mid-term margin assumptions like Stellantis

(unrated) announcing last week it expects a ‘sustainable double-digit operating margin’ to emerge

by 2026 and Volkswagen this week announcing a slight increase in its 2025 group EBIT margin

objective to 8%-9% from 7%-8%. BMW and Daimler target 8%-10% margins long term. Mass-market

automakers may enjoy a temporary period of higher margin once BEV production reaches critical

volume because of less complicated manufacturing on dramatically fewer powertrain parts.

However, the global automotive industry is highly competitive, and we surmise that long-term vehicle

margins for the sector will be commensurate with historical levels as excess profits are competed

away, which we have baked into our valuation models normalized sustainable midcycle assumptions.

So, for undervalued stocks like BMW and Volkswagen, the market appears to have discounted

valuation below our forecast margin levels for these companies.

For US autos, the main margin and capex change we would point at beyond the aggregate

spending is GM in late 2018 saying they can eliminate $1.5 billion in capex by stopping some ICE

programs and Ford in May saying they can do 8% total company EBIT margin in 2023. We have not

had firms reset the bar higher in terms of margin though GM has hinted at it when asked. VW just did

reset its margin goal higher this week. Long term there’s potential for higher margins but the transition

to a fully BEV automaker will probably go on into the 2030s if not even 2040s, so that potential could

take too long to be realized for a 2021 investor to buy the stocks solely for that reason.

• Can you share your observations on SPACs’ impact on the auto industry?

In general, we view SPACs as a riskier way to invest in growing EV adoption. This is because these

companies are generally earlier in their life cycle. Many are not profitable and many are not yet even

generating any revenue and still in the development stage to bring a product to market. As a result,

there are high company specific risks that can overshadow EV adoption trends. For example, if a

company needs to raise more capital, it would likely have to issue new shares and dilute existing

shareholders. If it is unable to repay debt, it may have to declare bankruptcy, both of which would

hurt shareholders regardless of what happens with EV adoption.

• What are some of the relevant ESG considerations to keep in mind, can you share some examples of

how you integrate ESG issues when thinking about the fundamental cashflows and financial forecasts

of the sector?

One of the biggest ESG considerations Morningstar keeps in mind for Tesla is the risk for product recalls.

This is similar to all automakers as a large-enough recall exercise could result in a large cost to fix the

issue, settle lawsuits, and potentially damage brand reputation. At this point, Morningstar does not

directly have such a scenario embedded in its Tesla forecasts.

ESG risks are included, in most cases, within the auto stocks’ uncertainty ratings. Besides product

carbon emissions, product governance is also another potential ESG risk, but many companies have

already reserved for this contingency as its part of every-day business in the auto sector. Local

governments recall vehicles for safety and other defect reasons on a regular basis and, in some cases,

even though vehicles were in compliance at the time they were produced, local authorities still

require recalls. This industry dynamic is well contemplated ahead time by automakers but

occasionally, they can be taken by surprise, such was the case in all the recalls because of the

defective Takata (unrated) airbags that effected many OEMs.


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Consequently, Morningstar has not materially changed most of auto companies’ cash flow or cost of

capital assumptions due to ESG risks although research reports include ESG risk analysis text on how

the firm has incorporated ESG in our models if additional details are needed. To illustrate, as

Volkswagen has one of the highest product carbon risk of the companies under coverage, this has a

direct impact on Morningstar’s EUR 343 fair value estimate which includes EUR 10 billion in additional

legal fees and potential fines as a direct cash reduction from Morningstar’s DCF model’s enterprise

value. With respect to cost of capital, Volkswagen still maintains very high cash levels and liquidity so

it is not anticipated that additional adverse implications to the company’s ability to access capital

markets. Even with this ESG risk incorporated in the fair value estimate, the stock is still 4-star rated/Buy

rated.

Environmental issues are one of the key focus areas going forward as auto firms are investing heavily

for BEVs and in some cases hydrogen because they see the market heading that way and they see

the potential for regulators such as California and the EU likely banning ICE sometime in the next

decade. The good news is that OEMs are not fighting the transition because they see a path to

profitability with BEVs. This is unlike the case a few years ago, which helped Tesla grow unconstrained

by formidable competition. One key focus now is on battery costs and firms now see that coming

below $100/kWh for cell or total pack costs this decade. Ford for example is seeing below $80/kWh

for the pack before 2030. Forecasts on EV spending is expressed through capex projections. At this

point Morningstar’s WACC and moat ratings remain intact given the companies are investing today

for the future, and while regulatory risk is present, the companies are already taking actions to

mitigate this risk.

Key stock updates

• BMW/Bayerische Motoren Werke (Buy, fair value EUR131) - Near term concerns over transient higher

spending levels and lower margin from EVs. Company is ramping up its BEV strategy, aiming for 50%

average annual growth rate in BEV unit sales from 2020-2025 (i.e. 2mn BEVs target by end 2025). By

2030, BEVs targeted to make up half of BMW’s global sales volume and BEVs to be available to 100%

of all its market segments.

• Borgwarner (Buy, fair value USD73) – Auto supplier stock with technologies to enable vehicle makers

meet required clean air targets. Recent acquisition of Delphi Technologies in October 2020 has

strengthened its electrified powertrain offering. Growth ahead should come from higher penetration

in ICE vehicles, as well as those with electrified powertrains.

• Continental AG (Buy, fair value EUR175) – Global auto supplier and tiremaker (top five customers:

Daimler, Volkswagen, Ford, Stellantis, Renault/Nissan/Mitsubishi alliance). Leader in active safety

technology, benefits from ADAS/AD and BEV growth. Spinning off powertrain group Vitesco in

September 2021.

• General Motors (Hold, fair value USD62) – Share price has rallied close to 40% year to date, adding on

to further gains since we featured this as one of our preferred picks ahead of the U.S. election last

year. We have taken profit on the name in our focus list this year due to limited upside to fair value.

Prefer to add new positions on pullback, given medium term outlook remains constructive. GM is

investing $35bn in BEV and AVs over 2020-2025 and plans to launch 30 BEVs through 2025 (two thirds

will be available in North America). Targeting to sell “zero” emission vehicles globally by 2035.

Turnaround story is still underway following significant cost cuts ($11bn as of end 2020), adding more

scale from new platforms and GM Financial on path (annual dividends of at least $1.5bn in a few

years, vs $375mn in 2018). Beneficiary of cheap gas prices, as majority of its U.S. volume comes from

light truck models and GM is a leader in the full size SUV segment with estimated segmental market

share of about 57%. Company is at a lucrative part of its product cycle now, with new models in

pickups, SUVs and Cadillacs.


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• Ford Motor (Hold, fair value USD17) – Laggard US recovery idea. Moving to unlock more scale,

improving its platform, marketing, product development and bloated warranty costs. Aiming for 40%

global all electric volume by 2030 (vs 3% last year). New CEO Jim Farley should be a positive catalyst

for the company, overhang has been improving with European, Russian and South American re-

structuring work. Investing in EVs and AVs, major product revamp done in 2019-2020 focused on light

trucks (its strength). Capex expected to total $29bn from 2019-2022e.

• Tesla Inc (Hold, fair value USD550) - Largest EV producer globally, also provides exposure to solar

generation and energy storage batteries. Tesla should see its mass market base expand in tandem

with EV adoption rates. Morningstar estimates total deliveries could grow to more than 5mn by 2030

(vs ~500k in 2020). Company plans to produce its own batteries and lower its manufacturing costs,

which should support margins.

• Volkswagen AG (Buy, fair value EUR343) – One of the traditional auto maker leaders in BEV model

introductions (By 2030, company targets 50% BEV share of group annual sales volume, or about 5mn

units). ESG concerns are admittedly higher for this name – but incorporated in Morningstar’s fair value

of EUR343 (haircut taken to enterprise value). Little difference between two listings except for voting

rights and EUR0.06 preference in EPS and DPS per year for the preferred shares (VOW3). Investors

should note that ordinary shares (VOW) is less liquid – this is because of the limited free float (large

stakes by Porsche 31%, Qatar 15% and Lower Saxony 12%).

• Denso (Hold, fair value JPY6800) has been consistently showing signs of improvement over the past

year, in terms of adapting to the CASE trend (especially electrification) and improving operations. The

company’s electrification systems business already has higher operating margins than companywide

level, and their advanced driver assistance systems (ADAS) business also turned to profitability ahead

of schedule. Also, a key component of Toyota’s latest fuel cell vehicle (FCV) model, “Mirai”, includes

Denso’s power control unit, which deal with the control of power generation/motors in various EVs

(FCV, battery, hybrid, etc.). Considering their product development and track record with new CASE

technologies, it is likely that Denso will be able to adapt to the “once in a century” change in the

automobile industry, and also undergo operating margin expansion from selling newer, higher value-

added products. Because of these factors, there has been very strong momentum for Denso’s shares.

ESG considerations - Increasing focus on EVs to tackle a rising emissions footprint driven by rising vehicle demand.

Automobile manufacturers constituents in the MSCI ACWI Index as of May 2021 accounted for ~13% of total

global carbon dioxide emissions (or nearly 4.7 gtCO2e). Out of this, an estimated ~80% were from vehicle

tailpipe emissions, which provides the backdrop for increasing pressure to decarbonise the automobile

manufacturing industry and focus on low emission vehicles such as electric vehicles.

It should be noted that it is not factually correct to think of EVs as completely emission free, given the batteries

used to power the vehicles are charted via national electricity grids, which is dependent on different

countries’ energy source mix (renewables/coal etc) and hence may not be emission free. The mix of energy

sources will ultimately influence an automobile maker’s S3C11 emissions even assuming a full EV transition in

its product offering. Hence, a comprehensive approach globally towards decarbonising electricity grids is

also key in the path towards net zero.

Out of the industry’s total greenhouse gas emissions (estimates broken down by Scope category, automobile

makers constituents of the MSCI ACWI index as of May 2021), it is estimated the majority (~77.6%) of the

industry’s emissions are in Scope 3 Category 11.


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The Greenhouse gas protocol categorises tailpipe emissions under Scope 3 Category 11 (S3C11), which

represents the industry’s largest challenge ahead in the pathway towards decarbonisation. Current

challenges include a scarcity of company disclosures and variation in assumptions used by auto companies

in their calculation methodologies. Only half of the 38 auto manufacturers reported their Scope 3 emissions

in 2019. Out of the half that reported, on average the majority of total emissions (~95%) were generated in

the use-phase of vehicles. By vehicle segments, Scope 3 Cat.11 emissions were broken down as follows:

truck/bus 43%, passenger vehicles 55% and motorcycles 2%.

Company specific ESG-related observations shared by Morningstar’s DM auto analysts:

• Meaningful progress has been seen in terms of corporates’ environmental awareness, evident

through the acceleration of BEV spending and volume targets across the industry.

• Most OEMS have exposure to carbon emission concerns, which regulators have become more

attentive to after the Volkswagen diesel scandal.

• Increasing BEV launches by traditional OEMs however should help the sector avoid fines for non-

compliance with stricter clean air regulations.

• ESG concerns are generally incorporated in Morningstar’s uncertainty ratings. Analysts also perform a

scorecard on their respective companies under coverage based on their understanding and

knowledge of the firm to identify and incorporate ESG risks. They then assess the probability impact of

those risks and if severe enough, this is incorporated into cash flows and the moat rating.

• Observations: Japanese auto makers are perceived to be tougher to exercise changes from the

outside. Ford family also has a high 40% voting control through their super voting shares.

• Denso is managing ESG risks well on the “environment” side, and has been included in reputable ESG

indexes like FTSE4Good and MSCI Japan ESG Leaders. They are laying out a green strategy with clear

goals like initially achieving carbon neutrality for electricity, using credits for gas, by 2025, and then

full carbon neutrality by 2035. The Japanese government is aiming to reduce CO2 emissions by

eliminating pure gasoline-powered vehicles by 2035, and Denso is adapting by developing

environmentally friendly technologies. They are already making clear progress on this end and have

been able to build a track record of supplying electrification technologies to Toyota and other major

OEMs like Ford and Honda.


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MSCI World Autos index has outperformed World equities year-to-date returns, easy gains made. Prefer a more selective stance.

Exhibit 10: Historical returns (past 1 year, normalized) – MSCI World Autos & Components (red) vs

World Equities index (black line)

Source: Bloomberg, Internal estimates

Exhibit 11: Valuations - MSCI World Automobiles Index vs World equities index

Source: Bloomberg


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DM Auto Sector – Valuations

Sources: Bloomberg, Internal estimates

2021E 2022E 2021E 2022E 2021E 2022E 2021E 2022E

US/Europe/Japan: Auto & components

MSCI WORLD AUTO COMP INX (MXWO0AC) 14.9 12.7 1.7 1.5 1.7 2.0 10.8 11.6

MSCI WORLD/CONS DIS (MXWO0CD) 26.9 21.6 4.4 4.0 1.1 1.2 14.0 12.3

MSCI WORLD (MXWO) 20.4 18.6 3.0 0.0 1.8 1.9 12.6 14.7

GENERAL MOTORS CO (GM US) 8.3 7.9 1.5 1.2 0.5 1.9 19.7 17.2

FORD MOTOR CO (F US) 10.9 7.4 1.6 1.5 0.5 1.8 12.0 17.1

TESLA INC (TSLA US) 147.1 101.4 23.8 19.1 0.0 0.0 15.3 17.7

FERRARI NV (RACE US) 41.4 37.8 14.1 12.1 0.7 0.9 37.8 34.1

HARLEY-DAVIDSON INC (HOG US) 12.7 11.9 3.1 2.6 1.1 1.8 25.7 19.5

ADIENT PLC (ADNT US) 10.7 7.2 1.9 1.4 0.0 0.3 19.1 25.3

MAGNA INTERNATIONAL INC (MGA US) 11.2 9.1 2.0 1.8 2.0 2.1 19.0 20.8

BORGWARNER INC (BWA US) 11.2 9.2 1.6 1.4 1.5 1.5 12.9 15.3

LEAR CORP (LEA US) 11.9 8.7 2.0 1.9 0.6 1.1 17.1 20.7

GENTEX CORP (GNTX US) 15.9 13.6 3.4 2.9 1.5 1.6 24.2 26.2

APTIV PLC (APTV US) 39.9 28.9 4.8 4.3 0.1 0.3 12.8 15.8

AUTOLIV INC (ALV US) 13.6 10.6 2.7 2.3 2.2 2.8 22.0 23.4

STELLANTIS NV (STLA US) 6.2 5.3 1.1 0.9 5.8 4.9 16.7 16.7

MSCI US AUTO & COMPONENT (MXUS0AC) 33.8 26.7 5.4 4.7 0.2 0.4 14.5 17.1

MSCI USA/CONS DIS (MXUS0CD) 35.3 27.3 10.9 9.0 0.6 0.7 29.5 16.2

DAIMLER AG-REGISTERED SHARES (DAI GR) 6.5 6.4 1.1 1.0 5.1 5.8 17.4 15.6

VOLKSWAGEN AG (VOW GR) 10.0 8.8 1.1 1.0 2.6 3.0 10.8 11.6

VOLKSWAGEN AG-PREF (VOW3 GY) 7.5 6.6 0.8 0.7 3.2 4.0 10.8 11.6

BAYERISCHE MOTOREN WERKE AG (BMW GR) 6.9 6.7 0.8 0.8 4.2 4.5 12.4 11.4

RENAULT SA (RNO FP) 15.1 4.9 0.3 0.3 0.1 2.2 2.0 6.3

CONTINENTAL AG (CON GY) 15.5 10.1 1.7 1.5 2.2 3.0 11.1 15.0

FAURECIA (EO FP) 10.0 6.7 1.4 1.2 2.9 4.0 15.1 20.1

MSCI EUR/AUTO & COMP (MXEU0AC) 8.3 7.3 1.1 1.0 3.6 4.1 13.9 13.3

MSCI EUR/CONS DIS (MXEU0CD) 19.6 16.3 2.5 2.3 1.9 2.3 13.9 14.7

TOYOTA MOTOR CORP (7203 JP) 10.3 9.5 1.1 1.0 2.9 3.2 11.1 11.2

DENSO CORP (6902 JP) 15.5 13.0 1.3 1.2 2.1 2.3 8.8 9.9

HONDA MOTOR CO LTD (7267 JP) 8.9 7.7 0.6 0.6 3.4 4.0 7.1 7.7

MSCI Japan/Auto & Compnt (MXJP0AC) 11.0 9.8 1.0 0.9 2.7 3.1 9.0 9.6

MSCI JAPAN/CONS DIS (MXJP0CD) 14.8 12.9 1.3 1.3 1.9 2.2 9.0 9.7

Price/Earnings Price/Book Dividend Yield (%) ROE (%)

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Developed Markets Autos Race towards electrification

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