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Consider auto stocks

Green technology automobile component suppliers could benefit from growing demand.

  • By Gordon Scott, Sector Portfolio Manager,
  • Asset Management
  • – 11/12/2013
  • Consumer Discretionary Sector
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During the next decade, the global auto industry will be significantly influenced by higher demand for more fuel-efficient vehicles. Rising consumer demand for vehicles that are more cost-effective, as well as government emissions regulations that are significantly more stringent, is forcing auto manufacturers to adopt new technologies. In most cases, these technology solutions are designed and marketed by a small group of component suppliers that stand to benefit from developing technologies that take advantage of the ongoing trend of decreasing emissions and increasing fuel efficiency per vehicle, thereby increasing their negotiating leverage with large automotive manufacturers.

New rules

In August 2012, the National Highway Traffic Safety Administration announced new fuel economy standards for U.S. light duty vehicles, including passenger cars and light trucks. By the year 2025, average fuel efficiency requirement for light vehicles will rise to 54.5 miles per gallon (mpg), approximately double the prevailing average over the previous 10 years.1 The pace of change in U.S. fuel efficiency standards beginning under the Obama Administration is significant compared with the previous two decades (see the chart, right).

Rising fuel efficiency standards are not unique to the United States; nearly ever major region of the world is putting in place more stringent regulations. According to the International Council of Clean Transportation, by the year 2020 China will approach 50 mpg on average for newly manufactured autos, while the European Union has proposed a target in excess of 60 mpg. Similar emissions standards are rising for light trucks and other commercial vehicles throughout the world (see the chart below).

To meet these requirements, global automobile manufacturers are pursuing a wide range of design changes, along with associated costs and efficiency trade-offs. For example, hybrid and electric vehicle sales are expected to grow approximately 14% per year over the next decade,2 but because of their higher cost to consumers, manufacturers must remain focused on improving traditional engine emissions as well. One of the most common solutions involves reducing engine size (e.g., from six cylinders to four) while adding a turbocharger for increased power. Advanced diesel technologies are also emerging as solutions.

Investment implications

State of the consumer discretionary sector

Companies in this group continue to generate moderate year-over-year earnings growth.
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Automobile component manufacturers with design patents and manufacturing expertise surrounding innovative emissions technologies are particularly well positioned to benefit from growing demand. In many cases, turbochargers, as well as lightweight components, electrical architecture, and other solutions are designed and controlled by a relatively small number of companies. Global scale requirements and tight manufacturing tolerances have proved to be barriers to entry. As the demand for these technologies increases, their volume growth and negotiating leverage with global vehicle manufacturers is likely to grow.

As these auto component suppliers benefit from a long-term pickup in the demand for their products, their stocks could experience a period of outperformance relative to broader U.S. equity market indices.

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1. Source: National Highway Traffic Safety Administration, “Obama Administration Finalizes Historic 54.5 mpg Fuel Efficiency Standards,” http://www.nhtsa.gov/About NHTSA/Press Releases/2012/Obama Administration Finalizes Historic 54.5 mpg Fuel Efficiency Standards
2. Source: Copyright, 2013 IHS Automotive.
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