Investors may be overlooking near-term risks in the electric vehicle revolution due to their eagerness to back the energy transition megatrend. 
The unassailable success of electric carmaker Tesla in 2020, epitomised by its 700 per cent share price rise last year, may have sparked overexuberance among investors about the broader market.
Strong share price recoveries from coronavirus pandemic lows in stocks such as Volkswagen, Daimler, and Stellantis (Fiat Chrysler/Peugeot) suggest investors are confident that legacy carmakers can deliver on their lofty electric ambitions.
But Volkswagen’s recent fine of more than €100m after narrowly failing to hit EU emission targets is one of several factors that should encourage investors to act more cautiously.
Blind faith in the ability of larger carmakers to emulate, or even exceed, the success of Elon Musk’s younger, more agile, firm could prove riskier than it initially seems.
Carmakers are trying to mitigate the risk for investors by funding their plans through green bonds, with Volvo, Volkswagen and Daimler all issuing such debt in September last year.
Clean transportation bonds represented 24 per cent of overall green bond issuance in 2020, up 20 per cent on the prior year, according to the Climate Bond Initiative. This figure could rise given that Volvo and Daimler want half their sales to be of electric cars by 2025 and 2030 respectively, while Volkswagen is aiming for 1.5 million electric vehicles by 2025.
Transition risk
Wide-ranging company overhauls can be difficult but the shift from combustion engines to electric is especially challenging and creates three significant and interlinked risks.
Regulation is a major one. Because legislation aimed at combating carbon emissions is the driving force for the ramp-up in electric car production, companies can be punished if they don’t move fast enough.
VW’s abovementioned fine came in spite of it buying carbon credits from several Chinese carmakers, and even though pure electric cars were counted twice in emission target calculations in 2020, a move aimed at helping companies cope with the new EU rules.
The more fines a company receives, the more its reputation among investors could begin to deteriorate, especially if the money used to pay authorities curtails its ability to hit its production targets.
And attached to the regulatory and reputational risks is execution: Can carmakers pivot their engineering expertise comprehensively enough to build the code-driven software that the success of an electric car relies on?
The fact that VW, the world’s largest carmaker, had to launch its ID.3 model after $50bn in research and development costs over five years without all the advertised technological features should make investors pause for thought.
There’s a growing risk that the price investors are paying for auto stocks, in particular, is based too heavily on exorbitant hopes rather than realistic predictions.
Macro concerns
Investors must also consider various factors beyond stock-specific risks though.
While share prices in many transport companies, particularly carmakers, are being supported by the shift to electric, transportation is the only sector whose emissions have risen in the past 30 years.
In 2019, EU transport-related emissions were 29 per cent higher than in 1990, accounting for a quarter of total emissions for the year.
This raises the prospect of more financial penalties being issued by governments if electric vehicle production targets are missed, in turn hitting the profitability of transport-related stocks.
Even if electric car numbers boom though, the infrastructure needed to support electric vehicles could also prove problematic for the transport sector.
Ethical focus
As investors develop more sophisticated criteria for their ‘green’ investments, they may avoid certain transport companies for reasons beyond a firm’s control.
For instance, while China is hailed as a great success in electrifying transport – with 99 per cent of worldwide electric bus production sent to the country in 2019 – nearly two-thirds of the electricity used to fuel its electric vehicles comes from coal, according to the US Energy Information Administration.
Investors might, therefore, decide only to invest in transport companies whose vehicles are predominantly sold in countries with a high proportion of renewable generation in their energy mix.
The UK has made great strides here, with renewable overtaking fossil fuels as the biggest source of electricity for the first time in 2020, generating 42 per cent of power against 41 per cent for fossil fuels.
With the UK’s Ten Point Plan for a Green Industrial Revolution announced last year, combined with continent-wide efforts in Europe via the €700bn Recovery and Resilience Fund (37 per cent of which must be spent on the green transition ), the chances of the necessary ecosystem emerging to support electric vehicle production looks promising at present.
Electric vehicles will inevitably be a major part of our transport future but key questions remain.
When will the number of electric cars outnumber conventional ones? Which companies will be successful? Could investments in supply chain companies be less risky than transport firms? and might investors secure a better risk-reward balance from green bonds, such as those issued by Volvo, than transport-related equities?
Investors need to have answers to these questions – and many more – or else the momentum in transport stocks could start running on fumes.
Liron Mannie & Pietro Sette are research analysts at MainStreet Partners. The views expressed above are their own and should not be taken as investment advice.