California's All-In On EVs: Buy Edison, Not Tesla

This week, the California Air Resources Board voted to ban sales of gasoline-powered vehicles by 2035. The new rules also target minimum electric vehicle market share of 35 percent by 2026 and 68 percent by 2030. And the 17 states that have tied their emissions standards to the Golden State’s will likely follow suit.

California’s “stick” to promote EVs follows the massive “carrot” of the Inflation Reduction Act (IRA), which includes unprecedented tax credits for purchasing new ($7,500) and used ($4,000) electric cars. There are also substantial incentives for US-based manufacturing of EVs as well as batteries, which could ultimately alleviate supply chain issues.

Count me a skeptic of any stock trading at more than 100 times trailing 12 months earnings—the case for some time with Tesla

. And in fact, that stock’s high valuation is arguably the biggest factor behind its sharp underperformance this year.

But any company able to raise prices in 2022 without taking a major hit to volumes is impressive. And Tesla didn’t just increase Q2 revenue by 43.6 percent. It held margins for automotive sales roughly flat as well, at 72.1 percent of revenue versus 71.6 percent a year ago. That pushed gross profit up 46.8 percent and raised income from operations by 87.8 percent.

Tesla’s solar power generation and energy storage business still looks like a loss leader. And the company is not wholly immune to inflation pressures, as operating expenses increased by 12.6 percent from the year ago quarter. But these results are the closest yet to demonstrating a sustainable business model. And that’s the most promising sign to date this company won’t have to rely indefinitely on the formidable capital-raising skills of its iconic CEO Elon Musk, who’s by far the largest shareholder at 14.84 percent.


Tesla’s results are also a contrast to General Motors’ (GM) paltry Q2 revenue gain of 4.7 percent, accompanied by 7.5 percent higher overall expenses. That testifies to Mr. Musk’s success carving out a high-end market for EVs by making them “cool.”

So far, rivals have utterly failed to dislodge Tesla as market leader. Nonetheless, I’m still treating shares with extreme caution. I’m giving an even wider berth to the company’s EV rivals. And I’m flat out avoiding the plethora of ETFs hyped as a “safe” way to bet on EVs—but are mostly loaded up on earnings-less stocks.

For one thing, only EVs with sufficient US manufacturing content will be eligible for the IRA tax credits. That means any chance of meaningful sales expansion will likely require substantial reshoring of everything from assembly to battery manufacture.

Second, the IRA requires needed commodities be sourced from countries with which the US has a free trade agreement. Australia and Canada both have meaningful reserves of key battery metals lithium, nickel and cobalt. But beyond those countries, pickings are slim, with only Chile and Mexico producing meaningful lithium, Morocco cobalt and the US lithium and cobalt.

Securing supplies for the magnitude of EVs needed to meet California’s mandate alone would be challenging enough even in normal times and without these limitations. And US manufacturers will be competing with a European Union cut off by sanctions from Russia, historically its most important supplier of commodities.

The prize of winning a healthy chunk of the US EV market is immense. And no one should underestimate the power of money to drive technology to resolve the industry’s commodity challenges. As for reshoring, Tesla supplier Panasonic Holdings said this week it will build a $4 billion battery plant in Kansas, and more announcements are likely to follow.

But there are still many bridges to cross before the US has real EV manufacturing capability. And in the meantime, supply chain challenges along with commodity and wage inflation will continue to pressure companies’ margins, including Tesla’s. There’s also potential for a substantial drop in sales by early 2023, should Federal Reserve efforts to quash inflation result in recession.

That adds up to rising probability of a further selloff in popular EV stocks, especially from current astronomical multiples to highly uncertain earnings. In contrast, selected operators and developers of EV charging stations and related grid support offer a considerably lower risk proposition.

Simply, electrifying transportation on a mass scale is impossible without a huge investment. And state regulators support the spending, as do tax credits/direct spending under the IRA and the previously passed Infrastructure and Jobs Act.

ChargePoint Holdings (CHPT) currently operates more than half of US charging stations. And management will likely report meaningful revenue growth with Q2 results next week. But the company is also unlikely to show real economies of scale, given margins shrank and losses grew in Q1 even as sales more than doubled.

The shares are still up over 50 percent from their July 2019 IPO. But the roughly -20 percent year-to-date loss and elevated short interest of almost 15 percent of float demonstrates justifiably rising investor skepticism in the business model.

Fortunately, US electric utilities offer a far lower risk alternative for betting on deployment of EV charging stations. California regulators have approved $1.4 billion of rate base spending on such facilities for its three largest utilities, including $800 million for Edison International
(EIX). And that’s in addition to other grid-related spending needed to support the state’s projected demand for EVs.

Edison shares trade at 15 times expected next 12 months earnings, a substantial discount to 21 plus for the S&P Utilities Index. That’s largely because the utility is managing wildfire liability risk as it hardens infrastructure. But if California is to be successful taking EVs from 16 to 100 percent of its new car market in 13 years, this utility is going to have to pump tens of billions of dollars into rate base for needed infrastructure.

This investment will flow directly to earnings growth. And the result is ultra-reliable yearly dividend increases in the mid-to-upper single digit percentage range, even if the US economy hits a major speed bump. To learn more about my preferred strategies going forward, go here.

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