Not So Fast
The internal combustion engine is dead. Long live the ICE!
Here's one theory of the future of the internal combustion engine: its already dead. The electric future is here.
In my neighborhood in Pasadena every other car seems to be a Tesla. EVs are eating ICE for lunch or using it smoothies or some other cheap pun. 55% more drivers chose to purchase an EV in 2022 than in 2021. But carmakers overall sold 8% fewer vehicles last year than in 2021.
Certainly, the stock market buys into this theory. Just look at the value of Tesla ($771 B) vs the next eight automakers combined ($764 B).
That theory makes good headlines. The death of the ICE is bad news for old fashioned 20th century car companies and bad new sells. Lots of people like EVs and want that side to win. Heck, I want EVs to win too! Heck, even car companies want EVs to win so they can capture some of that Tesla magic.
Here's another theory of the future of the internal combustion engine: its death is little overcooked.
85% of drivers in 2022 still chose to purchase an ICE or hybrid car to get around. In the US, just one percent of registered vehicles are electric. Hybrids are a faster growing choice for new car buyers than EVs.
EVs are the future, but that future is still a long way off.
Back from the dead
For the time being, the traditional car business still exists. Garrett Motion supplies this reality. It makes turbochargers that go into cars and trucks and industrial vehicles to make them more powerful and more efficient. Their gear goes into Charles LeClerc's F1 car. It goes into CAT dump trucks working lithium mines to supply EV batteries. It goes in my hybrid. Garrett's products fit into ICE and hybrid motors. They don't go into Teslas.
That's strike one for investor attention. Without that Tesla magic, investors find it hard to pay attention to anything car related.
Back in September 2020, Garrett management looked around from whatever makeshift WFH setup they could string together, saw their plant in Wuhan mothballed without a clear timeline to return to action, saw wild uncertainty in the broader supply chain for cars, looked at their looming environmental obligations stuffed down their corporate throat in a move that would make Machiavelli proud and declared bankruptcy.
On that last bleak piece of the puzzle: Honeywell spun off Garrett into a separate company in 2018. Honeywell also dubiously stuck it with some environmental liabilities related to another unit that made brakes. Garrett struggled under this burden then collapsed when COVID hit.
Bankruptcy cleared Garrett of its non-related environmental liabilities, reset its other burdens and sent it on a speedy onramp back to profitability. The cost, though, was a complicated and fractured capital structure that made it tough to understand.
The stink of insolvency and a capital structure only a lawyer could love? Strike two for investors.
Garrett spend the next two years spending what cash it made to clean this up. It finished the task earlier this year and is now as vanilla a corporation as they come.
Ok, so the corporate stuff is behind it, does Garrett have anything going for it on the business-side?
Once car companies say "we're making a hybrid" and choose a turbo supplier, those deals have a long runway that — so long as they're not disrupted by a global pandemic — ends up being a steady source of cash. "Car makers" act more like conductors of a sprawling orchestra of suppliers. They put all the pieces — including turbo parts — in place years in advance.
Garrett already has contracts for 80% of its 2026 revenue, 3 years ahead of time. It knows, roughly, the profit it will make on these contracts.
The other part of Garrett's business, commercial vehicles — giant mining dump trucks, highway hauling, and others — have an even longer journey to the electric future. Garrett sells 30% of its gear into the commercial vehicle market. There's also a lively aftermarket in this space. These trucks might run for 30 years or more. Parts wear out. It’s more efficient to replace them than to buy a whole new truck.
So, with a book of business mostly under contract for years, plenty of structural foundations for future demand, a squeaky-clean balance sheet, frothy cash generation, the market must love Garrett, right? …right!?
Well, the market doesn't expect much from Garrett. Its low share price means the market sees a good chance the company blinks out of existence in a few years or at least struggles to make a much profit on its efforts. EV's PR juggernaut has smothered enthusiasm for anything ICE-related. The market’s expectations reflect this vibe.
EV’s may be the future. But, where misplaced investor vibes split from a solid underlying market with a long tail, investment opportunities tend to crop up. Garrett continues to mint cash, return it to shareholders and get its future business under contract for years to come. It’s assembling all the parts for turbo-charged returns.
Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.