The Morningstar capital allocation rating evaluates company management’s impacts on shareholder value. “If a company invests well, that's obviously going to be important to their earnings growth, and that's going to reflect in the total shareholder return over time,” says Mathew Hodge, Director of Equity Research at Morningstar.
Hodge says the metric is particularly important in assessing a growth business, say transformational technology or biotech, whether the capital investment is allocated to the meaningful growth franchise. “We really care about, are they investing in the right things, like is the strategy right? Are they doing so at the right price? And is management able to execute?” he adds. The same logic can be applied to the EV industry, whether a company’s strategy is positioned for the growth of tomorrow.
Phelix Lee, an equity analyst at Morningstar Asia, says outstanding capital allocation decisions come even more important in the fast-changing electric vehicle (EV) – or more broadly new energy vehicles industry. “ If a company’s management turns out to be good stewards of money, the future value of holding this stock would increase. Currently, there is no true leadership for every corner in the EV industry. The opportunity to see an upside is thus amplified in a fragmented sector like EVs.”
What Are ‘Good Stewards’?
Lee, whose research coverage includes semiconductors and electronics, identifies two stocks that worth keeping an eye on, especially in the long-term. They are: Shenzhen Inovance Technology (300124) and Delta Electronics (2308). Inovance has more exposure in Chinese EV makers still attempting to turn a profit, while Delta has more exposure in conventional Western automakers that are transitioning to EVs.
Inovance, currently bearing an exemplary capital allocation rating, operates with a robust management team. “Clear guidance, consistent and transparent business strategies and strong execution of those plans are what we have so far found in Innovance and we have the conviction that they will continue to do so. It is reflected in the sustainable growth of 20-30% in each of the past 10 years, always in line with the management guidance.”
Delta, on the other hand, started in the 1970s making laptop chargers but has expanded the product lines to manufacture a variety of electronic components. The EV segment is one of them and the segment currently represents roughly 5% of its topline exposure.
By the same token, Lee says the product development process is steered by strong execution, which in turn leads to high levels of Delta’s product quality. The consistency in business directions and execution also leads to an 8-10% annual revenue growth. Also, with a sound balance sheet, Delta even runs a relatively low gearing, which would shield the company’s capital need from downcycles, and safeguard shareholder value from deteriorating. As of this writing, Delta’s capital allocation is rated standard as we are unable to verify whether Delta’s management or other entities ultimately control the two largest shareholding companies. Lee added that the fact does not seem to affect investor confidence.
Expensive, Worth Watching
By Morningstar’s fair value estimate, the two names are currently priced with a 30% premium over their respective fair values. This is because of heightened global competition rushing in to form the technical barrier in EV design and production. Like any players in the new electric car making field, Inovance and Delta are to deepen their foothold in the value chain. Moreover, the risk remains until a clearer industry position is sorted, they are both overvalued as an increasingly crowded electric vehicle component market may force Inovance and other component makers into a price war.
The continued entry of new players in the electric vehicle component space isn’t surprising, says Lee. It is sensible for companies that own at least one cutting-edge technology to secure a place in the ‘next big thing’, though the EV value chain is not necessarily very lucrative at the moment. For example, Taiwan’s Delta makes around 5% of revenue from the EV business and the management expects the segment to break even in one to two years.
Also, the R&D in many critical parts, such as energy storage and recharge, is still underway, making the entire space quite uncertain for now. Many treat Tesla as the pioneer but even for it, forming a wide technical leadership is not yet there due to immense uncertainty in the fast-evolving market environment.
Apart from Tesla (TSLA), which has already put four car models on sale, a slew of EV start-ups is prepping to take the slice of the pie. Pure-play companies such as Lucid and China’s NIO (NIO) and Xpeng (XPEV) are in different stages of rolling out their own EVs. Though, the competition that faces EV makers comes with different forms as legacy automakers like General Motors (GM) also readied to electrify their cars. Outsiders like smartphone makers are also actively marching to electric vehicles. Last month, LG-Magna was said to soon close a deal with Apple (AAPL) in making the EV models--a prototype of which will be teased sometime in early 2024, in addition to smartphone peers Xiaomi (1810) and Oppo.
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