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Discovery Investing: Cars

Michael Berry
0 Comments|October 16, 2006

Hybrid vehicles drive investment opportunities



Hybrid vehicles drive investment opportunities

Over the weekend Barron's published an interview with Weeden's venerable energy analyst, Charlie Maxwell. When I was a professor at the University of Virginia I used to reference Barron's frequently - and frequently Charlie Maxwell was quoted.

This past weekend he delivered his opinion on oil prices. He forecast that by 2015 oil will sell for $300 per barrel. He cites four reasons for this price appreciation. Foremost is his view that Hubbert's Peak will "kick in" by 2015. If you have the chance please read the article.

This is evidence from another industry icon that Hubbert's Peak* is real and will eventually result in declining oil production. Discovery Investing in the oilsands has gained in importance, in my view. OPEC meets this week to address the issue of production cuts.

On Monday, the Toronto Star is suggested that Ford Motor Company (NYSE: F), BullBoards) (and its Oakville, Ontario Assembly plant) is at a crossroads in its effort to survive. The company will introduce its new CUV offering called "Edge," today. CUVs (Crossover Utility Vehicles) are next-generation SUVs. The Toronto Star reported that the Edge will carry five people and achieve mileage of 14.08 kilometers to the liter (33.7 mpg) on the highway. The car will sell for $33,000 to $35,500 in Canada and commensurately less in the U.S. Industry observers suggest that the new CUV must be a "home run" in the next twelve months if Ford, the world's third largest automaker, is to survive.

"Richard Cooper, executive director for industry research firm J.D. Power and Associates Canada, said although Ford is restructuring and slashing costs, it needs new products like the Edge to generate large volume sales, otherwise the company's recovery will "be severely inhibited." "There is no doubt the Edge has to be a success for Ford," noted Cooper "But it won't be easy by any means."

This appears to be the state of the U.S. auto industry. It is an industry that waited far too long to innovate. Such are the liabilities of short term thinking. Now its participants face extinction. U.S. automakers must bet on "home run" product innovation. If the automaker can succeed in the discovery quest like Boeing (NYSE: BA), BullBoards) with its 787, RIM (NASDAQ: RIMM, BullBoards) / (TSX: T.RIM, BullBoards) with the BlackBerry or Apple (NASDAQ: AAPL, BullBoards) with its iPod, then Ford's restructuring can work. The Ford F-150 is running on empty and the new Ford Fusion has only had moderate success. Ford assembly plants at both St. Thomas, Ontario and Oakville eventually will be on the chopping blockalong with hundreds of jobs if the restructuring does not work. Ford lost $1.4 billion in the first half of 2006. Obviously such losses cannot be sustained.

At the same time Pacific Gas and Electric (PGE) recently completed a mailer to its 5.1 million customer base in which it encouraged the auto industry to develop new battery technology to enable hybrid vehicles to plug into ordinary 120 volt garage outlets for recharging. Such an advance on today's hybrid cars would allow revolutionary increases in mileage. Experts estimate that 40% of Americans travel no more than 30 miles on an average day, and 60% travel no more than 50 miles. The idea of a plug-in hybrid is that the electric motor would handle the first 30 to 50 miles of city driving before the gasoline or biodiesel engine takes over. Japanese carmakers are already at work on this technology. This is very good news.

There are problems with this "solution" to be sure. Could such a mass switchover occur quickly? Scientific American (Sept. 2006) estimates that it will take a minimum of 20 years before a mass switch to any new transportation technology can occur. Critics also suggest that the U.S. electrical grid could not handle the additional load. We believe that a national effort to develop advanced battery technology for the hybrids concurrently with the development of the cars can occur in the next decade. Why could we not coordinate this in a joint North American effort with expansion of nuclear and passive electrical generation capability? If the U.S. put men on the moon in the 1960s surely we can revamp our transportation and electrical generation in a decade. Global demand for oil is now 85 million barrels per day. Between 54 and 58 million barrels of oil are used for transportation each day. If that amount could be reduced by 30% the net effect would be to erase most of OPEC's power from the energy equation.

The Star reports that the Province of Quebec has developed an all-electric car with the French firm Dassault. The savings in energy per mile traveled, in tests, are 50% to 70% relative to gasoline. Charging batteries at night using cheap electrical rates and spare capacity is fortuitous. Cleaner hybrid cars also are a necessity. The Western world's trade deficits with OPEC are also at stake in this decision. With China's auto industry coming onstream there may be little choice.

Discovery is in the air in the auto and transport industry. Potential investment opportunities include battery technology, hybrid engine technology and, as in the case of Azure Dynamics (TSX: T.AZD, BullBoards), hybrid electric powertrains.

*Editor's note: Hubbert's peak is named for American geophysicist Marion King Hubbert, and refers to the peak of worldwide oil production. Hubbert created a model of known petroleum resources and predicted oil production from conventional sources in the U.S. would decline after 1970, and worldwide after 2005.

Michael Berry has been a portfolio manager for both Heartland Advisors and Kemper Scudder, where he successfully managed small and mid-cap value portfolios. He was a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia and has also held the Wheat First Endowed Chair at James Madison University. Dr. Berry is now a proponent of what he calls "discovery investing."


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