Vehicle Electrification – a Bird in the Hand

John Petersen

Since I’m frequently chastised for holding old fashioned views when it
comes to vehicle electrification, I’ll start this article by quoting
one of the oldest known versions of a common
English proverb, “A byrd in hand – is worth ten flye at large.”
While this theme is not always clear in my writing, it’s never far from
my thoughts. In fact it’s the foundation of my conviction that
manufacturers of cheap energy storage products are better investments
than developers of cool energy storage products and batteries are great
at minimizing waste but miserable at replacing fuel tanks. Just for
this week, I’m going to take the debate down a notch and focus on what
I see as a bird in the hand in the energy storage sector.

I’ve written about new
European standards that will require automakers to reduce CO2
tailpipe emissions to 130 g/km by 2015. I’ve also written about new
U.S. CAFE standards that will require automakers to achieve an
average fuel economy of 35.5 mpg by 2016. While I’ve never written
about the rest of the world, many governments are jumping on the
bandwagon and adopting emission standards based on the European model.
The following chart from Tenneco (TEN), a global leader in
automotive fuel
efficiency and emission control systems, provides a summary
overview of the current global regulatory landscape.

For the last couple of years, a huge amount of hype and media attention
has focused on a new generation of plug-in vehicles that automakers
plan to introduce soon. What these stories invariably fail to recognize
is that one or two million plug-in cars may contribute to the cause,
but the overwhelming bulk of the progress must come from efficiency
gains in the 48 million cars that can’t be built with plugs because the
world can’t make enough batteries. From my admittedly stodgy
perspective, the 48 million cars are a plump bird in the hand while one
or two million plug-ins are, at best, wild geese on the wing.

In mid-February, I wrote an article, Exploring
Energy Efficiency in the Automotive Sector, that included the
following summary table of efficiency technologies for cars without
plugs:

While all these efficiency technologies are important, the only ones
I’m qualified to write about are stop-start systems, mild hybrids and
full hybrids.

In a presentation at last fall’s IAA
Investor & Analyst Conference at the Frankfurt Motor Show, Dr.
Wolfgang Bernhart of Roland
Berger Strategy Consultants predicted that automotive powertrain
electrification would become a critical efficiency technology by 2020
and forecast high scenario market penetration rates as follows:

While some may find the distribution surprising, it actually fits nicely
into the concept of the standard bell shaped curve that we all learned
about in grade school when report card time rolled around. A few buyers will underperform and
continue to buy vehicles with internal combustion engines; most average
and
above average buyers will buy vehicles with stop-start and HEV systems;
and a few truly committed souls will buy vehicles with
plugs. As an investor looking to minimize risk, I prefer mass-market
certainty to early adopter potential.

The biggest impediment to the widespread adoption of stop-start systems
is that stopping and restarting an engine several times during a
typical daily
commute is very hard on flooded lead-acid starter batteries. While
stop-start systems don’t need an exotic chemistry like NiMH or Li-ion,
they do need a better grade of absorbed glass mat, or AGM, battery that
can withstand heavier cycling. Where automotive OEMs have historically
paid about $55
each for starter batteries, advanced batteries for stop-start
applications can cost from $150 to $250 each. The price difference may
be pocket change in the price of a car but it’s a huge revenue
opportunity for the
companies that can make starter batteries for millions of stop-start
vehicles.

Building top line revenue in any business is hard and the only ways I
know are to sell more products or to sell higher
value products. The same is true of bottom line profitability where the
only options are to improve margins or cut costs. A
business that can build revenue by increasing unit prices and
simultaneously increase profits by selling at a higher margin is rare,
but
that’s the direction the lead-acid sector is heading in. Assuming a
modest price differential of $100 per vehicle, the incremental revenue
to starter battery producers should be on the order of a billion
dollars within five years and three billion dollars within ten years.
Since the revenues will come from product upgrades rather than
increased volumes, the stresses on capital spending budgets, supply
chains and distribution networks should be significantly lower than
they would be with a new product. The net result should be higher
revenues and profits, which are always good things for low-priced
stocks.

No matter how the stop-start market ultimately unfolds, starter battery
manufacturers will thrive. If the OEMs bite the bullet and
buy better starter batteries, revenues from original equipment sales
will soar. If OEMs don’t upgrade their starter battery
specifications when they introduce stop-start systems, revenues from
replacement battery sales will soar. It’s just an updated version of
the old Fram
Oil
Filter advertising campaign, “You can pay me now, or pay me later.”

The three publicly traded U.S. companies that stand to benefit most
from the widespread implementation of stop-start systems are Johnson
Controls (JCI)
Exide
Technologies (XIDE)
and Axion Power International (AXPW.OB).

JCI and Exide are global competitors in the OEM battery space and they
each book billions in annual revenue from the starter battery business.
JCI’s Varta unit is selling batteries for over a million stop-start
vehicles annually. Exide is using the proceeds of a $34 million DOE
battery-manufacturing grant it received last August to build a new
factory that will make batteries for up to 1.5 million stop-start
vehicles per year. Both companies truly are bird in the hand investment
opportunities that are certain to see significant revenue and profit
growth over the next few years from market mechanisms that are already
in place.

Axion is a more speculative microcap company that spent the last six
years developing a
lead-carbon battery technology that’s ideally suited to the extreme
cycling demands of stop-start systems. During the R&D stage,
Axion’s prototype PbC® batteries withstood over 1,600
cycles at a 90%
depth of discharge while top quality AGM batteries
made by others failed after 300 to 500 cycles. After entering into a
worldwide supply agreement with Exide last April, the two companies
sent
pre-commercial PbC devices to several first tier automakers early last
summer. Ten months later, the testing continues to yield
positive results and negotiations are apparently in process for road
testing of PbC batteries in pre-production stop-start vehicles. If the
testing turns into orders, Axion will be able to leverage Exide’s
global manufacturing base by providing carbon electrode assemblies for
co-branded products. It’s not quite a bird in the hand, but it’s a lot
closer than the flock of wild geese.

I’m a former director of Axion and a big stockholder, so I’m clearly
cheering for my home team. That being said I know several of Axion’s
directors well enough to feel confident that they wouldn’t have
closed a $26 million down-round financing in December if management
wasn’t preparing for a major capital spending program. I expect that
we’ll hear a good deal more about Axion’s short-term plans when its
annual report is filed at the end of the month. The one thing I
can say for certain is that I feel much better about my risk/reward
profile today than I did in October 2006 when I bought the bulk of my
shares at a price that’s within spitting distance of the current market.

Disclosure: Author is a former
director of Axion Power International (AXPW.OB)
and
has a substantial long position in its stock, together with a small
long position in Exide Technologies (XIDE).

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