Page 13 - DIY Investor Magazine | Issue 32

‘AN ATTRACTIVELY VALUED ‘PICKS & SHOVELS’ TYPE
OF BUSINESS THAT IS FAR MORE APPEALING AS AN INVESTMENT THAN THE HIGHLY RATED ‘GOLD PROSPECTING’ BUSINESSES
In the EV industry, the most threatening ‘new entrants’ are the ‘old auto’ companies such as General Motors (GM), Hyundai, and Volkswagen (VW); late out of the gate, these companies are now investing heavily to counter the EV pioneers, and it is difficult to forecast how battles for market share will play out.
Consequently, we believe the best way to get exposure to the EV transition is through areas where technical barriers to entry are high, competition is correspondingly less fierce, and share price valuations less demanding; the EV battery industry for example. It is incredibly difficult to make large EV batteries reliably and at scale - not a business you can start up without deep pockets and a solid starting point in battery chemistry and mass production.
Therefore, EV battery production is a far more concentrated industry than auto manufacturing – dominated by a handful
of large players such as CATL, LG Chem, Samsung SDI and Panasonic. We invested in LG Chem, a Korean company that is the world no.2 EV battery maker with 26% market share, with strong strategic relationships with large automakers such as GM and VW, and also with dedicated EV manufacturers, such as Tesla and Lucid. Despite its leading position in an industry directly exposed to EV’s impressive growth profile, LG Chem’s shares value the company at 16x that of its 2022 forecasted earnings5.
We hold preference shares, which are roughly half the valuation of ordinary shares, despite having the same economic value (preference shares, unlike ordinary shares, do not carry voting rights).
We are thus getting exposure to growth in electric vehicles through a business which not only enjoys strong barriers to entry, but which trades at a share price valuation which is a fraction of that ascribed to dedicated EV manufacturers.
LG Chem’s low valuation may be partly explained by the company’s conglomerate structure, with divisions that include petrochemicals and agrichemicals.
However, we believe perceptions will change over time, as battery earnings grow and overshadow the petrochemical segment – and perhaps sentiment will change sooner rather than later, given that the company’s January 2022 initial public offering of its EV battery division, which brings full transparency to the value of this high-growth asset.
Until this change in perception occurs, shareholders of LG Chem are incentivised to wait, with the company aiming to pay out at least 30% of recurring profit as a dividend. For these reasons, we see LG Chem as an attractively valued ‘picks
and shovels’ type of business that is far more appealing as an investment than the highly rated ‘gold prospecting’ businesses of listed EV manufacturers.
CHROMA ATE: TESTING NEW MARKETS
Continuing with our ‘picks and shovels’ analogy, we believe Taiwanese company Chroma ATE closely fits the bill; it manufactures and sells electronic and automated testing solutions that spot faults and inconsistencies and provides feedback for a wide range of components and devices.
Originally focused on IT power solutions (power supplies for laptops and consumer electronics), Chroma has developed test equipment for the latest technical innovations over the past thirty years; it pioneered LCD display testing in 2006, solar cell testing in 2008, and 3D sensing in 2017. Because of this first mover approach, Chroma has consistently grown revenues ahead of the industry and has exposure to a diversified base of high-growth sectors such as EVs and 5G telecommunications.
EV component testing represents 30% of revenues and Chroma is one of the leading testing businesses globally; 5G is at an earlier stage but Chroma should see significant growth, driven by increasing network traffic and speed requirements. Regardless of who the 5G ‘winners’ are, or which EV maker comes to dominate the market, businesses like Chroma
will remain part of the critical infrastructure enabling
sweeping technological changes to take place. They are the unglamorous but indispensable side of technical revolution available for us, as investors, at sensible valuations. Chroma trades at a share price valuation well below that of many high- profile end customers which could not get their products to market without it.
5 Source: Bloomberg, to 21.01.22
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DIY Investor Magazine · Feb 2022