Fed Chair Jerome Powell confirmed rate cuts are on the horizon, relieving a big source of pressure for the EV sector.
Shares of electric vehicle (EV) stocks Tesla (TSLA 4.71%), Rivian (RIVN 9.72%), and QuantumScape (QS 4.55%) were all rallying on Friday, up 4.3%, 8.8%, and 4.3%, respectively, as of 2:28 p.m. ET.
There wasn’t any company-specific news today, so the moves can likely be attributed to Federal Reserve Chair Jay Powell’s dovish speech today at the annual Jackson Hole conference.
The prospect for lower interest rates would be a huge lift to all stocks that have been hammered by the rise in rates seen over the past two years, and EV stocks have been some of the hardest hit.
“The time has come”
Powell made news this morning by declaring in his speech, “The time has come for policy to adjust.” This declarative statement was perhaps even more definitive than investors were expecting, and indicated the Fed will most certainly lower interest rates in September, perhaps even by 50 basis points. In July, the Fed had left the federal funds rate unchanged at its cycle highs, just before a weak employment report, several soft inflation readings, and a downward revision in job growth were disclosed more recently.
That led to concerns the Fed was late to cutting rates, which could lead to a recession. However, Powell seemed quite confident in his speech that the data points more toward a “soft landing,” or lower inflation and interest rates without severe job losses, thanks to the central bank keeping long-run inflation expectations anchored. Powell said, “An important takeaway from recent experience is that anchored inflation expectations, reinforced by vigorous central bank actions, can facilitate disinflation without the need for slack [in the job market].”
Electric vehicle stocks rallied, and it’s not hard to figure out why. EV stocks have been hammered over the past several years by high interest rates in two ways.
First, cars are a big-ticket purchase, and are usually financed by car loans. Moreover, EVs are also generally more expensive than internal combustion engine vehicles, making the purchase all the more daunting. In response to higher rates and demand going down, EV companies have been cutting prices in order to move volumes, squeezing margins. You can see how even industry leader Tesla’s margins have gone in the wrong direction:
TSLA EBIT Margin (Quarterly) data by YCharts
The second way high interest rates hurt EV companies is by raising the cost of capital and hurdle rates. This is especially bad for low-profit or loss-making companies like Rivian and QuantumScape, and even high-multiple stocks like Tesla.
As high-multiple or loss-making companies theoretically have all of their profits out far in the future, higher interest rates lower the present value of those future earnings streams. Furthermore, loss-making companies may need to raise more capital, and higher interest rates make that more expensive, which also hurts a company’s intrinsic value.
So, a lowering of interest rates without a recession would be a huge relief for EV stocks on those two big fronts.
Image source: Getty Images.
But lower rates aren’t a cure-all
While lower rates would certainly help a whole lot, just remember that unlike other technologies, auto production is generally a capital intensive, cyclical, and competitive low-margin business. That’s why mature automotive companies tend to trade at low P/E multiples.
Of course, each of these companies appears to be on the cutting edge today. Tesla has long been known as a technology leader, but is making a big bet on robotaxis that may or may not pay off, and competition is creeping on its EV technology leadership.
Rivian is certainly a formidable company, and has garnered high-profile partnerships with the likes of Amazon and more recently Volkswagen. Still, Rivian still had a $1.4 billion operating loss last quarter alone, so its path to profits certainly remains a question.
Meanwhile, QuantumScape is not just unprofitable, but is actually pre-revenue, as it works to commercialize its solid-state battery technology. While solid-state batteries could revolutionize the EV and auto industries with their increased efficiency over lithium-ion batteries, the company is also losing money, with a $134 million operating loss last quarter alone, and under $1 billion of cash left on its balance sheet.
Interestingly, QuantumScape also recently inked a deal with Volkswagen that will inject more cash via a technology license, but will also cede QuantumScape’s intellectual property to Volkswagen in the future. Both VW deals should help Rivian’s and QuantumScape’s dwindling cash positions, but it could be also that Volkswagen is making a savvy deal with both players to obtain their cutting-edge technology at a good cost, due to both companies’ distressed situations.
As you can see, interest rates are only one piece of the puzzle. The auto industry is being disrupted by EV and autonomous technologies with high uncertainty, so investing in the sector isn’t for the faint of heart — even with lower rates.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Billy Duberstein and/or his clients have positions in Amazon. The Motley Fool has positions in and recommends Amazon, Tesla, and Volkswagen Ag. The Motley Fool has a disclosure policy.
