Deals driver Automotive trends and transactions June 2017 kpmg.ca/automotive Diesel, Batteries and the Gasoline Engine By Peter Hatges, Managing Director, KPMG Corporate Finance Inc. and National Sector Leader, KPMG in Canada As the auto industry continues According to the survey, a significant amount (78%) of executives believe fuel to innovate drivetrains, various cell electric vehicles will be the golden bullet of electric mobility. Fuel cells, or FCEVs, are expected to solve the problem of recharging and infrastructure. questions arise regarding Fuel cells are recharged quickly at a traditional gas station type facility, making the future of both the diesel recharging times of 25 to 45 minutes for batteries unreasonable. However, the technology is still in its infancy. and gasoline engines. While electric and hybrid cars are the Fuel cell cars are not a new technology. In 1966, General Motors launched the first fuel cell vehicle, the Electrovan, which was the first of its kind to generate current alternative to these electricity that powered the battery and motor with a combination of hydrogen fossil fuels, even battery and oxygen. The vehicle was able to travel approximately 150 miles before it needed to be refueled because it contained two large tanks – one for hydrogen powered cars may have a and one for oxygen – in the back. Fast-forward to today where engineers are questionable future. In KPMG’s able to fit batteries, fuel cell stacks and hydrogen storage inside the smallest 2017 Global Automotive vehicles due to advancements in technology. Executive Survey, executives Original Equipment Manufacturers (OEMs) such as Honda, General Motors and Daimler have fleets of fuel cell powered cars today, some of which are expressed reservations around used as testers for consumers. The U.S. is trying to promote fuel cell cars in the application of battery the marketplace in high population areas such as Los Angeles and New York technology. Limitations on City, while it rolls out fuel cell cars and hydrogen fueling stations concurrently. battery charging infrastructure, However, it is predicted there will be a limit to the sale of fuel cell vehicles – despite their lower costs – until more fueling stations are created. the improvement of the combustion engine and the Diesel – A dim future? application of turbocharging As alternative engine technology gains momentum and attracts R&D dollars, have prolonged the life of the the future of the diesel engine is in question. The rising price of diesel fuel has lessened the overall benefits of the diesel engine. More popular in Europe than combustion engine. in North America, the diesel engine has been plagued by rising fuel costs and the impact of the Volkswagen (VW) emissions scandal. © 2017 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Tougher standards and testing methods will increase costs to the point where diesel may be forced out of the market. Given the development costs to maintain engine competitiveness and ensure customer loyalty, few OEMs can afford to invest in a technology that has a dubious future. It’s not just the added costs; consumers now cast a questioning eye at diesel technology, worried that resale values will plummet or even worse, they may not be able to resell a diesel-powered car. Despite the VW scandal, sales of diesel engines had already been on the decline because they are expensive and the added cost often outweighed the potential savings on fuel. Furthermore, the VW issues also drew attention to the main problem areas for diesel engines, which are nitrogen oxide (NOx) emissions and the inconsistency with emissions recorded on the road and in regulatory tests. Diesel cars are commonly found to emit five times more nitrogen oxide than the legal limits in everyday use, which has contributed to environmental issues like smog and acid rain, along with a number of health issues such as decreased lung function and respiratory illnesses like asthma, bronchitis and pneumonia. However, in 2019, vehicle approvals will be based on emissions performance during real driving which will force manufacturers to install costlier emissions treatment systems. In the meantime, the sales of diesel engines continues to fall. In fact, with electric and hybrid car batteries becoming cheaper and more powerful, many industry experts are now predicting that manufacturers may stop producing diesel engines after 2025 because electric batteries will become much more affordable. This is causing manufacturers to withdraw from the diesel engine, making economies of scale, technological advancement and practical applications in various models difficult, if not impossible to maintain. As a result, diesel car sales are expected to drop to 9 percent of the European market in 2030 from 52 percent today, according to AlixPartners. Diesel fuel and trucks Let’s not count out diesel just yet. It is the drivetrain of choice in many trucks given that diesel engines are more efficient than gasoline engines and based on the number of miles driven in commercial trucks, this becomes a critical consideration. The alternative for heavy trucks is Liquefied Natural Gas or “LNG”, and several major trucking companies are testing LNG equipped trucks and considering the switch. Truck drivers and trucking company owners seem to be divided on the issue. Some believe that making the switch to LNG will decrease fuel bills, while others think that the price will increase steadily as the demand increases. Market analysts believe that LNG will stay below $40 per barrel for years, and Shell representatives are convinced that LNG is the fuel of the future. © 2017 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. © 2017 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. LNG and infrastructure The main argument against LNG as a fuel for large trucks (typically Class 8 trucks) is the lack of infrastructure. There are only about 1,000 fueling stations that dispense natural gas in the United States. California has taken the lead in offering LNG fuel to the public, but there still isn’t enough infrastructure to even begin supporting the thousands of trucks that could make the switch to natural gas. The demand for LNG is growing, as large companies such as Wal-Mart and CR England test trucks powered by natural gas engines. The fuel has its challenges. The American Trucking Association has questioned the current viability of long- haul operations as that they don’t believe LNG is currently a viable option. Higher maintenance costs, additional driver training and the weight of LNG tanks versus the weight of diesel tanks are a few of the reasons they believe it is not viable. As the industry moves forward and the infrastructure becomes more common, it is possible that LNG will become nearly as common as diesel as a fuel for local hauling, but will still face challenges for long hauling. One of the key steps forward is the highway reauthorization bill passed by the U.S. Senate in July 2015. The bill will help address the transportation and infrastructure needs. The bill included a provision to equalize the tax rates on liquefied natural gas and liquefied petroleum gas with the rates on diesel and gasoline in their 90-day Highway Trust Fund extension. By equalizing the tax rates between LNG and traditional fuels, Congress has eliminated an unfair disadvantage in the taxation of LNG that has impeded wider use of natural gas vehicles. Gasoline engines still have life Weight reduction, turbo charging and technological improvements have lengthened the life of the gasoline engine. And with a healthy infrastructure for fuel, significant economies of scale and installed base, hybrid technology and falling oil prices, there is continued in interest in the gasoline engine. Given the new Corporate Average Fuel Economy (“CAFÉ”) targets, large OEMs are expected to increase their CAFE to 54.5 mile per gallon from about 35.5 miles per gallon in 2016. The parties to the agreement to increase fuel economy are Ford, GM, Chrysler, BMW, Honda, Hyundai, Jaguar/Land Rover, Kia, Mazda, Mitsubishi, Nissan, Toyota, and Volvo – which together account for over 90% of all vehicles sold in the United States – as well as the United Auto Workers (UAW), and the State of California, who were all participants in the deal. Should the gasoline engine achieve those kinds of results, it may be with us a lot longer than people think. This article first appeared in the May 2017 issue of Canadian Underwriter. © 2017 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Public Comparable Companies (C$M) Capitalization LTM multiples NTM multiples Market Enterprise EV/ EV/ EV/ Company Country cap. Value (“EV”) Revenue EBITDA P/E EBITDA EV/EBIT P/E American Axle & Manufacturing United States 1,925 3,163 0.6x 3.9x 6.1x 3.4x 5.3x 5.5x Holdings, Inc. BorgWarner Inc. United States 11,854 14,537 1.2x 7.1x n.m. 7.2x 9.5x 12.3x Cooper Tire & Rubber Company United States 3,127 3,132 0.8x 4.3x 10.8x 5.1x 7.2x 11.8x Cooper-Standard Holdings Inc. United States 2,617 3,034 0.7x 5.5x 13.8x 5.1x 7.2x 10.3x Dana Incorporated United States 3,708 5,067 0.6x 6.2x 4.4x 5.4x 7.9x 11.0x Dorman Products, Inc.