Is it all smoke and mirrors?

Public Health England have said that using E-cigarettes (vaping) is 95% better than smoking. But is this claim a bit premature? If vaping has only been mainstream since around 2007 in the UK and US, can anyone say they know the long-term effects of usage?

There have been 48 deaths and a further 2,290 people made seriously ill as a consequence of vaping this year.”

 

Source: Centre for Disease Control and Prevention (CDC)

For those who aren’t familiar with the process- vaping devices heat up liquid to an aerosol state that is inhaled by the user. The liquids usually contain nicotine but also a number of other substances such as heavy metals and possible carcinogens – albeit in smaller amounts than in traditional cigarettes.

Two recent studies in the US that have found the damage to hearts is similar in vapers and “traditional” smokers but the research samples were quite small. These aren’t the only studies- there are a number of academic studies happening all over the world, so can expect more results from those over the next few years. With research fairly limited at the moment, there is still uncertainty surrounding health effects on users or those who are exposed to their exhalations.

According to the Centre for Disease Control and Prevention (CDC) in the US, there have been 47 deaths and a further 2,290 people made seriously ill as a consequence of vaping this year alone. It is unclear what the cause is. The victims are spread across all states (apart from Alaska) and the number of devices and liquids used are widely varied, albeit around 75% have added THC (the ingredient in marijuana that provides the high) to their vaping devices, and there is some evidence that an additive to thicken THC for vaping devices is causing the lung damage in 29 of the most recent cases. At the moment the problem doesn’t appear to have spread outside of the US, which could be because there are a high number of counterfeits in the US market.

That said, marketing to minors has also been aggressive by some players. Companies like Juul have been questioned over their marketing techniques and variations that would appear to be targeting children. Last year, an estimated 3.6m children in the US used a vaping device and a separate study in the UK claimed the figure was around 12% of 11-16yr olds. President Trump is currently contemplating raising the minimum age for vaping to 21 and banning the flavoured devices altogether in an effort to curb this “epidemic”.

As we have previously written, it can be very difficult to transition an already established business to a more sustainable alternative.  The tobacco industry faces these challenges. E-cigarettes have been positioned as a less-harmful alternative to traditional cigarettes, but we shouldn’t forget that similarly positive narratives were also used by the tobacco industry in the past.

About the author

Miranda Beacham is Corporate Governance Manager in the ESG Research team. She is responsible for monitoring, engaging and voting of investee companies in line with our Responsible Investment Policy. She joined us in 1994 as a research assistant in the UK equity team and has 25 years’ industry experience*. Miranda studied Chemistry at Napier University and has the IMC professional qualification.

*As at 30 April 2019.

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The Silent Disruption: Why traditional car makers and customers will get an Electric Shock! Part III

Part III: Practice makes perfect

In part I and II of my series on the disruptive shift to electric vehicles (EVs), I explained why it is normal for car buyers and traditional internal combustion engine (ICE) car makers to be surprised by it. As I explained, it is mostly about the relative rate of improvement on the key performance vectors (including the all-important affordability factor). But a key consideration when investing is understanding not just if, but when an inflection in demand will happen. So why now? A key factor in my conviction (combined with Christensen’s framework explained in Part I and II) is Wright’s Law. Formulated in 1936 by Theodore P. Wright, it states that progress increases with experience — specifically:

“Each percent increase in cumulative production in each industry results in a fixed percentage improvement in production efficiency.”

This law has successfully explained the cost curve of over 60 products from solar panels to cars, including the Model T Ford. In car production it has translated to 15% improvement for every doubling of cumulative production. Crucially, small numbers double much faster than large ones. Wright’s Law still applies to mature technologies, it just takes longer. What’s fascinating (to me anyway) is that the Tesla Model 3 is already following the path of the Model T Ford. By Q2 2019 Tesla had cumulatively produced 275k Model 3’s and will produce about 600k by the end of 2020. Based on Wright’s Law this should result in a 23% improvement in production efficiency. Translated to finance speak, this means higher gross margins and lower capex per unit of production.


Source: Ark Investment Management LLC, 2019

Tesla has produced more EVs than any other company. Unlike its incumbent competitors who have largely outsourced their innovation to suppliers, Tesla is a vertically integrated technology company. It designs and builds its own electric motors and batteries. It is adding production and battery capacity at a faster rate than any other company (with 44GWh they have almost 50% global EV battery capacity). It has been refining its own drive chain management software for years and it owns the largest and fastest charging network in the world. Does this company remind you of any others?


Source: Bloomberg survey October 2019 (5000 owners)

Range and recharge speeds are probably the two performance vectors on which EVs still lag ICE. However, with range there has long been what Christensen calls “performance oversupply”. Most car journeys are < 50 miles long and now you can refuel while parked, which means the necessity for rapid refuelling falls. Furthermore, Tesla recently announced a 3% range increase for the S and X and a 5% increase for the 3. These were deployed via an over the air software update. And for those who regularly drive further than 300 miles, the most recent generation of Tesla superchargers can deliver up to 75 miles of range in 5 minutes. Teslas are the only cars on the market today that continually add improved features to the car over the air for free. The car improves while on the road.


Source: Tesla Q3 2019 Shareholder presentation and researchgate.com.

Tesla are growing units of production and reducing cost per unit of production faster than anyone else, in a market that will grow faster than most expect. Quality is improving every month and the energy and creativity evident in product development meaningfully differentiates it in the design stakes. The recent #CyberTruck (pickup truck) is the most obvious example. Does any other automaker have the courage, creativity or technical ability to replicate it? What this all translates to – in my opinion – is a combination of underappreciated competitive advantage, underappreciated addressable market and an underappreciated inflection in demand.

“They can have it in any colour they want, as long as it’s black.” Henry Ford

In summary, I believe the winner in the transition to electric vehicles will be the company that has the clearest vision of the future, the least historical baggage (in terms of mindset, bureaucracy and source of revenue) and is innovating fastest. That company will never be perfect but at least we can have confidence that they are motivated to improve and move as quickly as possible in the right direction. The recent unveil of the Tesla Cybertruck is – to me – indicative of all of this. Bold and courageous, built from first principles, technically superior to any ICE pickup truck on the market at the same price… but with windows that need work before they can reliably be claimed to be bullet proof. Remember nothing is perfect to begin with!

“We can fix it in post” Elon Musk


Source: Tesla

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.  He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience (as at 30 April 2019).

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The Silent Disruption: Why traditional car makers and customers will get an Electric Shock! Part II

Part II: The incumbent’s perspective

Last week I wrote about why customers don’t appreciate the rate of change in disruptive technology until they experience it.  But it doesn’t stop there. Like their customers, established companies under threat from disruption tend to miss it too. And this feeds into the mainstream media, who are naturally attracted by the fallacious appeal to authority of the established brand names…. Surely if anyone knows, [insert established brand] would know!?

Despite the rapid advance of EVs in relative cost and performance terms, internal combustion engine (ICE) manufacturers still see electric vehicles (EV) as a small market, with negative margins which most of their customers don’t want. Why?

Clayton Christensen observed this behaviour repeatedly in his study of why great businesses with excellent managers fail to adapt to disruptive technologies. And just like their customers, it’s not because they’re idiots!

“It is in disruptive innovations, where we know least about the market, that there are such strong first-mover advantages. This is the innovator’s dilemma. Companies whose investment processes demand quantification of market sizes and financial returns before they can enter a market get paralyzed or make serious mistakes when faced with disruptive technologies. They demand market data when none exists and make judgments based upon financial projections when neither revenues or costs can, in fact, be known…Discovering markets for emerging technologies inherently involves failure, and most individual decision makers [within established bureaucracies] find it very difficult to risk backing a project that might fail because the market is not there.” – Clayton Christensen

Given the news last week that Telsa will build their European manufacturing facility ‘Gigafactory 4’ in Berlin, recent statements from BMW executives are extra ironic. I suspect that those who laugh at EVs and Elon Musk now will look back and laugh at ICE companies and Klaus Frölich in a few years. For now, such comments are usually taken as evidence that EV adoption will be slow. In a disruptive context however, dismissive comments like this are entirely predictable. Indeed, when viewed against the recent EV unit growth in all markets (1) and the fact the Tesla has not spent a single dollar on traditional advertising to date, I think they are a very positive contrarian signal. The quote below was sourced from a Forbes article in June 2019:

“There are no customer requests for [EVs]. None,” BMW’s director of development, Klaus Frölich, told a shocked round-table… “Europeans won’t buy these things… From what we see, [EVs] are for China and California and everywhere else is better off with plug-in Hybrid Electric Vehicles with good EV range.”

I believe the chart below is insightful when assessing the prospects of EVs. It tells me two things. 1) The demand is very high because people are willing to spend more than normal to purchase the item and 2) The addressable market is much bigger than most people think.

So it won’t surprise you to learn that I think Frölich is missing the biggest disruptive shift in automotive history, but I also believe he is overstating the role of hybrids in the transition. Why? Whilst it’s natural to cling onto the technology you know, pure EV costs will inevitably be lower than hybrids over time due to predictable cost reductions. These are reductions which can’t be achieved when combining both technologies, due to the complexity of doing so and the compromises needed. ‘Inevitable!?’ I hear you say ‘That’s a bold statement!’ Perhaps so, but in the context of history, I don’t think it’s that bold.

Source: SS Savannah 1819 (The first hybrid “steam ship” to cross the Atlantic).

Next week I will explain why EV costs will keep falling and performance will keep improving in the part III, the final act in the Trilogy of the Silent Disruption.

Source: European EV growth rates
https://insideevs.com/news/373420/august-2019-plugin-ev-car-sales-europe/
https://insideevs.com/news/373278/plugin-car-sales-europe-h1-2019/
Tesla surveys
https://www.bloomberg.com/graphics/2019-tesla-model-3-survey/market-evolution.html#intro

 

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.  He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience. *As at 30 April 2019.

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The Silent Disruption: Why traditional car makers and customers will get an Electric Shock! Part I

Part I: The customer perspective

 “If I’d asked people what they wanted, they’d have said a faster horse”– Henry Ford

 To most people, this quote from Henry Ford is a funny quip. It’s fun to look back and laugh at the silly old people of the past who thought cars would never replace horses.

But if you know how disruptive innovation works Henry Ford’s point is a serious one.

The reality of America in 1900 was that cars just didn’t make sense to most people. There were no gas stations. Roads were mostly mud or gravel tracks. There was no highway system. Cars were unreliable and very complicated pieces of machinery… and whilst black smiths were plentiful, there were no motor mechanics. Cars were too expensive for most consumers and considered ‘vulgar’ by those in high society. They were also noisy and not much faster than the average horse. The Model T Ford only had 20 horse power and a top speed of 40 mph. There were no traffic lights or laws governing how to drive. In fact, such were the barriers to adoption that Ford constructed a highway and gas station network to facilitate demand (1) and the Ford Motor Co. internally produced everything, because there was no established supply chain. How could there be?

As a result of these bold strategic moves, The Ford Motor Co. dominated the market for decades.
Source: Tony Seba, Stanford University

One paradox of disruptive innovation is that the customer is not always right. That’s because the average customer does not closely track the rate of change in disruptive technologies. In fact, it is normal for people to underappreciate the rate of change in a new technology that they do not yet use. Customers certainly can be fickle however, and whilst initially sceptical and resistant to the friction inherent in change, they will quickly flip when the perceived benefits outweigh the barriers to adoption. As Clayton Christensen observed in his seminal book ‘The Innovators Dilemma’, this can be confusing for the incumbent companies who closely track their customer’s desires.

“Most companies with a practiced discipline of listening to their best customers and identifying new products that promise greater profitability and growth are rarely able to build a case for investing in disruptive technologies until it is too late.” Clayton Christensen


Source:Innovators Dilemma, Clayton Christensen: Sustaining (i.e. incumbent) technology improves slowly vs. disruptive technology

I believe Electric vehicles (EVs) have quietly moved to a place where they outperform internal combustion vehicles (ICE) on almost every performance vector (2) without most people realising. Indeed, on an apples-to-apples comparison today, the only vectors on which they don’t, is fully loaded range and refuelling speed. And I stress today, because as we’ll see in part III, these frictions will be solved too. In this context, Elon Musk has a proverbial ‘walk in the park’ compared to Henry Ford. Furthermore, his conviction to rapidly expand global production, the Tesla charging network and service centres should make a lot more sense to the cynical naysayers and incumbent competitors.

Yet many traditional car makers still don’t see EVs as a meaningful threat to the status quo. Yes they’re improving but they are still a niche market and will be for decades. Next week I will explain why – like they’re customers – they are blind to this disruptive shift. And as you’ll find out, it’s not because they’re stupid.

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.

He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience. *As at 30 April 2019.

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Powerful dark forces….whahahahahahaha

It’s that time of the year. In Scotland we call it ‘guising’. In other places it’s called ‘trick or treating’. Collins dictionary describes it as, ‘the practice or custom of disguising oneself in fancy dress, often with a mask, and visiting people’s houses, especially at Halloween.’ At a stretch, you could also call it doorstep lobbying…..

But when it comes to the murky world of corporate lobbying, there’s a bit more at stake than a few Haribo or spending a night in with the curtains drawn and the lights off. Although US lobbying spend is actually down this year versus last, it’s not something we should ignore since it spans a multitude of sectors and its impacts are multi-faceted.

For instance, most readers will be familiar with the idea of a company’s direct (operational) and indirect (supply chain, product use) greenhouse gas emissions. But what about the impact of a corporates direct or indirect lobbying on climate? Not-for-profit InfluenceMap argue that at some companies, the dark forces of climate lobbying are in fact the largest component of their carbon footprint.

Source – InfluenceMap

And to an extent we would agree. We expect the highest ESG standards and we also want a level playing field for all the companies that we invest in. Which is why (in contrast to some of the world’s largest investment managers), we have consistently supported shareholder resolutions relating to climate lobbying. The most recent of which was at BHP Plc’s1 AGM.

BHP isn’t a bogey man. It is a reputable mining company with well-managed operations in relatively low political risk geographies. But alongside 20% of other shareholders, Kames recently voted for a resolution at the company’s AGM seeking the company take further steps to address the lobbying activities of the industry bodies it is a member of. TBH, given that 2.5% of BHP’s EBITDA is from thermal coal (one thermal coal mine in Australia), its associations with certain organisations and defending their anti-climate narrative (which is inconsistent with its own) struck us as an unnecessary distraction for management. But anyway, post the AGM, its pleasing to see that BHP appears keen to engage with investors further on the issue.

At the same time, we recently co-signed a letter to a number of other Australian-listed corporates on the issue of climate lobbying by industry associations. And elsewhere, Kames voted for similar resolutions at the AGM’s of ExxonMobil Corp1  and  NextEra Energy, Inc.1 and a review of lobbying activity influenced our thinking when voting BP Plc’s1 AGM earlier this year.

In a previous soapbox, we described ourselves as ‘Capitalists with a conscience’. We have multiple investments on behalf of our clients across multiple industries. Climate change presents a risk for many companies and an opportunity for some that we need to understand and shady behaviours, industry obfuscation and lobbying prevents investors, customers and voters from making better informed decisions. Ghosts and ghouls need to be bought into the light; so does inconsistent corporate messaging and lobbying about climate change.

1 At the date of writing, Kames held BHP Plc, BHP Limited, ExxonMobil Corp, NextEra Energy Inc. and BP Plc across a number of investment strategies except Kames Global Sustainable Equity and Kames Ethical Equity, Ethical Corporate Bond and Ethical Cautious Managed.

About the author

Ryan Smith is Head of ESG Research. He joined Kames Capital in October 2000 as an SRI analyst and was appointed to his current position in September 2002. He has 18 years’ industry experience*. His role involves managing the team that conducts the ESG screening process for our Responsible Investing funds. Ryan’s team also provides corporate governance screening and research for all equity investments, and conducts research into environmental and social issues. Before joining us, he worked as an environmental chemist for Severn Trent Water. Ryan has an MSc in Environmental Chemistry from Nottingham Trent University and is a CFA charterholder.  *As at 30 April 2019.

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[Video] Insulin Prices in America. What the…?!

Insulin prices in the US have gone up by 1171% over the last 20 years. Patients pay half, insurance companies pay half- and they employ a middle man to negotiate the price down and prevent price rises. So, how has this price increase happened? Craig Bonthron tells us why this greed will catch up with companies in the long term, and talks about the sustainable companies disrupting this trend.


For a more in-depth analysis of the insulin situation in the US see our two-part blog here: part 1, part 2

About the author

Craig Bonthron is an investment manager in the Equities team, responsible for actively co-managing high conviction global equities portfolios. He focuses on analysing disruptive and sustainable investment trends within the technology, healthcare, industrial and consumer sectors in order to identify high conviction stock specific investment ideas.

He joined us in 2014 from SWIP, where he was an investment director in global equities. Prior to SWIP, he was a portfolio manager at Kleinwort Benson Investors. Craig has a 1st Class honours degree in Building Surveying and an MSc with Distinction in Business Information Technology Systems from Strathclyde Business School. He has 18 years’ industry experience.  *As at 30 April 2019.

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