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Driverless Cars (Part One)

From time to time we will use this resource as a venue to hear from you, our friends, and clients. This is our first discussion on driverless (or autonomous) cars.  Over time we will discuss how it will impact society, its cost savings, the technology, and how it will impact your portfolios being managed at Princeton Global Asset Management.  There is no doubt that the technology of driverless cars will be extremely disruptive.  According to an article in the Wall Street Journal on August 15, “Driverless cars have the potential to reshape a wide range of occupations held by roughly one in nine American workers, according to a newly released U.S. government report.”  This disruption will take time to develop. Ultimately there will be corporate winners and losers.  Our first commentary on this subject will focus on sectors of the economy where the development of driverless cars will likely have a negative impact.  Within these sectors, there will be companies that can successfully adapt to the disruption and thrive and our goal is to identify those companies as well as others who will be beneficiaries of the driverless car technology whose shares would be attractive additions to our clients’ portfolios.

Driverless Cars Part 1

The journalist David Leonhardt recently wrote a column in the Wall Street Journal that highlighted a conundrum given to the students of the former Dean of Yale law school, Guido Calabresi.  The students were asked to consider a new invention that would make life more pleasant for almost everybody.  The invention, however, would have a cost – a very high cost.  The cost would be 3,000 people would lose their lives every day.  The students are then asked if they would accept the deal.  Almost all say no.  We have queried many our clients and friends and almost all of them say no.

And Yet!

  • We already have this product.
  • And most of us approve.
  • And most of us use it. It improves the lives of virtually everybody we know, and is directly responsible for the death of 3,000 people per day.  The product is the automobile and worldwide over 1.2 million people die in road crashes each year.  Another 35 million people are injured or disabled.
  • And the toll on the young is particularly upsetting.  More than half of all road traffic deaths occur among young adults ages 15-44.  Road crashes are the leading cause of death among young people ages 15-29, and the second leading cause of death worldwide among young people ages 5-14.  Over 90% of all road fatalities occur in low and middle-income countries, which have less than half of the world’s vehicles.
  • And the cost is even greater than that.  Road crashes cost $518 billion globally, costing individual countries from 1-2% of their annual GDP.

We put up with these costs because we imagine them as problems with no cure.  However, we may very well be wrong.  The digital revolution is changing the equation, and the change may very well be closer than we think!

One solution is the driverless car.  Both Lyft and Audi have recently announced that the driverless car is a reality.

Lyft announced on July 21 it will introduce driverless cars in Boston before the end of the year, and expand the program to other cities in the near future.  Driverless cars will be chosen for particular customers by Lyft depending on traffic, weather, route and time of day.  These cars will be manufactured by a variety of partners and plugged into Lyft’s “Open Platform” network.

On June 4, Audi stated that its new A8 will be fully self-driving for up to speeds of 60km/hr using its “Audi AI”. Contrary to other cars, the driver will not have to do safety checks such as touching the steering wheel every 15 seconds. The Audi A8 will be the first production car to reach level 3 autonomous driving and Audi will be the first manufacturer to use laser scanners in addition to cameras and ultrasonic sensors for their AI (Artificial Intelligence).  “Level 3” has been billed as “no feet, hands, or eyes,” but drivers must be ready to take back control immediately.  “Level 4,” also known as “mind off” requires no driver attention is ever required for safety.  We at PGAM have dubbed this “sleep permitted driving”.  If the vehicle gets to a non-supported area it will abort the trip and park itself.  Of course, there is a level 5, also known as “wheel optional” where no human intervention is required.

There are many videos on the Internet demonstrating self-driving level 3 technology.  Our favorite involves a Tesla Model X. The web address is below.  It’s worth watching to the end when the car parks with no human aid.  It first tries the parking lot, but gives up and pulls out into the street and finds a parallel parking opportunity: https://www.youtube.com/watch?v=O-xbDK3-5ew

Almost everybody thinks they are an excellent driver.  However, many of us are reckless teenagers, faltering elderly, inclined to distraction, prone to fatigue, and uncontrolled in their rage.  Below is a list of the top causes of car accident fatalities.

  • Distracted Driving – The number one cause of accidents.  This includes texting while driving as well as other behavior destined to kill, such as phone calls, eating, grooming, disciplining children, talking, and playing with your radio.
  • Speeding
  • Drunk Driving
  • Sleep Deprivation
  • Running Red Lights and Stop Signs

The common theme of these accidents is they all involve human error.  According to an article from the Transportation Research Institute over 92% of car accident fatalities are from human error.  Consulting firm McKinsey & Company estimated that widespread use of autonomous vehicles could “eliminate 90% of all auto accidents in the United States, prevent up to US$190 billion in damages and health-costs annually and save thousands of lives.  The Eno Center for Transportation estimates that in the US the number of accidents would drop from 6million to 1.3 million per year if 905 of cars were self-driving.

You’re probably wondering how this new technology is going to impact your portfolio.  First we’d like to address sectors where change will have a negative impact on the status quo.  Our preliminary list includes 7 areas:

  1. Insurance
  2. Auto Manufacturers
  3. Auto Parts Manufacturers
  4. Hospitals
  5. Oil Companies
  6. Parking garages
  7. Downtown real estate

This “List of Seven,” is our first thoughts of sectors which seem vulnerable to the disruption caused by the emergence of the driverless car.  Within these sectors, there will be companies that will be able to adapt and thrive.   For those companies which are unable to adjust, we see a risk to current earnings multiples and future earnings. We would like your opinions on whether there are other sectors which will be adversely affected as well as those which will be beneficiaries.  We are interested in your input on this matter and have posted a board for your opinions and comments. A few preliminary reflections on our “List of Seven”:

Insurance: With human error taken out of the picture the number of auto accidents would nose dive.  There would likely be more car sharing and the number of auto insurance policies would decline.  And then the companies would need to recreate their business models and figure out who to insure.  Not good news for the current big dogs like Allstate, Progressive and Geico if they do not adapt.

Auto Manufacturers: Think about your car.  It probably sits in your garage or commuting park spot most of the time.  (Cars are unused almost 95% of the time).  With driverless cars entering the equation, the logistics will change.  The driverless car that takes you to work can go home and service other people in your family and then come back to pick you up after the workday.  The need for multiple cars in your family declines.  Fewer cars due to car sharing translates to fewer vehicle sales, and less revenue for the car manufacturers.

Auto Parts Manufacturers: A large part of the demand for the products in this industry is from supplying replacement parts after auto accidents.  With more car sharing, the total number of vehicles on the road will decline, reducing the demand for normal maintenance parts as well.  Moving to autonomous cars and electric vehicles also reduces the number of moving parts in a car like fuel injectors or turbochargers.  Continental and Magna are leaders in this industry.

Hospitals: Motor vehicle injuries account for 12% of emergency departed related visits, 15% of hospital admissions, and a substantial 26% of hospital revenue.  Hospital emergency departments are often seen as money losers, but studies have shown ED’s are profitable as getting more profitable as more patients gain health care coverage through the Affordable Care Act.  Add on the revenue from emergency department patients admitted to the hospital and fewer motor vehicle accidents would be a material revenue void.

Oil Companies: Half of every barrel of crude oil is used to make gasoline.  Fewer cars on the road could translate to lower demand for gasoline.  However, some believe the average miles driven for each car will rise.  So why does the demand for oil drop.  The answer is driverless cars will run on cruise control all the time which experts believe will deliver a 20-30% improvement in fuel economy.   Furthermore, the anticipated lower weight and aerodynamic styling combined with active traffic management could lead to a 50% improvement in fuel economy from driverless cars.  As technology evolves and innovators continue to advance the capabilities of all-electric vehicles, the threat to the revenue stream of the oil industry will grow.  U.S. oil refining companies appears most vulnerable to lower gasoline demand including Valero, Marathon Petroleum & Phillips 66.

Parking Garages:  The cost of a parking space in an expensive city like New York can be prohibitive.  According to Miller Samuel Real Estate Appraisers the average parking space in New York City costs $165,019 or $1,100 per square foot.  This is close to the average apartment price of $1,107 per square foot.   The average cost of NYC monthly parking is around $430.  Daily rates can easily top $50 for a prime location.  As you travel further away from the prime location the opportunity for cheaper parking rises.  The opportunity to get out of your car at your destination and have it travel a few miles away without a passenger to find a cheap parking space will be irresistible to some.  The prime space parking garage will have to compete with much cheaper competition.  This is not a good formula for a healthy revenue stream.

Downtown Real Estate:  In some cites downtown parking garages occupy up to 30% of the real estate.  If many of these parking garages are closed in favor of offsite locations there will be a new supply of real estate available for other uses.  This will probably put some downward pressure on real estate prices.

In our next discussion, we will focus upon those sectors which we believe will benefit from the development of the driverless car technology.  Stay tuned!!

Sincerely,

Princeton Global Asset Management LLC

Important Disclosures:
This report is for informational purposes only, and contains data based on information Princeton Global Asset Management (PGAM) believed to be accurate.  However, PGAM cannot assure the accuracy of the data. Past performance is not a guarantee of future results.  Portfolio holdings and characteristics are subject to change. The information in this report should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of these securities transactions or holdings that may be cited were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of securities cited.

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