Demand for electric vehicles (EV) is growing quickly, and so is the EV battery industry, which has been dominated by a few large players. In 2020, China’s CATL (300750.SZ), South Korea’s LG Chem (051910.KS), and Japan’s Panasonic (6752.T) enjoyed a combined EV battery market share of 68%, according to Goldman Sachs’ estimates.
That dominant trio is about to get a potentially powerful new competitor in the form of South Korea’s SK Innovation (096770.KS), which is part of billionaire Chey Tae-won’s SK Group, the country’s third largest conglomerate. After agreeing to pay a 2 trillion won ($1.8 billion) settlement to LG Chem for the alleged theft of its intellectual property, SK Innovation is now putting the pedal to the metal in the EV battery business. The market saw the deal as a clear win for SK Innovation, whose shares gained 12% on the first day of trading after it was announced.
The U.S. International Trade Commission (ITC) had ruled in LG Chem’s favor on February 10, which meant that SK Innovation was barred from producing EV batteries in the U.S. The settlement came at the 11th hour of a 60-day window in which the Biden administration could overturn the ITC’s ruling. By settling, SK Innovation is now free to produce EV batteries in the U.S., and it saves the Biden administration from having to step in to further its EV agenda. SK Innovation will finish building out a $2.6 billion factory in Georgia which will supply up to 310,000 EV batteries per year to Ford Motor Co. and Volkswagen AG. Here are other some things you should know:
SK Innovation has deep pockets, and it really wants to grow in EV batteries.
This intellectual property fight was a battle of titans. SK Innovation and LG Chem are subsidiaries of two of South Korea’s largest chaebol, SK Holdings and LG. The SK group of companies is a sprawling industrial conglomerate which employs more than 70,000 people across more than 90 businesses. Now it is expanding aggressively in EV batteries.
In addition to EV batteries, SK Innovation, which lost $1.3 billion dollars in 2020 and is not expected to turn a profit until 2022, makes separators, which prevent the batteries from exploding in the charging process. It also owns Korea’s largest oil refinery. The company’s single digit share of the EV battery business, much less than LG Chem’s and CATL’s roughly 25% shares each. It seemed to have been willing to do almost anything to get bigger. According to LG Chem’s complaint to the ITC ruling, SK Innovation allegedly hired away 80 LG Chem employees to gain access to its rival’s trade secrets. The ITC concluded that SK Innovation had destroyed documents, purportedly to cover up the alleged theft. And now it is paying LG Chem a hefty settlement. SK Innovation must view this as worthwhile table stakes for entry into the U.S. EV battery market.
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What is the bull case?
In 2020, SK Innovation delivered 10 gigawatt hours of EV batteries to car makers, up 195% over 2019. Its factory in the state of Georgia will complement existing factories in South Korea and China, along with ones planned in Hungary and Poland. All told, its manufacturing capacity will rise to 125 gigawatt hours (including joint ventures) by 2025. By comparison, CATL had 87 gigawatt hours of capacity in 2020, which is expected to reach 414 gigawatt hours in 2025.
SK Innovation counts Volkswagen and Ford in the United States, Daimler in Europe, and Hyundai/Kia in Asia as anchor OEMs. Strong shipments for the Hyundai Kona EV in Europe, and the Kia Niro EV boosted growth, and there may be more to come. Relations between LG Chem and Hyundai/Kia soured when the Kona EV, a best-selling model, had to be recalled after vehicle fires were attributed to LG Chem’s batteries, and the rumor is that LG Chem’s loss may be SK Innovation’s gain.
BNEF projects global EV car sales will rise from 1.7 million units, or 2.6% of cars sold, in 2020, to 26 million units or 28% of all cars sold, in 2030. Goldman Sachs analyst Nikhil Bhandari, who has a “buy” rating on SK Innovation, thinks it can maintain an 8-10% share of the market between now and 2030, but thinks the stock is only pricing in a 3%-5% share. Bhandari estimates the company will turn a profit in 2022. His price target, taking the settlement into account, is W350,000, affording shareholders a possible 30% return.
What are the risks?
SK Innovation has an unusual business configuration and less-than-stellar corporate governance. Net debt to equity is high, at 52.4%, and its leverage will likely rise as it builds out its manufacturing capacity. Asset sales could help reduce leverage. Options include a recently announced sale of its stake in two Peruvian gas fields for 1.25 trillion won, the potential IPO of its separator business, or a possible sale of its SK Lubricants subsidiary, among others.
Another threat to the company’s story is the trend toward in-sourcing batteries, as seen with Tesla, and most recently, Volkswagen. At its Power Day in mid-March, Volkswagen announced that it’s building out a staggering 240 gigawatt hours of EV battery facilities across Europe. Some of this will be in-house and some through joint venture partners Northvolt AB, which recently placed a $14 billion EV battery order, and solid-state battery maker QuantumScape, though it does not rule out buying from existing partners like SK Innovation.
The big question is whether pricing will remain rational as players build out capacity. If not, companies such as SK Innovation could find themselves driving into a wall.