The Henderson Global Growth strategy, which reached its 5-year anniversary in May 2015, seeks to identify key themes driving world change. One of these is greater energy efficiency. This has been a key theme within the portfolio of the Henderson Gartmore Global Growth Fund for a number of years with holdings well placed to benefit from further government initiatives and technological advances.
The quest for greater energy efficiency is being driven by a combination of factors. Firstly, from an environmental perspective, global temperatures are rising and energy related CO2 emissions are a material contributor to this change. Warmer temperatures are linked to higher incidence of extreme weather, which in turn has a disruptive effect on global food production and water supply.
Energy independence
Secondly, carbon fuels are ultimately a finite reserve and intensity of consumption must be curbed while alternative energy sources are developed for mass use. Additionally, energy independence has become a key topic for governments wishing to insulate their economies from fluctuating commodity prices and supply restraints. Confronting these issues, governments in countries covering 80% of global passenger vehicle sales have set stringent targets for fuel economy or emissions.
Increasing fuel efficiency
In the US, for example, the National Highway Traffic Safety Administration (NHTSA) has mandated that the average passenger car’s fuel economy must increase from around 35 miles per gallon (mpg) today to 56mpg by 2025, and other regions and countries are following suit as shown in the chart below.
We believe that in order to meet these government mandated standards, improving the efficiency of the internal combustion engine will be a key consideration for automotive manufacturers for at least the next 10 years.
Smarter engineering
The US Department of Energy estimates that only 18-25% of the energy in gasoline is converted to powering the wheels in the average internal combustion engine powered car, so there is clearly room for gains to be made through smarter engineering.
We invest in companies that manufacture parts and sell technologies which increase the efficiency of the internal combustion engine, and are growing the value of their parts within the car. Stocks currently held related to this theme include Continental, a Germany-based automotive supplier, Valeo, a multinational automotive supplier based in France, along with US auto component manufacturers Delphi and BorgWarner.
Many of the improvements being made by these companies are typically based on proprietary technology, generated through superior engineering and provide the companies with a long-term competitive advantage, which protects their high market shares. The table below shows the positive effects from using various types of car technology on fuel consumption and carbon dioxide emissions.
Stock in focus: Continental
We believe the market has undervalued the pace and sustainability of the growth which these auto component companies possess, creating an attractive investment proposition today for our funds.
For example, Continental, which the fund has a weighting in of approximately 1.7%, has strong market positions across its powertrain division with a broad portfolio of engine parts from turbochargers to start-stop technology, geared towards increasing fuel efficiency and reducing emissions. Based on our investment criteria, Continental is attractive on a number of measures:
German efficiency
Continental also has one of the market-leading tyre brands and currently trades on 14 times 2016 estimated earnings*. With a rapidly improving balance sheet and strong cash flow generation, investors in Continental have benefited from recent capital growth, as shown in the chart below, as well as a healthy return of cash. We see further upside based on the company’s high exposure to the secular growth areas of carbon dioxide reduction, active safety and in-vehicle infotainment (systems in automobiles that deliver entertainment and information content).
Ian Warmerdam is Director of Global Growth Equities and lead manager of the Henderson Global Growth Fund, the Henderson Gartmore Global Growth Fund.
