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I wrote about the future of the driverless car last week, and discussed how auto technology is moving toward a future where cars have the ability to assist drivers in making maneuvers and avoiding accidents.
But I know that a lot of people aren’t entirely thrilled with the idea of ceding control over cars to computers. And I don’t think this is a small part of the population – even if the technology can decrease the severity and frequency of accidents.
So today I want to discuss another trend in auto technology that might hit a little closer to home for many investors. That trend is connected car technology.
In some ways this isn’t exactly a new trend – cars have been equipped with satellite radio and other relatively limited connectivity features for a while. But over the last two years the available features and level of integration with other mobile devices have grown significantly. And all signs point toward an explosion in connected car technology over the next five years.
IHS Automotive estimates that in 2013 there were 23 million connected cars worldwide. The research group sees that figure growing sixfold, to 152 million, in 2020.
That forecast implies that around 25% to 30% of new automobiles sold by 2020 will have connectivity features. (I’m assuming 74 million new automobiles sold this year and annual growth of 2.5 million units.)
Every major car manufacturer is introducing connectivity features into new models. And it’s not just the premium models anymore, either. Whether you’re looking at a Ford, Volvo, Volkswagen, Audi, Toyota, or BMW, you’re sure to find models equipped with connected technology that helps differentiate the model in question.
Capturing a Captive Audience
Why the big push? It’s pretty simple really. The car is arguably the one place outside of the home where a small, captive audience is just begging to be entertained, if not productive.
The connected car satisfies demands that many consumers didn’t even know they had, until they experienced the benefits.
It’s not just about a car stereo system anymore, though that’s certainly a big part of the appeal. It’s also about large screens displaying back-up cameras, blind-spot monitoring and a host of applications that until recently were only available on smartphones and tablets. And it’s also about differentiating cars in an industry that has enjoyed years of growth due to a Great Recession-induced delay in the upgrade cycle.
Let’s take a closer look at Volkswagen AG (OTC: VLKAY) as an example of what just one manufacturer is doing. In addition to the core brand, Volkswagen also owns the premium and ultra-luxury auto brands Audi, Porsche, Bentley and Lamborghini, as well as the motorcycle company Ducati.
The VW brand isn’t doing all that well in the U.S., where it only has around 3% market share. But there is potential for connectivity features to help change that.
One interesting feature is an Apple (NASDAQ: APPL) Watch app that will allow VW Car-Net-enabled vehicles ($17.99 per month or $199 per year) to monitor fuel levels and car location. The app will also be able to control locks, and it will allow parents to remotely monitor the speed of the vehicle – extremely handy (though potentially overbearing?) for parents of teenage drivers.
Connected-car features should also help sales of Audi in the U.S., a market where the brand has had more success than the VW brand.
In fact, all 2016 model year Audis will be equipped with Audi Connect, a wireless service powered by AT&T (NYSE: T). This service should be an easy addition for customers that already have an AT&T Mobile Share data plan.
For a broader perspective of how connectivity features could alter the global auto industry, consider the uncertain future of Nokia’s (NYSE: NOK) Here map service. Nokia has reportedly been looking for a buyer for the service, which is reported to power 80% of U.S. and European on-board navigation systems.
Potential suitors include Microsoft (NASDAQ: MSFT), Apple, Facebook (NASDAQ: FB) and Uber. But the big three German auto manufacturers – including Volkswagen, BMW (OTC: BAMXY) and Daimler AG (OTC: DDAIF) – are also interested in acquiring a majority stake.
If they could get their hands on Here they could potentially fend off competing connectivity services from large U.S. tech companies, while also helping to cement access to important technology to help develop autonomous vehicles.
Investor Road Map
Investors can easily purchase the stocks of automobile manufacturers to play this trend. But it’s hard to pick a potential “winner” from this group, given that they’re all producing some version of the connected car. Nokia is another option. But there is a lot more to this business then Here, so that’s not a very targeted play.
I think a better option is to go with select semiconductor stocks. At the very core of every smart automobile – whether it features advanced driver assistance systems (ADAS), simple back-up cameras, advanced sensors and radar, or the most advanced infotainment module money can buy – lies a complex array of advanced semiconductors. And that’s never going to change.
Over 60 companies supply the $30 billion automotive semiconductor market with chips, but the top six hold a concentration of 50% market share.
Many of these stocks have been strong performers over the last couple of years, and the long-term trend is to only incorporate more technology in automobiles. For that simple reason, the chip stocks are a good place to start. If you’re interested in learning about my favorite chip stock you can find out more here.
Another good option that is fairly specific to infotainment is Harman International (NYSE: HAR). You’ve likely heard of this company, or at least its well-known brands which include Infinity, JBL, Lexicon, AKG, Harman Kardon and Mark Levinson.
Harman is doing the right things at the right time, and it’s paying off. The company has become the key player to connect new technology developers and auto manufacturers. As CEO Dinesh Paliwal has said, Harman is the bridge between Silicon Valley and the automakers.
It’s not that easy to become the go-to audio device maker for a large car company. But Harman has done just that, in large part because of the popularity of its Infotainment business, which features dash consuls with integrated entertainment, navigation and communication technologies.
As I said before, it’s not just about audio anymore. Access to maps, social media, restaurant reviews, security, safety services and video entertainment are just a few additional features that customers are coming to expect while in their cars.
Harman has pulled back from its 52-week high of $149 and now trades around $120. Based on consensus estimates it is fairly reasonably priced with the forward price-earnings ratio sitting at 17.5. That factors in average annual revenue growth of 14% over the next two years, and average earnings per share growth of 24%. You’ll also earn a modest 1% dividend yield with the stock.
With demand for automobiles running strong in this extended upgrade cycle, manufacturers are pushing the limits to bring connectivity into the one place beyond the home where there is always a captive audience.
And I believe there remains many, many years of growth for the right semiconductor and infotainment stocks, especially given the warm reception with which many consumers have greeted the technologies thus far.
Have a great Fourth of July holiday, wherever you will be.
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