Views From the Floor - One Part of the Battery Market is Showing Classic Signs of a Bubble

While the electrification trend helped electric vehicle (EV) makers in previous quarters, attention has more recently turned to not just EV battery makers in general but to a specific section of the market involved in manufacturing a specific component of the batteries: the cathode. And the frothiest of the technologically advanced manufacturers are currently to be found in South Korea.

Although the trigger for the bursting of a bubble is always difficult to pinpoint, there are a number of classic signs that are apparent when an asset bubble is inflating, and the South Korean cathode bubble displays them.

• Colossal equity price increases with little change in fundamentals. One of the listed South Korean holding companies involved in EV battery materials has seen a share price return of 1,100% annualised in the year to date (YTD) and now has a market capitalisation of close to $25bn. Its listed subsidiary has shot up by over 400% YTD.
  
  The strategy of floating the cathode companies has worked wonders. As in many other bubbles, it creates a circularity of “bonheur”: the subsidiary with a smaller free float goes up, pushing up the more liquid holding company too. But the cathode companies are moving up not based on fundamentals and valuations but simply on announcements of future capacity expansions. The more management teams announce capacity increases, the more the stocks go up. Value creation prospects associated with this capacity increase simply do not seem to matter.

Figure 1. Looking like a bubble, one of the South Korean cathode companies

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Source: Bloomberg. As at end July 2023. The organisation depicted is for reference purposes only. The content of this material should not be construed as a recommendation for their purchase or sale.

• Valuations become meaningless. Korean cathode makers are trading at around 40 to 50 times 1-year forward EBITDA multiples, according to Bloomberg data. The historical average and worldwide reference for an auto supplier is a multiple of around 5 times. Chinese cathode peers are more expensive than the global average but still trade at an average of 8 times EV/EBITDA multiple.
• Disproportional movement in the supply chain. This staggering market performance by cathode companies has not been followed by their clients, the Korean battery makers. Despite the cathode being just a small part in the EV battery value chain, Korean cathode makers command a market cap that is higher than the battery manufacturers who buy from them.
• False claims of proprietary intellectual property features. The cathode space is – and will increasingly be – a commoditised part of the battery value chain. Market insiders estimate the global cathode market will be in an oversupply situation over the next decade. The space is deemed ripe for consolidation, with the largest players set to derive the highest return – and yet not even that is a sufficient condition to guarantee the cost of capital will be covered.
• Concerns with governance. There have been high-profile cases of industry individuals illegally profiting from the frenzy by using undisclosed information from cathode companies.
• Index inclusion. The prospect of tracker funds being prompted to buy the stocks if they are included in broad-market indexes would create even further incremental demand for the stocks.

To put this into context, a historical comparison is useful, and a picture paints a thousand words. Figure 2 shows how similar this run-up phenomenon is to the rapid price gains up to the peak of the Nasdaq bubble of 2000 and more recently the Bitcoin frenzy of 2021. Those experiences are not dissimilar from what appears to be in the making for the Korean cathode makers.

Figure 2. Korean cathode maker compared with the Nasdaq and Bitcoin bubbles

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Source: Bloomberg. Korean cathode company price data from July 2018 to end July 2023. Nasdaq Index shown from December 1996 to December 2001. Bitcoin price from July 2018 to end July 2023.

There is no doubt that there is a seismic shift being brought about by the energy transition theme, and careful investors may well reap substantial profits from it in the longer term. However, the speculation in this specific segment of the South Korean market could well be a bubble waiting to burst.

(With contributions from Firmino Morgado, Portfolio Manager at Man GLG).