What’s going on with electric vehicle (EV) stocks like Rivian (NASDAQ:RIVN), Lucid (NASDAQ:LCID), Fisker (NYSE:FSR), Gores Guggenheim (NASDAQ:GGPI) and Nikola (NASDAQ:NKLA)? Shares of the mentioned EV companies were all red at some point during the day today. Reports of a continued shortage in semiconductors have hampered shares of EV stocks this week. In addition, soaring prices of key EV battery components, such as lithium, nickel and cobalt, have caused disruptions across the industry.
On top of that, comments from Federal Reserve Chair Jerome Powell have spooked investors, sending shares of long-duration names down.
Let’s get into the details.
Why Are EV Stocks Down Today?
Many EV companies, like Lucid and Rivian, currently produce very little cash flow. As a result, the value of their stocks lies in the basis of discounting cash flows from the future back to the present value. With increased interest rates, these future cash flow values will be reduced. Furthermore, companies with cash flows far out in the future are classified as long-duration.
The basis of this concept draws from the discounted cash flow model. In the model, interest rates positively correlate with the weighted average cost of capital (WACC). The WACC measures a company’s cost of capital across all sources of debt and equity. Additionally, the WACC is used as the discount rate and is placed in the denominator of the model. Meanwhile, cash flows are placed in the numerator of the model. Therefore, if interest rates go up, the value of future cash flows goes down.
Powell’s Comments Send Electric Automakers Lower
Yesterday, Powell stated that a 50-basis-points (bps) interest rate hike “will be on the table” the next time the Fed meets on May 3-4. With inflation running rampant, the Fed chair noted that “it is appropriate to be moving a little more quickly.”
Now, overnight federal fund futures are implying that the Fed will increase interest rates to between 2.75% and 3% by the end of the year. To achieve this, the Fed would have to raise rates by 50 bps at the next three meetings, and then raise rates by another 25 bps at each of the remaining three meetings. Reuters reports that a rate between 2.75% and 3% would take the interest rate beyond the “neutral” level. As a result, the high rate could potentially restrict economic activity.
All told, interest rate increases historically do not bode well for stocks, especially long-duration names. If the Fed aggressively hikes rates, then the rest of 2022 could continue to be a rough year for EV stocks.
On the date of publication, Eddie Pan did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.