Batteries are taking over the world

The battery industry is surging. But picking investment winners will be exceedingly hard

“The storage battery is, in my opinion, a catchpenny, a sensation, a mechanism for swindling the public by stock companies,” wrote Thomas Edison in 1883.

Today, the battery industry is mustering for exponential growth as car makers electrify their fleets, most visibly at Tesla ’s USD 5 billion factory in Nevada. For investors looking to gain from the battery’s rise, though, the doubts of the 19th-century entrepreneur linger. The path to profitability is far from clear.

Your mobile phone contains a lithium-ion battery and so does every battery-electric or hybrid car. The difference is that cars require vastly more powerful batteries. The industry will need to increase production from 68 gigawatt-hours of lithium-ion cells last year to 1,165 GWh over the next decade, estimates brokerage Berenberg.

A handful of big East Asian companies have rushed into this supply gap. For all the “gigafactory” hype, Tesla doesn’t make batteries: Cell production is the responsibility of its Japanese partner, Panasonic. The other leaders in the field are LG Chem and Samsung SDI, both listed subsidiaries of the namesake Korean conglomerates, which supply the electric-vehicle projects of Nissan Motor , General Motors and BMW , among others.

Hot on the Koreans’ heels are two Chinese companies determined to supply the ballooning Chinese electric-vehicle market: BYD , 8.25 %-owned by Berkshire Hathaway and an electric-car maker, and Contemporary Amperex Technology, which is planning a USD 2 billion initial public offering in Shenzhen in coming months. These five companies and a few newcomers intend to build 24 factories with a total capacity of 332 GWh by 2021, calculates Simon Moores, managing director of consulting firm Benchmark Mineral Intelligence.

The CEO of Tesla at a presentation of his car

Investors looking to benefit from this gold rush need to take a long-term view. The capital requirements are vast, and the contracts being signed are at wafer-thin margins.

Negotiating with car makers will also be tough. Outside China, the automotive industry is highly consolidated, and manufacturers are under intense pressure from environmental regulators to sell electric cars even though their cost is uncompetitive. The only solution for car makers will be to pile pressure on battery prices. Big new factories will enable suppliers to cut unit costs, but profits could get lost in the squeeze.

Investors may be better off looking further up the supply chain. The most valuable component of a battery is its cathode, from which lithium ions scuttle back and forth in the charging and discharging process. The chemistry is sophisticated and fast-evolving, which should offer cathode makers some protection from cost pressures. Japan’s Sumitomo Metal Mining supplies Panasonic for Tesla, while Belgium’s Umicore and a few others cover the rest of the market.

The risk for these companies is that a radically new technology makes existing investments obsolete. John Goodenough, a 95-year-old professor at the University of Texas considered a founding father of the lithium-ion battery, this year claimed a breakthrough with “solid-state” cells. Toyota Motor expects to sell cars with solid-state batteries by the early 2020s.

The battery industry is poised to expand very fast, but the growth will be capital intensive and may be technologically volatile. Batteries may no longer be a trick for swindling amateur stock pickers, but that doesn’t mean they will provide an easy way to make money.