The journey toward clean or efficient transportation has been slow and bumpy—much like a new driver learning to operate a clutch on a hill—but a number of sectors along this route are picking up speed.

In addition to electric and hybrid-electric vehicles, greater focus is being directed toward natural gas-powered vehicles, more-efficient engines, lighter-weight materials, mass transportation projects and other efforts aimed to reduce gasoline consumption and carbon emissions.

“Efficient transportation was bifurcated by the Great Recession and then cleantech stimulus was given and taken away,” says Bill Page, a senior vice president and portfolio manager with Essex Investment Management Company LLC, a Boston-based investment advisor that manages more than $700 million in assets. Also hindering growth, he says, has been strong lobbying power for fossil fuels and the politicization of climate change.

Now global supply and demand economics, rising fuel economy standards and mounting environmental concerns are making it harder to ignore this “sort of under-recognized area of cleantech,” he says.

Page co-manages the Essex Global Environmental Opportunities Strategy (GEOS), an all-cap, global, listed-equity strategy that invests across nine cleantech themes. He also provides coverage on cleantech and clean energy stocks held in Essex’s other growth-oriented investment strategies and has published and contributed to reports on efficient transportation. “Investment opportunities in efficient transport are primarily based on the need to do more with less,” he says.

According to the International Energy Association (IEA), transportation accounts for nearly one-quarter of global CO2 emissions, about three-quarters of which comes from road travel. In the U.S., 28% of the energy supply is used by the transportation sector, which consumes 72% of all petroleum supply sources, he also notes.

By 2025, the U.S.’s Corporate Average Fuel Economy (CAFE) standards for new cars and light-duty trucks must average 54.5 miles per gallon, nearly double the current requirement. By 2020, vehicle makers must meet fuel economy standards of 57.6 m.p.g. in the EU and 47 m.p.g. in China.

“The race is really just starting,” says Page, who notes that reaching these standards will require carmakers to add efficiency to nearly every component of a vehicle. This includes redesigning engines and drivetrains and using lighter-weight materials. Reducing a vehicle’s weight by 10% can help improve its fuel economy by 6% to 8%, according to the U.S. Department of Energy.

At the same time, global demand for vehicles is booming. According to the report “World Energy Outlook 2011” from the IEA, the number of passenger cars on the road is expected to double to nearly 1.7 billion by 2035 versus its volume at that time. Much of this demand will come from the developing world. “We believe one needs to have a global perspective on this and we have significant exposure to companies in emerging markets,” says Page. “The next 3 billion middle-class consumers are there.”

While EV and hybrid vehicles still represent a very small part of global unit sales (their combined market share for U.S. passenger vehicles was just 3.4% in 2012), “they are game-changing and we think they’ll be a significant part of the auto industry in the next 15 to 20 years,” he says. He expects to see market fragmentation, with many city-based drivers opting for small plug-in vehicles as their suburban counterparts stick with larger, traditional vehicles.

As engine efficiency and drivetrain efficiency technologies become more commercially viable, he thinks they will begin to be offered in vehicles at all price points. He also anticipates greater adoption of route optimization software by fleets, which helps reduce energy usage and emissions, and growing interest in the car-sharing concept, which was popularized in the U.S. by Zipcar. Companies in China and India launched car-sharing operations last year. 

Page is not permitted to discuss positions held in the GEOS portfolio, but he says some companies reflected in these efficient transportation themes include aluminum manufacturer Alcoa (NYSE: AA), carbon-fiber and composite maker Hexcel Corp. (NYSE: HXL) and BorgWarner (NYSE: BWA), a global technology leader for engines and other vehicle systems.

Next-Generation Opportunities
Global venture capital investment in clean transportation fell from $261.9 million in the second quarter of 2012 to $131.9 million in the second quarter of 2013, while the number of investments climbed from 15 to 24, according to the report “Cleantech Redefined,” published in October by Kachan & Co. (a cleantech research and consulting firm headquartered in Vancouver) and U.S.-based nonprofits As You Sow and the Responsible Endowments Coalition.

“I wouldn’t be worried about the lumpiness from quarter to quarter,” says Dallas Kachan, the managing partner of Kachan & Co. and a co-author of the report. Just a few deals can skew asset figures, he notes, and he is encouraged by the rising number of deals. “It speaks to the fact that a lot of people are placing bets on next-generation transportation,” he says. Furthermore, the role of corporate capital in clean transportation is also growing but is not being tracked, he says.

Electric vehicles, which can be charged quickly and yield zero emissions, appear to be the technology for the immediate future, he says. The drawback, he says, is that the power to charge them has to come from somewhere.

He thinks it’s too early to predict the future of fuel cell technology, which the big automakers continue to pursue. Water vapor is the only emission, he says, “but the challenge is making hydrogen is a pretty dirty process, and they haven’t quite cracked the code.” Even if seawater can be used, an option being studied, it requires a lot of electricity, he says.

Kachan views Toyota Motor Corp. (NYSE: TM) and Nissan Motor Co. (TYO: 7201) as the top large-capitalization opportunities in the electric, hybrid electric and fuel cell vehicle space. “They are the most progressive in hybrids,” he says, “and they have the technology, distribution and financing structure to push any vehicle to market and succeed.”

Next-generation mass transit systems can have the biggest impact on the largest number of people, he says. This includes high-speed rail systems and magnetic levitation (maglev) trains, which float above tracks in an electromagnetic field. Central Japan Railway (TYO: 9022) is a leader in this space, he says.

Electric vehicle charging technologies is another investment idea identified by Kachan and his colleagues. They point to ABB, a Zurich-based global leader in power and automation systems (NYSE: ABB) and Schneider Electric S.A., a France-based global specialist in energy management. Its shares trade on the Euronext Paris exchange under the symbol “SU.”

Kachan is interested in traffic control systems, which aim to reduce urban congestion and fuel consumption by using GPS-based technology to bill drivers based on time of day and location. London implemented such technology more than a decade ago and more municipalities are trialing it. He is keeping an eye on micro-hybridization technology, which turns off combustion engines when vehicles stop. Although uncommon in the U.S., more than 40% of cars in Europe utilize this, he says.

He is also looking for opportunities in ancillary sectors such as waste heat recovery systems, which eliminate the need for air conditioning and auxiliary power units in long-haul transportation trailers. “Anything that helps raise gas mileage today is worth exploring,” he says.

Kachan is concerned about the valuation of electric carmaker Tesla Motors. So is Elizabeth Levy, a portfolio manager who co-manages the all-cap core strategy and fossil-fuel-free strategy at Boston-based Trillium Asset Management. Trillium, which manages over $1.3 billion of assets, used to own Tesla’s stock but feels it’s too expensive now. In late March, it was trading at 123 times the 2014 earnings-per-share consensus from FactSet.

“It’s lofty for an early adopter technology and a story with significant execution risks,” she says, but “we like the company and expect it to continue to be successful in rolling out electric cars.”

Useful and Practical
“We’re always looking for companies that provide more transportation using fewer resources,” says Levy, and “we like to look at technology that’s already useful and practical and from more mature companies.”

Trillium clients own shares in railroads Canadian Pacific—which trades on the New York and Toronto stock exchanges under the symbol “CP”—and Kansas City Southern (NYSE: KSU). According to data cited by the American Association of Railroads, railroads are on average four times more fuel efficient than trucks, and moving freight by rail instead of by truck lowers greenhouse gas emissions by 75%, on average.

Since its 2012 management change, Canadian Pacific has seen improved operating margins and is putting more emphasis on efficiency and safety, says Levy. The FactSet consensus calls for earnings growth of 26% in 2014, 27% over three to five years—well above the industry average of 13% and 15%, respectively, for the six publicly traded Class 1 railroads in the U.S./Canada.

Kansas City Southern, the primary north-south line that travels through the middle of the U.S. and into Mexico, moves a lot of freight in intermodal containers. “Intermodal is one of the main drivers of freight in the railroad industry,” she says. New car factories being built in Mexico for the U.S. car market should also help drive growth, she says. FactSet consensus earnings growth is predicted to be 16% in 2014, 17.6% over three to five years.

Trillium clients also hold Wabtec Corp. (NYSE: WEB), a leading supplier of positive train control (PTC) systems. These systems, “which let trains and tracks talk to each other to prevent accidents,” explains Levy, must be implemented across much of the U.S. rail system as of year-end 2015 under the Rail Safety Improvement Act of 2008. “It’s a great company,” she says, “and also a good sustainability story because of increased safety.”

BorgWarner is another Trillium holding. The company develops products, including turbocharging systems, which improve fuel economy, reduce emissions and enhance performance. It sells to most of the global carmakers, says Levy.

Trillium also holds Westport Innovations (Nasdaq: WPRT), whose engines enable medium-duty trucks and buses to run on natural gas. Although the company is not expected by analysts to be profitable until after 2016, its technology is proven and it has a joint venture with power leader Cummins, says Levy. “We’re excited about this opportunity because natural gas has lower greenhouse gas emissions,” she says. “Natural gas is acting as a bridge fuel away from more carbon-intense fuels for the short term.”

Kachan notes that Westport also makes conversion kits that enable gasoline engines to use natural gas. “Short of moving to a natural gas vehicle,” he says, “it gives access to lower-priced fuel that burns cleaner.”

Final Words
Page encourages investors to keep an open mind about efficient transportation and cleantech in general. “The beauty of cleantech today is a lot of the artificial stimuli are gone and the excess capital has come out of the market,” he says. “There are plenty of places to go in the cleantech world beyond wind and solar.”

Down the road, Kachan thinks efficient transportation companies requiring modest amounts of capital, say maybe around $1 million, may be able to successfully use crowdsourcing. Crowdsourcing platforms Kickstarter and Indiegogo are already helping fund next-generation cleantech, he says, and he is awaiting implementation of the JOBS Act.

“In theory, it should open the floodgates for a large number of unaccredited investors” in clean transportation, he says. “Everyone knows what a car is, has seen The Jetsons and wants a next-generation vehicle—it captures the imagination.”