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Tesla Motors, Inc.’s (TSLA - Analyst Report) decision to build a $5 billion Gigafactory to meet its requirement of lithium-ion battery packs brought glaring focus on the shortage of supply of this emerging energy storage technology. Lithium-ion batteries are used by many auto manufacturers, including General Motors Co. (GM - Analyst Report), Navistar International Corp. (NAV - Analyst Report), BMW, Daimler AG (DDAIF) and Ford Motor Co. (F - Analyst Report). They are also used in cellphones, laptops, and other electronic devices as well as in the aerospace and defense sector.

However, the market for lithium-ion batteries has a lot of untapped potential. Tesla, for example, is facing problems in meeting the demand for its electric cars due to shortage of battery packs, which is limiting its production capacity. This was one of the chief reasons behind its decision to build a large-scale factory to produce lithium-ion batteries in collaboration with various partners. The electric carmaker’s Japanese battery pack supplier, Panasonic Corp. (PCRFY), is widely believed to be one of the partners.

By 2020, Tesla expects the annual lithium-ion battery production of the Gigafactory to exceed the global production in 2013. The factory will produce enough battery packs to allow Tesla to build around 500,000 electric cars annually by 2020.

However, Tesla’s Gigafactory will not start production until at least 2017. Till then, the focus will be on other lithium-ion battery manufacturers. Thus, it would be a good idea to invest in some companies that manufacture these batteries.

Let’s take a look at two stocks that are looking good at the moment:

Arotech Corp. (ARTX) has two business divisions – Training and Simulation and Battery and Power Systems. The Battery and Power Systems division manufactures and sells Lithium and Zinc-Air batteries and chargers for the Military.

Arotech reported a 150% positive earnings surprise in the third quarter of 2013. This Zacks Rank #3 (Hold) stock is expected to report 100% and 411.11% year-over-year growth in earnings per share (EPS) in fourth-quarter and full-year 2013, respectively, based on the Zacks Consensus Estimate of 2 cents and 28 cents, respectively.

Arotech has a price-to-book (P/B) ratio of 1.3x, significantly lower than the industry average of 3.1x. Even the price-to-sales (P/S) ratio of 0.6x is lower than the industry average of 0.9x.

EnerSys (ENS - Snapshot Report) is the largest manufacturer, marketer and distributor of industrial batteries in the world. It also manufactures and distributes chargers, power equipments and battery accessories and provides aftermarket services for industrial batteries. The company recognizes the growing market share of lithium-based battery technology in the aerospace and defense sector, and is thus trying to develop products based on lithium and other new energy storage technologies to increase its market share in the aerospace and defense sector.

EnerSys, a Zacks Rank #2 (Buy) stock, reported a positive earnings surprise in each of the trailing 4 quarters with an average beat of 3.44%. The Zacks Consensus Estimate for the company’s fiscal 2014 (ending Mar 31, 2014) earnings is $3.87 per share, reflecting an estimated 9.01% year-over-year growth.

EnerSys has P/B ratio of 2.6x, far below the industry average of 6.5x. Its P/S ratio is 1.5x, also lower than the industry average of 1.9x. Long-term EPS growth rate for the stock has been pegged at 15.3%.

Bottom Line

According to Frost & Sullivan, the global market for lithium-ion batteries is expected to double to $22.5 billion in 2016 from $11.7 billion in 2012. Consumer goods and automobile sectors are driving the demand.

The share of the automobile sector in the lithium-ion battery market is expected to grow to 25% in 2016 from 14% in 2012, per the data from Frost & Sullivan. This represents a Compounded Annual Growth Rate (CAGR) of 37%. With the increasing use of lithium-ion batteries in consumer electronic products as well as efforts to promote the use of electric cars by many governments to curb pollution, the demand for these batteries is expected to rise.

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