Renewed global commitment to the environment has ignited much investment chatter, driving stocks in the clean tech and renewables space to ultra-high valuations. It is easy for investors seeking outsized returns to get caught up in the hype. But investors seeking long-term alpha (beating an index) or just positive returns should proceed warily given the valuation risks in the clean tech sector.
Climate change is everything
The 2020 Covid-19 pandemic initiated a great reawakening for climate change issues amidst a renewed focus on the green agenda by global governments. In the US, newly inaugurated President Joe Biden has already cancelled the Keystone XL pipeline, re-joined the Paris agreement and plans to ban new oil and gas leases on federal land.
Even coal-reliant China has now pledged to achieve carbon neutrality before 2060. It also expects to lower its CO2 emissions per unit of GDP by 65% from the 2005 level by 2030, increase the share of non-fossil fuels in primary energy consumption to 25% and bring its total installed wind and solar power capacity to more than 1.2 billion kilowatts.
Meanwhile, Europe is leading the world in terms of committed capital expenditure. The European Green Deal is pushing for net zero emissions by 2050, earmarking at least €1 trillion of public green energy funding.
There is also a call for Southeast Asia to meet the rapidly growing demand for change by using clean energy to minimise environmental impact. In February, The Asian Development Bank and Japan’s Ministry of Economy, Trade and Industry signed a memorandum of cooperation to enhance their joint efforts to promote clean energy in Southeast Asia. The focus will be on the areas of renewable energy, energy conservation and efficiency, and other technologies that will facilitate the transition to low-carbon energy.
With the added push from other developed economies driving their own initiatives, green energy infrastructure investments should grow into the trillions of dollars – mostly funded through public-private collaboration – to de-carbonize the global economy.
Is the sustainable route more lucrative for investors?
Clean technology and renewable energy are thus poised to be the biggest areas of global capital allocation. The sector should offer investment opportunities in the areas of renewable sources such as solar and wind, green hydrogen (as an alternative for natural gas) and infrastructure investments to support electrification.
However, this does not mean that opportunities will translate into outsized returns. In fact, investors should be wary of lofty valuations in the clean tech sector. For example, we’ve also observed a giant in offshore wind power that is trading at an exceptionally expensive multiple of 47 times 2021 earnings per share (47x 2021 EPS).
There are nevertheless still some opportunities in better valued companies. For example, we own Quanta Services in the Foord Global Equity Fund. Quanta is a US leader in the construction and maintenance of electric grids that trade on a much lower multiple of 23x 2021 EPS. While not exactly cheap, it is still far more affordable than some of the bigger companies.
Furthermore, investors should consider how companies diversify their earnings. For example, Quanta will benefit from upgrades needed to generate green energy via wind, solar or hydrogen. Also, many US and European utilities, such as Scotland’s SSE and California’s Edison International—both owned at times in the Foord Global Equity Fund—are forward thinkers and leaders in the transitional to green energy. These companies offer a similar exposure to renewables at a fraction of the valuation of bigger players. At the time of writing, SSE and Edison are on 15.5x and 12x 2021 EPS, respectively.
Stay the lane or go against the grain?
Clean tech and renewable energy trends are on the right side of history and seem like a clear investment bet. But while clean technology and renewables should provide opportunities for investors seeking investment growth or just to make a difference, the strategy should be to be invested for the long haul. Speculation and trend-following will guarantee neither outcome. Investments must be assessed for long-term returns via their long-term earnings. This requires that investors take positions based on a deep understanding of the market and valuations, instead of following current market sentiment.
Recent events have illustrated a great deal of interest and potential in the sector. The best investment approach to the trend is one that offers asymmetric risk reward to protect investor capital and deliver a safe investment yield. This can only be achieved by constructing diversified investment portfolios based on rigorous fundamental research, high-conviction ideas and an adaptable, value-driven investment policy.
Brian Arcese is a portfolio manager at Foord Asset Management.