14 Sep 2021
Andrew Chambers, Portfolio Manager, Real Assets
Over the past few years, we have seen many high-profile companies and sub-sectors perform well on the back of increased demand for green energy. We are now seeing Electric Vehicle (EV) makers, clean energy developers and equipment providers, mining companies, input suppliers and others trading on very high multiples and/or offering very little yield to investors.
The demand for green energy is not going away, but by looking further afield into related industries, we believe very attractive yield and growth opportunities can instead be found in the ‘lower-profile’ or the ‘behind the scenes’ Real Asset stocks.
The areas that excite us the most are the incumbent utilities in Electricity Transmission and Distribution. These are an integral part of the transition to cleaner energy sources, linking the bourgeoning clean energy supply chain with the growing demand.
Companies in the Electricity Transmission and Distribution Utilities space generally have very strong market positions and pricing power, high barriers to entry and are regulated monopolies. In our opinion, this could lead to strong cash flows, profit, and dividend generation over many years, irrespective of the business cycle.
As a result of their regulated nature, investors have often viewed these sub-sectors as just boring ‘yield plays’. Instead, we believe there is significant undervalued income growth ahead as electrification demand and new clean energy asset connections to the grid continue to grow.
Many regulated utilities’ asset bases and revenue streams are also escalated with reference to inflation or have operating cost increase pass through mechanisms, therefore higher inflation (even if transitory) can further increase revenue growth.
We are starting to see some movement on this way of thinking in the market, for example, with the recent takeover proposal for Australia’s Spark Infrastructure from private North American consortiums, we believe the market is starting to recognise the value of strong growth ahead, and this kind of activity will start to narrow the valuation gap.
We see that the demand for clean energy supply will continue to evolve and benefit the incumbent Electricity Transmission and Distribution Utilities for years to come. This is due to several interconnected themes related to the transition to clean energy:
Greater electricity demand overall
Increased demand for both green and standard energy is being seen from new technologies such as:
New large scale clean energy projects
Wind, solar and hydro have a lower capacity factor versus existing thermal generation.
This means that when clean energy projects are connected to the existing electricity network and customer base, capacity needs to be 2-3x larger than the existing thermal generation to accommodate demand. This provides opportunities for the incumbent utilities to grow their infrastructure with less risk.
Increase in household solar
The increase in solar panel installations on household rooftops is facilitating the reversal of household electrical flows. New larger and more efficient systems will create excess power available in the middle the day that needs to be carried.
Construction of electricity storage projects
Connecting large scale batteries and pumped hydro storage projects to the grid will facilitate the storage of intermittent clean energy such as wind and solar.
Growth in the absolute number of connections
New connections to the electricity network are a function of Asia Pacific population growth outlook and in parts of Asia the growth is further boosted by connecting electricity to new areas/regions for the first time.
The potential of hydrogen
While it is early days in terms of widespread adoption of hydrogen, we are witnessing strong interest from several Asian countries for Australia to become a major producer of green hydrogen.
For the green-hydrogen industry to develop scale, there will also need to be significant investment in large-scale renewable energy network infrastructure to aggregate the renewable energy and bring it closer to market.
Greater demand = better earnings and long-term dividend growth
The increased demand for a clean energy supply will flow on to demand for the services of the Electricity Transmission and Distribution Utilities sub-sectors and we believe this could be an exciting growth opportunity for income-focused investors.
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