Franklin Templeton: UK Smaller Companies: transformative trends

Dan Green is tapping into four key long-term investment themes where pioneering goods and services are an emerging trend: The Digital Economy, Consumer Brands, Content & IP Creation and Decarbonisation. In the final instalment of a four-part series, he discusses the structural transformation driven by society’s shift to net-zero carbon solutions.

Decarbonisation as a global megatrend

The 2015 Paris Agreement triggered a swathe of announcements from governments and business leaders, with many publicly declaring their intention to reduce CO₂ emissions which result from human activity. The eventual goal of eliminating such greenhouse gas emissions - in pursuit of limiting global warming to 1.5⁰C above pre-industrial levels - is accepted by many as an ambitious yet essential target. Decarbonisation is now broadly considered a global megatrend which will force sectors to undergo structural change and fundamentally alter traditional business models - new business models will appear that place sustainability at the heart of company operations. The UK government has set out their proposals for decarbonising all sectors of the UK economy by 2050, in a net-zero strategy they have coined, ‘Build Back Greener.’ It is clear the transformation to lower-carbon solutions must become an important cornerstone in the strategy of every company. UK smaller companies are already supporting this shift in outlook, either by adapting their business model in line with the government led strategic path to net-zero, or by supplying goods and services that enable businesses and consumers to decrease or offset carbon emissions.

"The UK government has set out their proposals for decarbonising all sectors of the UK economy by 2050, in a net-zero strategy they have coined, ‘Build Back Greener.'"

Within the Martin Currie UK Smaller Companies Strategy we highlight three businesses that are beneficiaries and supporting the move to low carbon solutions.

Volution manufacture energy efficient ventilation products for residential homes and commercial properties and has been held in the fund since its IPO in 2014. The business aims to provide healthy indoor air in a sustainable manner with ambitious internal targets to be met by 2025 for 90% of plastic in its products to be recycled (currently at 67%) and for low carbon products to account for 70% of sales (currently 66%). In its core markets of the UK, Nordics, Germany and Australia regulatory drivers seeking to reduce carbon emissions from residential are driving sales with high energy costs now providing extra stimulus. For example, all new housing in the UK is set to be net zero carbon ready from 2025, requiring sophisticated ventilation and heat recovery products. These structural drivers have enabled Volution to consistently expand revenue over the last decade at a compound annual growth rate 

(CAGR) of 13.2%, which has been achieved through a combination of organic and inorganic growth. Now operating under 19 brands in 14 countries, Volution has a strong competitive position leading to operating margins over 20% and a high return on capital employed (ROCE). 62% of revenues are generated from non-UK customers, enabling the business to capitalise on the decarbonisation of the global economy and is an example of how UK smaller companies are not just aligned to the UK economy.

Gresham House is an alternative investment manager with most of its investments in real assets including forestry, renewable energy, battery storage and sustainable infrastructure. As the UK’s largest commercial forestry asset manager and with a growing international footprint we believe that they offer specialist and niche expertise as investors look for alternative and sustainable investment opportunities. The outlook is supported by resilient market trends – global alternative AUM is forecast to grow from $13.3tn at the end of 2021 to over $23tn by 2026.* Furthermore, funds with an ESG tilt have proved more resilient to asset flows over the past twelve months. This differentiated exposure relative to traditional asset managers has instilled a degree of resilience in the company with Gresham House growing its AUM in the first 9 months of 2022, including launching a carbon credits strategy for UK-based institutional investors. Despite strong relative performance in 2022, Gresham House still trades on a material discount to other listed alternative asset managers and to recent M&A activity such as Schroders purchase of Greencoat. The Gresham House 2025 plan to grow AUM to £8bn, EBITDA margins of 40% and ROCE to 20% is well on track with current AUM growing to £7.3bn at the interim results in June 2022 and we believe is just a staging post to becoming a much larger business.

DiscoverIE design and manufacture custom electronic components for industrial equipment manufacturers, with a niche in innovative electronics that make a difference to the planet and people’s lives. It consists of diverse businesses which are increasingly focussed four sustainable growth areas it has targeted: Renewable energy, transportation electrification, personal life and care enhancement, and energy efficiency, with its largest customers manufacturing renewable energy solutions in wind and solar. The business is benefitting from the alignment to structural growth areas driven by the decarbonisation agenda and is also reducing its own carbon emissions, lowering costs, and driving more efficient production. The 2025 carbon emissions reduction target was recently upgraded to 65% from 50% and the move to renewable energy sources such as solar to power their manufacturing sites has shielded them from some of the increase in energy costs seen recently. With the tailwind of being aligned to structurally growing markets such as renewable energy and energy efficiency DiscoverIE continues to evolve into a higher margin, more geographically diverse and higher ROCE business.

Source: Bloomberg, 31 December 2022 unless otherwise stated
* Source: Preqin as at 31/12/2021