Energy Energy Energy

Energy is your hedging friend, energy crisis spells trouble for solar

Equities 8 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  The Q4 earnings season has shown that companies are facing significant headwinds on operating margins from inflationary pressures. Our analysis of the largest companies in the US and Europe shows that the energy sector and mining companies are the ones that are experiencing expanding operating margins as expected as inflation is coming from the supply side of the economy. These two themes continue to hedges against inflation and geopolitical shocks that investors should favour in their equity portfolios. We also touch on the collapse of solar stocks driven by surging poly silicon prices which interestingly enough is partly a function of the current energy crisis in oil and gas.


The regime shift in energy requires investors to embrace non-ESG companies

In some of our recent equity notes we have talked a lot about inflation and to what degree it impacts equity returns. The recent results from Home Depot, Danone, and MercadoLibre show why inflationary periods are difficult for companies. It is generally difficult to pass all of the rise in input costs as it can destroy your demand, so later in the inflationary cycle (where we are now) many companies begin absorb inflation into their operating expenses lowering operating margins and return on invested capital.

When inflationary forces are driven by the supply side of the economy, the natural hedges are in the mining and energy sectors, and to some degree financials to the extent that interest rates go up with inflation. We looked at the 537 companies (excluding financials and real estate) in the S&P 500 and STOXX 600 that have reported Q4 earnings and how their operating margin (quarterly EBITDA margin) was impacted in Q4 vs Q3 2021. The table below shows average quarterly change in %-points in the quarterly EBITDA margin across the different sectors. It is clear that energy stocks are the best hedge against current inflationary pressures, but the consumer discretionary, health care and IT sectors are also holding up well, while the industrial, communication services, consumer staples and utilities are seeing their operating margins being the most under pressure.

Where is mining companies in all of this you might wonder. Mining companies are classified under the materials sector which also consists of chemical, construction materials, packaging and paper companies, and the majority of mining companies are either not reporting quarterly financial figures or have not reported yet. It is very clear for the half-year results we have seen from miners such as Rio Tinto, BHP Group and Glencore, that the mining industry is seeing expanding margins. Again, energy and mining companies are investors’ best hedge against the current inflationary environment. But it requires that the ESG consciousness is put aside for a while.

Source: Bloomberg and Saxo Group

The histogram above of these changes in the quarterly EBITDA margin also shows that the distribution is negatively skewed with the median at -0.9%-points suggesting a widespread contraction in operating margins among the largest companies in the world. The table below shows the 40 largest publicly companies in the US and Europe and their change in the operating margin. On a positive note companies such as Apple, Exxon Mobil, Walt Disney and ASML stand out as companies that have pricing power whereas companies such as Microsoft, Alphabet, Amazon, Johnson & Johnson and Home Depot are experiencing margin pressure.

NameSectorMarket Cap (USD mn.)Chg. EBITDA margin in %-pts
Apple IncInformation Technology2,681,6113.5
Microsoft CorpInformation Technology2,156,998-2.4
Alphabet IncCommunication Services1,713,282-3.9
Amazon.com IncConsumer Discretionary1,528,543-3.0
Tesla IncConsumer Discretionary849,058-0.6
NVIDIA CorpInformation Technology584,7500.5
Meta Platforms IncCommunication Services550,0500.5
Visa IncInformation Technology479,0481.6
UnitedHealth Group IncHealth Care435,175-0.4
Johnson & JohnsonHealth Care423,680-2.0
Procter & Gamble Co/TheConsumer Staples378,569-0.3
Walmart IncConsumer Staples378,496-0.4
Mastercard IncInformation Technology359,995-0.5
Home Depot Inc/TheConsumer Discretionary330,157-2.1
Exxon Mobil CorpEnergy323,6993.2
Coca-Cola Co/TheConsumer Staples270,013-11.2
Walt Disney Co/TheCommunication Services269,6186.3
Pfizer IncHealth Care266,780-5.4
ASML Holding NVInformation Technology259,7434.4
AbbVie IncHealth Care257,4602.5
Chevron CorpEnergy255,226-3.5
Broadcom IncInformation Technology236,5351.6
Cisco Systems Inc/DelawareInformation Technology233,8800.0
PepsiCo IncConsumer Staples232,904-5.4
Novo Nordisk A/SHealth Care229,970-7.5
Eli Lilly & CoHealth Care228,7507.1
Verizon Communications IncCommunication Services226,263-5.0
Costco Wholesale CorpConsumer Staples222,683-0.3
NIKE IncConsumer Discretionary218,519-4.4
Comcast CorpCommunication Services212,790-1.8
Accenture PLCInformation Technology211,7051.4
Novartis AGHealth Care209,654-4.3
Thermo Fisher Scientific IncHealth Care208,802-1.0
Abbott LaboratoriesHealth Care207,227-2.6
Adobe IncInformation Technology206,7930.0
Shell PLCEnergy202,15310.5
Oracle CorpInformation Technology197,934-43.6
salesforce.com IncInformation Technology192,203-1.8
Merck & Co IncHealth Care191,84522.2
Danaher CorpHealth Care190,3197.1
Source: Bloomberg and Saxo Group

The energy crisis is ironically slowing down the green transformation

The green transformation theme in equities has been under pressure for over year now and the longest running ETF on solar stocks (TAN:arcx) is down 46% from its peak in early 2021. There are several factors driving this with one being the price on PV grade poly silicon which is up 430% since the lows in 2020 driving up costs of solar PV panels and thus making solar projects more expensive.

There two factors behind the current high poly silicon price and those are that Chinese manufacturers increased production into excess capacity in 2018 and 2019 simultaneously with slowing demand of solar projects amplifying the oversupply issues. In 2020, no new capacity was added in China and through massive stimulus and focus on green energy projects demand came back roaring in 2020 and 2021 pushing up demand way above supply. In addition global logistic costs have gone up increasing total costs of solar panels even more and the energy crisis in China has also pushed up prices on coal which is the main energy source for electricity production in those regions producing poly silicon. With high energy costs expected on traditional energy sources we can expect poly silicon prices to remain high impacting demand for solar projects.

It is an irony that an energy crisis and metals scarcity are causing the green transformation to slow down. It is becoming clear that the green transformation cannot be a binary transition without investments alongside in oil and gas.


Source: Bloomberg
Source: Bloomberg
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