We have chosen the companies with no consideration for historical performance or predictions for the future. Instead we have focused on market cap, preferring larger over smaller companies within the industry, and an emphasis on pure plays whenever possible.
Green industries have different risk profiles
The risk factors impacting the different industries are both systemic and idiosyncratic. From a risk perspective relative to the general equity market the hydro, nuclear, recycling and water industries are less risky as their demand profile is more stable than the overall business cycle. The solar, wind, electric vehicles and building materials are more cyclical than the general market and would be impacted more negatively during a recession.
The fuel cell, bioplastic and food (in this case plant-based) industries have far more idiosyncratic risks as they are far more nascent than the other industries. The fuel cell industry is heavily dependent on government subsidies as the industry rolls down the technology curve in terms of cost of production and thus the industry is very high risk. The bioplastic industry is likely to experience very high growth rates as many consumer companies, McDonald’s and Unilever to name a few, have said they will improve their plastic packaging over the next decade. But bioplastic is a small fragmented industry and the publicly listed bioplastic companies could easily lose out to larger names in the traditional chemical industry.
Significant valuation premium except nuclear and wind
Except for the nuclear and wind turbine industry all of the other industries trade at a valuation premium to the global equity market. This premium obviously reflects investors’ optimism about future cash flows in those industries, though with high expectations come higher risk in general if these expectations are not met. While we understand the valuation discount on nuclear due to low growth we find it more difficult to reconcile the valuation discount for wind turbine makers given the positive outlook for the industry and vastly improved industry conditions over the past 10 years.
Another important point about these industries is that they are operating in the physical world compared to the software industry, where return on capital is insanely high and easily scales. These greener industries all require vast amount of capital to operate and thus the low interest rate environment has helped fund growth in these industries and making projects more profitable. If interest rates rise again this should have a negative effect on their operating conditions and especially on equity valuations as high growth stocks fall more than value stocks in a rising interest rate environment.
Government support is key in green transition
Many of the industries mentioned are dependent on government support either through subsidies (wind, solar and fuel cells etc.) or liability caps (nuclear power) which means that shareholder returns in the future will be dependent not only on technological advancement but also the continuing support of governments. With the green policy agenda adding speed in many countries the risk of losing government support is most likely small but it’s still a risk. The risk would rise in the event of a recession where a government could be forced to reduce subsidies on green policies as resources are diverted to unemployment benefits and other social welfare costs.
One final way to get exposure to the transitioning to a less carbon intensive economy is through carbon emissions which could rise in the future if the European Union (the only place in the world where a market-based carbon emission market exists) limits the supply of carbon emissions. This could happen if the EU decides that current carbon emission prices are not curbing carbon emissions enough. Carbon emissions are traded through futures expiring each year in December (Saxo ticker code on the December 2020 contract is CFIZ0*).
* Carbon emission futures can also be traded as an expiring CFD contract (the December 2020 contract has the Saxo ticker EMISSIONSDEC20)
High growth renewable energy sources
Solar energy has been a known technology for over 180 years as the photovoltaic (PV) effect was discovered in 1839 by a French physicist. However, the energy efficiency has been too low until recently with new industrial-scale solar farms now producing electricity at cost levels making it competitive, in some areas of the world even without subsidies. As with the computer hardware industry, the ongoing technological advancement is constantly pushing down prices making it very difficult for PV solar panel makers to make consistent return on the invested capital. The economic benefits have so far mostly flowed to consumers and utilities. Solar energy will most likely play an important role in the energy mix and especially in the world’s most sunny regions.
The wind turbine industry operates with far greater technology moats, or entry barriers, which has boosted operating margins over time and the return on invested capital. The industry is dominated by a few companies and few new companies are entering the industry. This is good from a shareholder perspective but as with solar industry the majority of the economic benefits from wind energy has flowed to utilities and consumers, and to a lesser degree the wind turbine makers. The latest battlefield for wind turbine makers is offshore wind turbines that a decade ago looked too expensive to ever work, while today it looks like offshore is the future for the industry. Industry leader MHI Vestas Offshore Wind announcing the first 10MW offshore wind turbine in September 2019, a major technical breakthrough for the industry. In Europe, 63% of renewable energy investments was in wind energy in 2018, and the continent also leads on expected installed offshore wind capacity by 2040.