Global energy markets are undergoing fundamental and rapid change towards a greater reliance on renewable energy. Growth in wind and solar markets is driven by government concerns for energy independence, a will to reduce nuclear power operations post Fukushima and to mitigate climate change, as evidenced by the outcome of the Paris Climate Agreement last December.
There are many ways to access the investment opportunities in the high growth renewables sector. Here we discuss the current merits of three different areas for investment in the renewables value chain.
1. Risks in “yieldco’s” often overlooked: “unfavourable”
Wind farms and solar parks are high up the wish list for European pension funds and sovereign wealth funds which tend to regard them as effective vehicles for long term liability matching. In this low interest rate environment we see a significant risk for investors who may well be overpaying for the income from these “yieldcos”. We believe that “yieldcos” offer limited upside. Furthermore, many investors do not appear to be aware of the power price and political risks to which they are exposed in some markets, or of the depreciation of the underlying assets which is rarely taken into account in their valuations.
2. Equipment suppliers: “some interesting opportunities”
As in other energy sectors, there will be periods of both over and under supply which impact margins and growth rates. Equipment suppliers are cyclical stocks and can be volatile. For example, a leading global manufacturer of wind turbines, has seen operating profit margins ranging from losses to +13% over the last 10 years. The sector is currently attractive and we have identified opportunities in companies with solid growth and attractive valuations. Similarly, solar panel manufacturers which saw a massive margin opportunity during the period to 2011, when supply was constrained, have seen their margins undermined by overcapacity in Chinese manufacturing in the subsequent years. With the expansion of end markets, and subsidies becoming a smaller aspect of project economics, the solar industry is now more broadly based and we see low cost manufacturers (predominantly in Asia) with positive and growing margins once again. An active investment process supported by deep industry and stock research is needed to navigate the complex dynamics of this market.
3. Project developers: “the current sweet spot”
In a world of falling technology and installation costs, and with growing demand for completed assets, we believe that developers of renewable energy projects currently have strong growth prospects. We see opportunities for significant upside from development and construction of projects and their subsequent sale to institutional investors or “yieldcos”. Our listed equity funds hold a number of these companies with balanced exposure to US, EU and Asian markets.
There are also interesting investment opportunities in the form of private equity pooled vehicles which focus on renewable infrastructure development. These vehicles purchase preconstruction assets (individually or in portfolios) for construction and eventual sale. This “buy build sell” model should mitigate development and construction risk for investors while maximising value to deliver strong returns.
By Jon Forster, Director, Senior Portfolio Manager, Impax Asset Management
This article was first published in the Guide to Clean Energy