Mike Appleby

Renewable energy: opportunities and challenges

Mike Appleby

This article was first published by Alliance Trust Investments on 5 July 2016.

Mike Appleby, investment manager on the ATI Sustainable Future fund team, outlines where he sees both the promise and the pitfalls in the renewable energy sector.

We like renewable energy because – fundamentally – it will help to reduce CO2 emissions and combat climate change; now recognised as an existential threat to both the global environment and global economy. Moreover, we think that there will be structural growth in wind and solar power as they continue to displace conventional installed thermal capacity (fossil fuels) over the next decade and beyond.

We are, however, targeted in how we invest in renewable energies and only pick those in which we see profitable growth and that are trading at undemanding valuations. We see some opportunities in renewable developers and operators, where they are able to contract long term power purchase agreements to reduce exposure to wholesale or pooled power prices. These include European firms EDP Renovaveis and Gamesa. We also like exposure to countries that are growing and short of energy; as in the case of some emerging markets.

We see renewable energy generation as a big disruptor to existing thermal power utilities. We believe established energy providers will struggle as their business models are challenged by increasing renewable penetration on the grid and the resulting super-abundant power at virtually zero marginal cost. There are opportunities in improving the grid and we think that, in time, energy storage will be a big feature as battery costs fall.

As the cost of renewably generated electricity falls, the sector is going through a transition period before the majority of renewable energy can compete with other forms of electricity generation without subsidies. In this deflationary environment for wind turbines and solar modules, we are wary of profit margin compression in pure manufacturers of these main renewable technologies. While competition is good for driving down prices and increasing competitiveness, structurally falling margins do not make for a good backdrop in which to generate investment returns.

Energy efficiency

Thus while we see good growth in renewable energy generation over the medium to long -term, finding companies that have reasonable prospects of becoming profitable is much harder. As such we see more opportunities in energy efficiency where more visible business fundamentals give us confidence that growth in these areas will be profitable – and so generate good investment returns. Specialist components used to make cars more efficient or safer; building insulation to reduce the energy needed to regulate the temperature of buildings; and efficient lighting methods like LEDs are all areas we are invested in.

US firm Acuity Brands, which is the world’s leading supplier of LED lighting, is a good example of a strong, profitable company in the energy efficiency sector. LED light bulbs use a semiconductor chip to convert electricity into light, typically cutting energy consumption by around 80% compared to conventional light bulbs and lasting 25% longer. The rapid adoption of this technology in the US and globally has translated into strong gains for Acuity, with shares up more than 230% in US dollar terms over the three years to 29 June (1) compared to 51% returned by the US’s S&P 500 index over the same period (2).

Similarly, Ireland based building materials manufacturer Kingspan is also a key holding in the ATI Sustainable Future funds. The company produces thermal building insulation, which helps to dramatically cut the amount of energy needed to heat the buildings we live and work in. The firm has grown exponentially in recent years, with shares climbing 98.5% since 29 June 2013 (3) compared to a return of just 16% from the FTSE All Share index (4).

Renewable energy is certainly a strong long-term growth area, however investors need to choose their investments wisely as the sector continues to face obstacles. However, compelling opportunities abound in companies involved in the energy efficiency sector and this is where we are currently focussing our attention.

Sources

1 Google finance https://www.google.co.uk/finance?q=NYSE:AYI&ei=cwd1V6HOGsGEsAH4zo2ICg

2 FE Analytics June 2016

3 Google finance: https://www.google.co.uk/finance?q=LON:KGP&ei=2DV1V-GzDsX8sAGN_bW4CQ

4 FE Analytics June 2016

 

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Tuesday, July 5, 2016, 12:00 AM