We are in the middle of an electrification revolution, driven by increased demand for clean energy.
Over the past few years, we have seen many high-profile companies and sub-sectors perform well on the back of increased demand for green energy. However, we are now seeing Electric Vehicle (EV) makers, clean energy developers and equipment providers, mining companies, input suppliers etc. trading on very high multiples and/or offering very little yield to investors.
The demand for green energy is not going away, but by looking further afield into related industries, we believe very attractive yield and growth opportunities can instead be found in the ‘lower-profile’ or the ‘behind the scenes’ Real Asset stocks.
The areas that excite us the most are the incumbent players in Electricity Transmission and Distribution Utilities. These are an integral part of the transition to cleaner energy sources, linking the bourgeoning clean energy supply chain with the growing demand.
Why do we like Transmission and Distribution Utilities for income?
Companies in the Electricity Transmission and Distribution Utilities space generally have very strong market positions and pricing power, high barriers to entry and are regulated monopolies. This can lead to strong cash flows, profit, and dividend generation over many years, irrespective of the business cycle.
In other words, Real Assets generally can protect future income from inflation and can provide more predictable free cash flow and dividends.
Why are Transmission and Distribution Utilities undervalued?
As a result of their regulated nature, investors have often viewed these sub-sectors as just boring ‘yield plays’. Instead, we believe there is significant under-valued income growth ahead as electrification demand and new clean energy asset connections to the grid continues to grow.
Many regulated utilities asset bases and revenue streams are also escalated with reference to inflation, therefore higher inflation (even if transitory) can further increase the growth in the assets base and income profile.
We are starting to see some movement on this way of thinking in the market, for example, with the recent takeover proposal for Spark Infrastructure from private consortiums, we believe the market is starting to recognise the value of strong growth ahead, and this kind of activity will start to narrow the valuation gap.
The areas that excite us on this clean energy and electrification theme are the incumbent players in Electricity Transmission and Distribution Utilities.
Why do we see demand for Transmission and Distribution Utilities growing?
We see that the demand for clean energy supply will continue to evolve and benefit the incumbent Electricity Transmission and Distribution Utilities for years to come. This is due to several interconnected themes related to the transition to clean energy:
- 1. Greater electricity demand overall
- 2. New large scale clean energy projects
- 3. Continued increase in household solar
- 4. Construction of electricity storage projects
- 5. Growth in the absolute number of connections
- 6. The potential of hydrogen
Increased demand for both green and standard energy, is being seen from new technologies such as:
- the electrification of transport and EV charging at home;
- heat pump efficiency gains and a growth in electrical heating (vs. gas);
- digital device purchases;
- use of automation or robotic labour for activities such as cleaning.
This demand will particularly be seen in the evenings and overnight, which will provide opportunities for incumbent utilities.
Wind, solar and hydro have a lower capacity factor versus existing thermal generation.
This means that when clean energy projects are connected to the existing electricity network and customer base, capacity needs to be 2-3x larger than the existing thermal generation to accommodate demand. This provides opportunities for the incumbent utilities to grow their infrastructure with less risk.
The increase in solar panel installations on household rooftops is facilitating the reversal of household electrical flows. New larger and more efficient systems will create excess power available in the middle the day that needs to be carried.
Connecting large scale batteries and pumped hydro storage projects to the grid will facilitate the storage of intermittent clean energy such as wind and solar.
New connections to the electricity network are a function of Australia’s population growth outlook. We discussed this in a recent blog, FORECASTING BABY SHOWERS FOR AUSTRALIA’S POPULATION GROWTH.
While it is early days in terms of widespread adoption of hydrogen, we are witnessing strong interest from several Asian countries for Australia to become a major producer of green-hydrogen.
For the green-hydrogen industry to develop scale, there will also need to be significant investment in large-scale renewable energy network infrastructure to aggregate the renewable energy and bring it closer to market.
My colleague Will Baylis discussed more on Australia’s hydrogen work in a recent blog, AUSTRALIAN OPPORTUNITIES IN THE RENEWABLE TRANSITION.
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