Across the Asia Pacific region, we are witnessing 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. 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 utilities in Electricity Transmission and Distribution. 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 leads 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 or have operating cost increase pass through mechanisms, therefore higher inflation (even if transitory) can further increase revenue growth.
We are starting to see some movement on this way of thinking in the market, for example, with the recent takeover proposal for Australia’s Spark Infrastructure from private North American 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 utilities in Electricity Transmission and Distribution.
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;
- heat pump efficiency gains and a growth in electrical heating (vs. gas) and new air-conditioning installations;
- digital device purchases and strong growth in Asia Pacific Data Centres;
- use of automation or robotic labour for activities such as cleaning and manufacturing.
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 Asia Pacific population growth outlook and in parts of Asia the growth is further boosted by connecting electricity to new areas/regions for the first time.
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.
Where are the opportunities?
Specifically, we believe that Asia Pacific Transmission and Distribution Utilities such as India’s PowerGrid, Australia’s AusNet Services and Spark Infrastructure, Philippines’ Manila Electric are well placed in this regard.
- PowerGrid Managing Director Shri K. Sreekantmentioned in their 2020 Annual Report that “Going forward, the sector expects sustained growth in installed capacity with greater share of renewables and the company is well positioned for the same”.
- Spark Infrastructure’s CEO Rick Francis also used their February 2021 results presentation to point out that the “Growth agenda for regulated and contracted assets is substantial” and that their “Renewable development pipeline (is) established; (and that they have a) disciplined approach to ensure high-quality accretive growth”.
- AusNet Services Managing Director Tony Narveaz said during their May 2021 results presentation “Growth continues to be a major focus for us as we look to take advantage of what has been described by some analysts as a once in a generation opportunity to facilitate the energy transition to renewables”.
- Manila Electric’s President and Chief Executive Officer, Atty. Ray C. Espinosa said at the May 2021 annual meeting that “We continue to energize more customers as shown by the year-to-date customer count growth rate of 4%” and also said “We energized 261 sites including remote and far-flung communities and brought light to more than 11,000 households in our service area”.
Greater demand = better earnings and long-term dividend growth
The increased demand for a clean energy supply will flow on to demand for the services of the Electricity Transmission and Distribution Utilities sub-sectors. This should create a stronger long-term earnings and dividend paying ability for the incumbents.
For our Real Income strategies, which focus on Real Assets with Sustainable Dividends, we see this as a truly exciting income growth opportunity for our income-focused investors.