Few themes have been hotter recently than the energy transition, but prominent themes can be tricky to navigate as an investor. Timo Smuts, investment analyst at Orbis Investment Management, believes that some value can be found below the surface of the theme.
There are governments and companies around the world making an earnest effort, and spending real capital, to reduce the world’s dependence on carbon-based energy. This will create some losers, but also many winners. There are ways to transition that do not involve switching off all the lights.
Investors should take a holistic, long-term view of how the world’s energy systems might evolve, and think through the second-order effects. Newsworthy themes can be tricky to navigate as an investor, but can also lead to rewarding opportunities if you take the time to separate the facts from the froth, including the three examples below.
Siemens Energy
Siemens Energy touches every piece of the energy transition and electricity chain. Today, the most valuable part of the company is its 67% stake in Siemens Gamesa, the global leader in offshore wind turbines. Siemens Energy combines this high-growth green energy exposure with a gas turbine business, a segment that focusses on electricity transmission, and promising efforts in producing green hydrogen.
Gas turbine technology has become much more efficient since the early 2000s, and burning gas produces only half the carbon emissions and essentially none of the particle pollution of coal or oil-based energy generation. We believe Northern Hemisphere countries that aren’t sunny or windy will have to balance intermittent green solutions with reliable baseload generation as electric vehicles (EVs) and homes draw ever more power from the electric grid. Gas is a cheap and relatively clean solution.
Yet investors seem to expect that natural gas will be phased out in the near future, much like coal. This seems premature especially when compared to work from climate-focused policy makers in California, where dependence on gas power generation is expected to increase out to 2050.
Increased demand for electricity will put increased strain on grids, just as those grids are growing more complex and dispersed. As the grid changes, transmission infrastructure must improve. As the world’s largest producer of transmission equipment, Siemens Energy should be a key beneficiary over the long term.
If we value the company’s Gamesa stake at market prices and assume investors are valuing the other segments at a 20% discount to the relevant peers, we are getting the gas turbine business for free at today’s price, alongside a free option on the company’s hydrogen efforts. We believe the market will come to reward our view over our long term investment horizon.
AES
AES has gone through a decade-long transformation from coal-based power to being a global leader in renewable energy and energy storage. The market has been slow to credit that transition, and we believe the economics of the business are under-appreciated. As a power producer, AES actually benefits when customers demand more solar energy, as AES can profitably expand its generation capacity while locking in longer-term contracts. Yet despite growing more quickly than its closest peer, NextEra Energy, AES trades at just 16 times forward earnings, compared to 30 times for NextEra.
In addition to its core unit, AES owns an energy storage joint venture with Siemens called Fluence—which we believe is a hidden gem inside the business. Fluence is the world’s second largest energy storage company (after Tesla), and the largest one focused on utility-grade storage—the part of the market expected to see the highest growth.
Signify
Signify is the world’s largest producer of LED bulbs for both residential and professional use. According to the European Commission (EC), 40% of energy is consumed in buildings, and 75% of buildings are energy inefficient, so the EC is rolling out financial incentives with an aim to double the rate of building renovations over the next five years. A large chunk of those renovations will include a switch from fluorescent to LED lighting. (The UK, meanwhile, plans to ban fluorescent bulbs entirely.)
Aware that the European Green Deal will produce a windfall for European municipalities, Signify recently launched an initiative to help them spend it. With similar renovation plans coming out of the Biden White House, we can expect above-trend renovation growth across both continents over the coming years.
These attractive growth opportunities are not reflected in Signify’s valuation. Over the years, sentiment on the stock has been weighed down by price pressure in LEDs. That pressure is abating, but sentiment is moving more slowly. Early this year, market valuations implied that Signify would shrink in perpetuity, despite all the tailwinds mentioned above. While the shares have recovered somewhat since then, it may take the market some time to reflect the valuation we believe the company deserves. At the current price, they offer an attractive 9% 2021 free cash flow yield and the company just paid out a healthy 5% dividend.
