By Angus McCrone
Bloomberg New Energy Finance
Take Apple, Intel and Microsoft. Or Cisco, Google and Amazon. Or China Mobile, Vodafone, and NTT DoCoMo. Whenever a young, fast growing sector comes of age, it spawns a handful of giant global companies that becomes staples in the portfolio of the general investor.
Sounds sensible – except that with the transition to low-carbon energy such an important theme in the world economy now, it is striking how poorly renewable energy and efficiency companies are represented among the world’s largest stocks by market capitalisation.
If we take as our list the Financial Times’ top 500 for 2009, there are just two specialist clean energy companies – Iberdrola Renovables, the Spanish wind project developer, at number 282, and First Solar, the US thin-film module maker, at number 460.
Their market capitalisations, at $17.5bn and $10.8bn respectively in the FT500 comparison for 2009, are pipsqueaks compared to those of the list’s titans – Exxon Mobil at number one weighs in at $337bn, and even Novartis at number 26 still commands a market cap of just over $100bn. The top ranks are dominated by sectors such as oil, telecommunications, drugs and consumer goods.
There could be various explanations for the near-absence of clean energy stocks. One is that the sector is just not nearly as important in the world economy as those of us immersed in it imagine. Another is that there are reasons why specialist clean energy firms are unlikely to establish market dominance in the way that Cisco, BHP Billiton, Nestle, Coca Cola and scores of others have done in their respective sectors.
Looking at the first possible explanation, total new investment in clean energy in 2009 was $145bn according to Bloomberg New Energy Finance figures. That is a lot of money, but not nearly so big when you compare it to some other aggregates – for instance it was some 6% of the size of the UK economy, and only a quarter of a percentage point of the size of the world economy at market exchange rates.
However any comparison has to be a fair one. Investment is only one component of GDP, so we should not be comparing investment in clean energy with UK or world GDP. The sector’s total economic size would also have to include the value of clean energy consumed by the private sector and governments.
We can compare apples with apples by saying that the clean energy investment total of $145bn is equivalent to 33% of the International Energy Agency’s estimate for investment by the oil and gas industry last year. According to the United Nations Environment Program’s Global Trends In Sustainable Energy Investment report 2009, some 41% of new global generating capacity added in 2008 was renewable, if you include large hydro, and the size of this investment was greater than that in fossil-fuel generating sources in that year. However if you compare investment in clean energy with that in the whole of a large economy, our sector starts to look punier – non-residential gross private domestic investment in 2009 in the US was a $1.4 trillion.
Profitability provides another striking contrast. Vestas, the Danish turbine maker has a 25% market share in wind, the largest sub-sector within clean energy. In 2009, Vestas made net income of EUR 579m ($781m) – a small fraction of the profits achieved by market leaders in other sectors such as Exxon ($19.3bn), Microsoft ($14.6bn), or Roche ($7.8bn).
So we are getting a picture of a sector that may look quite big to those inside it, but not in the same league as some of the large global industries. On the other hand, it is growing rapidly and many of them are expanding much more slowly, so you would expect that differential to be reflected in market capitalisations. Annualised growth in investment in clean energy since 2004, despite the modest setback in 2009, has been more than 30%, while overall gross capital formation in the US economy – for example – has only increased at an annualised rate of 2.5% during that time.
Yet that pace of growth in clean energy is not particularly obvious from the stock market ratings of many of its largest companies. Vestas shares, at the time of writing, were on an estimated historic price-earnings ratio of 14, and even First Solar, champion of a particularly fast-growing segment within the PV industry, was on a less-than-stellar historic multiple of 14.5 times expected 2009 earnings. The market average p/e for the US S&P 500 index, by comparison is around 16.9. Evidently, investors do not expect leading clean energy companies – apart from a few exceptions such as Hong Kong listed electric car and battery firm BYD, currently on a historic p/e of 72 – to grow at the same kind of speed that the sector as a whole managed between 2004 and 2009.
That might be because they expect sector growth to slow sharply compared to the average in the years since 2009. Certainly, in 2008 growth in investment slowed to just 5% and in 2009 it went into reverse, total new investment falling 6.5%. However those years saw the deepest world recession for more than 50 years. And leading sector forecasters predict significant, albeit bumpy, growth ahead – Bloomberg New Energy Finance expects new investment in clean energy to grow to $350bn-a-year by 2020, equivalent to 8.5% compound annual expansion.
The International Energy Agency, in its last World Energy Outlook last November, predicted that $7.1 trillion – or $310bn-a-year – would need to be invested in power generation between 2008 and 2030. Even on its business-as-usual (Reference) scenario, some 16% of the extra TWh would have to come from renewable energy, implying a much higher proportion than that of the total GW built – since wind and solar capacity factors average only 15% to 30%. The IEA figure relates only to the asset finance part of new investment in clean energy, and that was $91.9bn in 2009 according to Bloomberg New Energy Finance data. The room for growth, even in the IEA’s conservative Reference Scenario, seems clear.
So how can we explain the attitude of stock market investors? Well, they may not have woken up to the forecasts, or they may doubt them, or they may believe them but they do not think this translates into vast profit opportunities for leading clean energy stocks such as Vestas and First Solar.
Some investors may see sense in the forecasts, but also take the view that since clean energy is more expensive and requires policy support, and the speed of improvement in many technologies is uncertain, it is prudent to risk-adjust them and so discount the value of clean energy stocks.
Profit margins are key to the ratings given to individual sectors – whether airlines or carmakers, with their thin or negative margins, or the likes of Google, which enjoyed pre-tax income of $8.4bn in 2009, on sales of $23.7bn, equivalent to a margin of 35%.
In IT, market power went to companies with control of established operating systems (Microsoft), established and vital applications (Oracle), corporate computing (IBM), and the microprocessor heart of personal computers (Intel). All did a tremendous job of fighting off competition, perhaps particularly Intel of that group, but they were helped by inertia – it was difficult for users to move supplier because of the difficulty of transitioning to entirely new platforms. In pharmaceuticals, another key sector in the FT500, market power and profitability are protected by the multi-year patents extended to key drugs, and by vast budgets for the research and development of new drugs.
The classic framework for working out if clean energy companies will ever have good margins is Porter’s Five Forces: buyers, suppliers, barriers to entry, threat of substitutes, industry structure and rivalry.
The clean energy industry has few powerful and concentrated suppliers, except for some niche areas such as rare earth minerals and some bottleneck components like HVDC cables, and it faces powerful buyers (utilities and governments). It has relatively low barriers to entry to defend itself against big engineering companies, except in a few areas where patents matter.
Also, the threat of substitutes is high: there is the risk that the policy support is removed, which would mean that fossil fuel remains competitive, and the risk that someone else comes along with a new technology. Nuclear power and natural gas remain dangerous rivals, as renewable energy firms in the US have discovered in the last 12 months as low gas prices have driven down the value of PPAs, and “shale gas” discoveries have caused worries over utilities’ long-term fuel choices.
Patent protection exists on new clean energy technology, but companies have found a multitude of ways of building thin-film solar modules or three-bladed wind turbines. Vestas and its five major competitors now face increasing challenge in all markets from Chinese-made turbines – plans are well in train for at least two US wind farms using Chinese hardware.
There could be breakthroughs in other areas where patent protection would enable a company to defend a market position for longer – possibilities include battery and power storage technologies, or perhaps enzymes or algae for biofuel production. Last year, power storage and energy efficiency stocks out-performed spectacularly, reflecting partly excitement over government “green stimulus” programmes and the electric vehicle trend, but also perhaps a search by some investors for sub-sectors where profit margins might enjoy strong patent protection.
Project developers and owners are in a different boat on margins. The largest cap clean energy stock right now is Iberdrola Renovables, as stated above. Other project developers and owners also have multibillion dollar capitalisations, for example EDP Renovaveis at some $7bn and China Longyuan Power Group at $3.1bn. They may be joined at some point this year by Italy’s Enel Green Power, if its parent decides to float the business.
Well chosen wind or solar projects, with high capacity factors, reliable technology and long-term policy support, should continue to enjoy attractive returns – as long as politicians do not go back on their commitments. In some cases, it may be possible to improve project margins still further in the future by repowering, refinancing, or extending leases on the land.
The likes of Iberdrola Renovables and EDP Renovaveis could swell into organizations owning dozens of GWs of renewable power assets, provided the bond and equity markets are accommodating. If so, and it is a big “if” that also depends on the policy environment, these firms could command valuations that would push them much higher up the FT500.
However it is also possible that it will make more sense for this type of company to sell their mature wind and solar assets – which cost much less to operate than coal or gas-fired capacity and may have long-term secure returns via feed-in tariffs or power purchase agreements – to pension funds. The rump company would then concentrate on project development and early-stage operation.
There is another possibility: that the transition to low-carbon energy will mean that almost all specialist renewable energy technology suppliers and developers will be swallowed up by their established fossil-fuel equivalents. In that case, clean energy companies may never achieve the status of global titans.