Power play for investors with insight

The financial crisis turned the New Energy sector from market darling to pariah. But pockets of premium growth are appearing as uncertainties over traditional energy sources increase.

The New Energy sector has fallen out of favour since the onset of the financial crisis. But it warrants consideration by the patient investor searching for premium growth potential without a premium price tag.

Although equity markets have been upbeat thus far this year, the recent correction has offered a sobering reminder that Europe’s economic strife is far from resolved.

Measures such as the European Central Bank’s long-term refinancing operations have brought us back from the brink but not yet back into growth and prosperity. There will doubtless be further twists and turns in the road to recovery.

The cost of inactivity for an investor, though, may be great. Those tempted to seek refuge in T-Bills and money market funds (in the hope that in six months or two years they will arise from their safety bunkers to a world of high growth and high return) risk having the purchasing power of their portfolios steadily eroded by the negative real yield these investments offer.

Among the opportunities for the patient investor wanting to put some money to work is one offered by a sector that has fallen out of favour. A torrid financial crisis turned the New Energy sector from market darling to pariah within the space of just a few years. (Trends continues below)

But there is cause for optimism, and within this sector there are pockets of premium growth.

The New Energy sector is underpinned by a simple ­thesis: the rising cost of traditional energy, the need to address climate change and the desire to improve energy security mean that renewable energy is forecast to become a larger part of the energy mix; concurrently, businesses, people and governments are encouraged to make use of traditional energy more efficiently.

Austerity is a headwind, but government-mandated growth has broadly held firm. Meanwhile, the sector’s reliance on subsidies has decreased at a rapid pace: the wholesale price for a solar panel is down by about two-thirds since the beginning of 2009.

”Companies involved in using traditionally produced energy more efficiently comprise an increasingly important component of the sector”

Two other concerns may also have accelerated the sector’s arrival at a re-rating: the Arab Spring and the tense situation with Iran have pushed energy security back up the agenda, and doubts remain about nuclear energy.

The New Energy sector is yet to fall under a firmly ring-fenced definition. What is important to highlight, however, is that its scope extends beyond renewable energy production.

Wind farms, solar panel makers and hydropower plants are only one subset of the sector; companies involved in using traditionally produced energy more efficiently comprise an increasingly important component of the sector and, indeed, our portfolios.

The energy efficiency theme has garnered growing investor and government focus, primarily because its technologies are largely competitive without subsidies. In the economic malaise of 2011, this area was one of the few that experienced a year of growth.

Take power infrastructure as an example. Investment in the electricity network is required to replace ageing equipment, absorb increasing volumes of renewable energy capacity and improve system efficiency.

After decades of underinvestment in developed country power grids, we appear to be in the early stages of an investment up-cycle.

This has been most evident in America, where $16 billion (£10.2 billion) of large transmission projects have been awarded over the past two years, compared with less than $10 billion for the 2000-09 period as a whole.

Companies exposed to this trend, including ITC Holdings and Quanta Services, were some of the best performers in 2011 in our New Energy portfolios and remain well-placed to benefit.

Quanta is the leading North American grid contractor, with earnings set to double in the next two years. Despite this outlook, the valuation is at the bottom of its historic range.

Similar opportunities are evident in gas infrastructure owing to the growing global importance of liquefied natural gas and the need to build pipelines in America to support the expanded use of natural gas.

Less than 10% of our New Energy portfolios is invested in the manufacturers of renewable energy technology; a further 20% is invested in the operators and developers of renewable energy assets.

Much of the remainder is therefore exposed to energy efficiency and infrastructure themes – companies such as Quanta and ITC or, in a different area, Novozymes.

Novozymes makes enzymes used in applications that range from ethanol fuel to energy-efficient washing powder. The stock has outperformed world equity markets (represented by MSCI World Energy) in all but one of the past 10 years, and has fantastic growth platforms in its businesses as well as a market leading opportunity in second-generation ethanol.

This sector is much more than a renewables play, which is the area that faces the strongest headwinds (in the form of developed power demand that still has not recovered to pre-crisis levels, and tight financing conditions). Within the sector as a whole, we are finding many attractive investment opportunities, and they are coming cheap.

The New Energy sector has lost its premium rating but it offers pockets of premium growth. The market is unwilling to pay up for that potential, but investors with appetite should take comfort from being in the company of a group with insight.

Industry participants are capitalising on the value opportunity, and the sector saw a sharp increase in merger and acquisition (M&A) activity last year. M&A is often a leading indicator for the direction of equities. If this remains true, it offers further scope for optimism.

Robin Batchelor is the manager of the BlackRock New Energy Investment Trust.