Net zero isn't "woke capitalism". It is capitalism

Decarbonisation has been reduced to a political battleground between the left and right wings of politics. 

It's probably at its most fervent in the United States, where decarbonisation is frequently weaponised as a political cudgel against green policy proposals. "Woke capitalism," they call it. 

Things aren't a whole lot better here in Australia. "War on the weekend", one former prime minister labelled a proposed vehicles emissions policy.

The ESG culture wars have gotten so bad that Citi has cited “anti-ESG” risk in its 10-K (the business and financial condition document that US public companies must submit every year to the Securities Exchange Commission). 

Despite all that, you'd be hard-pressed to find a fund manager who doesn't view the energy transition as an investment opportunity. Even if their funds don't invest in it, they still recognise the fundamental transition net zero represents. Much like the shift from horse and carriage to the car, from the transistor radio to television, or from Encyclopaedia Britannica to Google.  

The headline for this wire isn't original. It comes verbatim from Larry Fink, CEO of the world's largest asset manager BlackRock. He also said in the letter to the CEOs of companies BlackRock invest that:

"We focus on sustainability not because we’re environmentalists, but because we are capitalists and fiduciaries to our clients."

The purpose of this wire isn't to stoke the fire. That fire needs no stoking. 

Rather, it's to shed light on some of the misconceptions around ESG, the investment case for it, and some of the best companies that make it up (and also some to steer clear of). And for that, I reached out to Alphinity's Jessica Cairns and Elfreda Jonker. 

What are some of the greatest misconceptions around decarbonisation?

That the cost of decarbonisation is too high. This entirely depends on the issues being addressed. For companies where most carbon emissions come from electricity, decarbonisation is relatively simple. They can either purchase renewable energy or install renewable energy on-site. Depending on the size, the payback is usually between 3-5 years. For companies where most carbon emissions come from fuel like petrol, diesel, gas etc, the practical and economic case can be more challenging. Typically, this will involve either switching to electric (eg electric vehicles) or switching fuel types (e.g. to green hydrogen which is not widely available yet). With some of these technologies still under development the payback can be much longer. If rolled out correctly though most initiatives will still result in lower operating costs over the longer term. Particularly as the price of fossil fuels continues to increase.

That the decarbonisation pathway is linear. The pathway to decarbonisation is going to be bumpy. This is true for individual companies and for global economies. We’ve all experienced this recently with the souring share prices of energy stocks around the world. We can’t expect the pathway towards decarbonisation to be a straight and simple process.

That planting extra trees will solve our problems. On more than one occasion we’ve heard comments that companies should just offset their emissions to solve the decarbonisation problem. To achieve decarbonisation we need real technological solutions and a range of options to improve energy efficiency, switch to renewable energy, remove carbon from the atmosphere, and offset remaining emissions.

What is the economic and investment case for decarbonisation? 

When we think about beneficiaries of decarbonisation, this includes industries across the whole value chain. For example, semi-conductors used to improve energy efficiency, base metals and commodities like lithium and nickel needed for batteries, electric vehicles, including auto manufacturers which need to transition their fleets, renewable energy manufacturers, constructors, transporters and operators, and finally, waste management companies to close the loop.

The economic and investment case is different for each of these sectors and will be specific to individual companies, however, at a high level we believe that the global economy is on a pathway towards net zero and companies that support that transition will have better economic outcomes in the longer term.

91% of global GDP is now captured by national governments' net zero commitments (June 2022)[1]. The timing varies, but the trajectory is clear. The introduction of the Inflation Reduction Act (IRA) has created incentives for investing in and delivering renewable energy and energy efficiency projects. As an example, through the IRA, around 370 billion USD will be disbursed for measures dedicated to improving energy security and accelerating clean energy transitions. The Netherlands also has a Sustainable Energy Transition Subsidy Scheme, under which new technologies like Carbon Capture and Storage are eligible for up to €13 billion of funding.

Most experts in this space agree that the cost of inaction is going to be more than the cost of action. Global climate change is causing significant negative impacts through rising temperatures, and increasing severity of weather events and climate conditions. Deloitte research reveals inaction on climate change could cost the world’s economy US$178 trillion by 2070[2]. This of course doesn’t take into account the non-measurable costs related to people’s health, well-being, safety, and communities.

Where are the best opportunities?

Schneider Electric (EPA: SU) is a leading global manufacturer of equipment for energy management and industrial automation. Its products include circuit breakers, switches, transformers, power grid automation and electric car charging systems etc. Their underlying market is expanding driven by strong market demand and government incentives. Schneider continues to take share within the industry, leading to consistent organic growth of mid to high single digits. Add to that effective M&A plus margin expansion from mix (more software) and efficiencies and we estimate that Schneider can deliver double-digit earnings growth over a 3-year horizon.

Nextera Energy (NASDAQ: NEE) is one of the world’s largest investors in renewable power assets and provides clean energy to approximately 5.8m US customers. NEE is among the best-positioned companies to benefit from the IRA, with a 20% share across US wind, solar and storage markets. NEE’s recent 4Q22 result rounded out the year with a record 8GW of renewable energy, with a total backlog of 19GW. NEE raised their renewables targets by 15% and extended it to 2026 in response to the IRA. NEE has a long history of double-digit earnings growth and is likely to continue beating their targets in our view. Following a recent selloff, the stock is attractively priced at 23x price/earnings, at the lower end of its 5-year trading range.

Albemarle (NASDAQ: ALB) is the largest, most diversified, lowest-cost Lithium producer in the world and will be a key player in the electrification of the world in the next decade. Full vertical integration from resource to conversion is a long-term competitive advantage especially as it increasingly negotiates long-term contracts with the big EV manufacturers. It is estimated that global demand for Lithium, used in EV batteries, will increase by 3x by 2025 to 1.5mt, and by >6x by 2030 to over 3.5mt. ALB is expanding their infrastructure capabilities to multiply its production from 140kt in 2021 to 500-600kt by 2030. ALB nearly tripled earnings guidance through 2022, based on persistently strong Lithium price and restructuring of its contract portfolio (from largely fixed price contracts historically to 75% variable benchmarks. ALB continues to enjoy strong earnings upgrades for FY23 & FY24.

What are some companies worth avoiding?

Wind and solar: Some wind and solar companies are currently not good investments due to cost pressures and other challenges. This is not to say that this will always be the case.

One such example is Vestas (CPH: VWS), which holds a key position as a leading manufacturer of wind turbines with a strong onshore wind position and a developing offshore wind business. The key strength for Vestas is the servicing business that is underpinned by long-term contracts at margins of 20-25% EBIT. While the growth prospects for Vestas are strong, the profitability has been challenged. While revenue has grown 50% from FY16 to FY21, operating income has declined by 68% and turned into a loss in FY22 as an intensely competitive environment combined with rising input costs have curtailed the business’s ability to generate reasonable returns. While Vestas has plans in place to restore profitability towards long-term targets, we will need to see evidence of an improved project pricing environment flowing through to economic returns before we buy the stock.

Orsted (CPH: ORSTED) (previously named DONG Energy) is another example. It is the largest offshore wind developer and operator globally. It is headquartered in Denmark and is a market leader in green growth. They have equally been plagued by persistent higher-than-expected costs through operational & financial implications of weather patterns & commodity prices, self-inflicted concerns of an equity raising and rising rates. Orsted has been in an earnings downcycle for a number of years and we would need to see it turn positive before we will invest.

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