Play "the largest capital investment cycle the world's ever attempted" with these stocks

When people hear the words energy transition, the very obvious comes to mind. So perhaps it is a big shift away from fossil fuels to renewable power like wind and solar. Perhaps it's electric vehicles or disruptors like Tesla (NASDAQ: TSLA), and maybe it's even green hydrogen that comes to mind, but it's a lot more than that. And I think what people tend to think about is that we are talking about a very narrow set of companies that are going to benefit from the transition. And perhaps that means it's a crowded trade. Perhaps it means these companies are going to trade on really high valuations, and you certainly can see a lot of companies in this very popular thematic trade on very high valuations, but that's certainly the sorts of investments we are looking to avoid. If investors focus on the very obvious beneficiaries of this transition, we would agree it's actually quite a high risk place to invest.

What I think is important to remember is that this is a significant area of change. I mean, this is the largest capital investment cycle the world's ever attempted. And so what that means is it's going to touch many different economies, different parts of the world at different places in time, and it's really going to rely on government mandates for this change as well. So what all that means is that when you have a bigger investment cycle, you're going to see periods of overinvestment in certain sectors. You're going to say see periods of in underinvestment as well. That's naturally going to create cycles, and that's what we're trying to take advantage of as investors. It's certainly not a linear change in any way, shape or form. So we can find many different areas to invest for this transition. 

LW: How does PGTX tap into the transition?

We are looking for the less obvious beneficiaries of this transition. Perhaps they've been overlooked. Now, some of these businesses might be experiencing structural change. Perhaps the industries they're operating in are undergoing some change, but that is what creates the opportunities. And if we can get these investments early in the inflection point, we can actually invest at quite reasonable valuations. 

To give you an example, batteries is one area we've done a lot of work on. We own LG Chem and Samsung SDI. Of course, batteries is an obvious area of change, but last year there were fears of recession. There was a gas crisis in Europe. People were really concerned that investment in electric vehicles would slow down and it still might. But what we were of the view was that if these car manufacturers are going to sell electric vehicles in five years time, they can't slow down their investment. They'll keep going. And so it was a great opportunity to invest in some of these battery companies at that time, at very low valuations because people were concerned about the very short term.

And it wasn't just that we could also find that extended supply chains in electric vehicles being sold down quite heavily. So power semiconductors, the companies that are involved in manufacturing the electric vehicle and battery plants, the component suppliers, the companies involved in upgrading electricity grids, all of that, companies all across many different sectors, were sold down for the same reasons, and it gave us quite a nice entry point in into some of these names. 

LW: Which sectors and stocks riding the transition are offering the most value?

I'll mention two. Pulp and paper is one area we're invested in and people shy away from it at the moment because we are peak cycle in pulp and paper. But UPM-Kymmene Oyj (HEL: UPM) is one we've owned for a while now, that's based in Finland. It's Europe's largest paper producer now. Paper's been in decline for well over a decade now. As we know, we've shifted to online content.

So UPM's been quite early in its transition, there are many other sectors out there, and what they've done is recognise they have this great wood resource, it's biodegradable, it's carbon-neutral, and it's found other use cases for that wood. Some of it is pulp in parts of the world like Uruguay. You need pulp to replace plastics with more sustainable packaging. The other area of investment for UPM is biofuels. They use that to decarbonise transport in Finland and Sweden. And then biochemicals is a new area of growth for them as well. They've got a new plant coming online in Germany this year, and you use biochemicals to replace fossil fuels in things like PET bottles. And of course the consumer goods companies out there want to know that they're putting products out there that have a lower carbon footprint. So UPM is trading on 10 times earnings, but once these big projects in pulp, biofuels and biochemicals come online in the next two years, it's a transformation in this company's earnings profile and much higher returns on capital.

So I think once that happens, we will see a re-rating in the shares. Another stock connected to this sustainable packaging thematic is Crown Holdings (NYSE: CCK). Now Crown is one of the larger aluminium can producers in the world, and we got an opportunity to invest in that stock last year. Again, there were fears around recession. There was a lot of inflation, which impacted the aluminium price, which is a key raw material that goes into producing cans. The beverage companies decided to pass all of that through to consumers, and then consumers stopped buying alcoholic beverages, consumer soft drinks, and we saw a pullback in volume in that company. So again, the shares were sold down quite aggressively at that time. It also came at a time when Crown and its peers were really investing in a lot of new capacity, so it was sort of a perfect storm.

What we've now seen is these companies have stopped their capacity expansion. They're going to be a lot more disciplined. They're going to generate a lot more free cash flow, and we should see that return to shareholders in the coming years. We still think that aluminium can demand is going to be there as a strong structural growth driver as we replace more plastics. In fact, 80% of new product introductions are now going to the can going forward. Because we have the material today, it can be easily recycled. And it's a cheap way for beverage can makers to hit their goals on using more recycled content going forward.