Why the best value from electrification won't be found in Tesla

It's ironic that in some corners of the investing world, 'decarbonisation' has become a dirty word. 

But while arguments can (and should) be made about its impact on global warming, the fact that the transition is underway is not up for debate. Governments have set their targets, as have companies, and institutional investors are including it in their mandates. 

Like all thematics there will be winners and losers, and everything in between. So finding the section of the transition with the best investment case will be critical. 

Iain Fulton, Portfolio Manager, Yarra Global Share Fund, believes he's found that pocket of value. And it's not downstream in the electric vehicles we see gracing our roads. 

We have a shortage of charging infrastructure and our grid itself is struggling to cope even with the relatively small number of vehicles that are electric today. 

We've got something like 270 million cars in the US, and a similar number in Europe and Asia. To electrify all of that, the charging infrastructure and the investment in the power grid that we need is absolutely enormous. 

In this interview, Fulton expands on this thesis and backs it up with some companies that are primed to benefit.  

Note: this interview was recorded on September 7, 2023.

Edited transcript

LW: How has the investment opportunity landscape changed?

The landscape for opportunities has polarised a little bit. I think there are good opportunities out there, we're seeing some areas, such as technology, being rewarded rapidly. On the other hand, some areas, like emerging markets, have remained out of favour for quite a long time, facing challenges as an asset class over the last decade. 

When we look at economies like Indonesia or India, we think the evolution of the consumer and the stage in their development is really quite interesting. India, for instance, has shifted towards cashless payments and has almost achieved full banking and account penetration. That allows a platform for penetration of consumer credit to a deeper level and an evolution of consumption away from basic, staple type demand into more aspirational goods.

These dynamics create opportunities, albeit valuations sometimes come at a bit of a premium. 

It's become polarised, but I think there are very interesting opportunities potentially developing in those emerging markets.

LW: Where along the decarbonisation supply chain are you seeing most value?

There are two primary areas where we see value in the energy transition supply chain.

Number one is in the theme of electrification, and we're very bullish on the adoption of electric vehicles. 

There's significant competition with new models entering the market leading to prices coming down, all while consumer demand for electric vehicles is on the rise. But we face a shortage of charging infrastructure and our grid is struggling to cope even with the relatively small number of electric vehicles in use today. In the US alone, there are approximately 270 million cars, a similar in Europe and Asia. Electrifying this vast fleet would require an enormous investment in charging infrastructure and power grid enhancements. Companies like Schneider (NYSE: SNDR) and Amphenol (NYSE: APH), are likely to benefit from this growing demand. And not to mention the fact that AI really increases power consumption in the data centre, which puts further strain on the grid. 

We think that the theme of electrification is, pardon the pun, very powerful.

An additional area that we think is attractive is engineering and construction. The paradox of the energy transition lies in the fact that to develop the necessary infrastructure to electrify our entire automotive fleet or to move to a sustainable, low-emission power grid and power-generation system, a substantial amount of infrastructure is required. Building this infrastructure demands energy resources, and with limited number new fields for exploration and development being authorised, we need to make the most of the reserves that we have today.

There's a bull market running in energy services. Examples are Schlumberger (NYSE: SLB), ChampionX (NYSE: CHX), Worley (ASX: WOR) and KBR (NYSE: KBR). 

They are experiencing growth in their traditional energy services businesses, which is being overlooked. But on top of that, businesses like KBR and Worley, with their engineering and construction arms focusing on sustainable projects and consulting on new infrastructure projects, have an excellent long-term opportunity to capitalise on what we think is a structural shortage in engineering talent and pricing power related to these new projects and the energy transition.

LW: Will the trend in travel spending continue and how are you gaining exposure?

We see the consumer travel boom, with the US up 30% and Europe up 10% where it was in 2019, potentially easing into 2024 as economies weaken.

However, we are quite optimistic about the return of the Asian and Chinese travellers. as the Chinese government is allowing larger groups to travel to places like Korea and Japan, which is a favourite destination among these travellers. We think they'll come back into the market in 2024 and that will support overall travel activity and benefit companies like Samsonite, Amadeus and Booking Holdings (NYSE: BKNG).

LW: What is the market underestimating at the moment?

I think there's a danger of increasing financial leverage in the system. This may have emerged from the bailouts of the regional banks in the US, which are funding private equity and commercial real estate.

As these banks are recapitalised by money centre banks, they aren't re-extending that finance into the real economy via mortgages or the commercial real estate market, instead it is being extended into the financial sector through repos into hedge funds, allowing equities to rise and surge.

The unintended consequence of this credit crunch may be an expansion of the available liquidity for equities, pushing them higher in a slightly unsustainable way.

There's a danger that if that music stops, then we could be in for an interesting ride.

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The future return on investment and the growth of a company's cash flows are key focus points. Iain's team seek companies where the future is not reflected in today's valuations. 

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Yarra Global Share Fund

Global Shares

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