The proposed European Green Deal and the EU Taxonomy for Sustainable Finance show the EU is serious about its climate ambitions. One of the beneficiaries of this trend is the European utilities sector, which has faced a decade of challenges. The main headwind was tumbling power prices driven by a combination of falling fuel prices, carbon price and oversupply. This resulted in earnings and cash flows coming under pressure against a backdrop of stretched balance sheets and resulted in a number of financial restructurings and dividend cuts. Unsurprisingly this also drove poor returns for investors.
Fast-forward to today and the picture looks very different. The earnings mix has changed materially, with networks and renewables representing close to two-thirds of sector earnings compared to one third in 2010. Earnings are being driven much less by power prices. This means that the sector’s earnings profile is less volatile and less macro-sensitive at the same time as being well positioned for higher growth as driven by decarbonisation and energy transition. This trend is already underway as a result of the improving cost competitiveness of renewable technologies and an attractive backdrop for access to capital.
Investors are increasingly focusing on this trend across the capital structure with the expansion of the green bond market and the rapid growth in environmentally focused equity products. This means that on top of the more visible earnings growth, companies can benefit from a lower cost of capital alongside an already accommodative bond yield environment.
Offshore wind industry
One example of the growth opportunity is the offshore wind industry, which has until recently been focused on Europe. As the technology has become more competitive and mature, it is starting to expand into new markets such as the US. Last year the International Energy Agency estimated that the offshore wind addressable market alone could grow at a 15% CAGR to 2040, requiring over 1 trillion dollars of investment. Further policy initiatives such as the EU Green Deal and an increasing focus on the ‘journey to net zero’ should further enhance visibility around this trajectory. The European Utilities sector is home to some of the leading players in the industry, such as Orsted.
Planes, trains & automobiles
A focus on lowering carbon emissions amongst a broader range of stakeholders is leading to implications beyond renewable energy and utilities. ‘Flysgskam’, or ‘flight shame’, is a term which has entered into common parlance in recent years and describes the shame we should feel about flying given its impact on the environment. One implication of this is the emerging trend of consumers to shift from air travel to rail, given rail’s lower emission profile.
Recent data from Germany has shown weakening of domestic flight passenger numbers in favour of long distance rail. In November 2019, the German Airports Association (ADV) registered a 12% drop in passenger numbers year on year for German domestic flights. It is not just consumers being attracted towards rail. Only last year Germany announced VAT cuts for rail travel and recently announced an 86 billion euros rail infrastructure plan agreed between the federal government and Deutsche Bahn. This is just one example of the favourable demand backdrop for rail industry suppliers. Clearly the ‘clean transport’ discussion extends further into the transition to electric vehicles and the electrification of the wider economy, where Schneider Electric should be well positioned.