Power trip: Energy transition opens investing opportunities in small-to-mid-sized Canadian companies

September 17, 2023
Written by Aman Budhwar
Power trip: Energy transition opens investing opportunities in small-to-mid-sized Canadian companies

As seen in Financial Post on September 17, 2023

Climate resilience has emerged as a key theme shaping government policies and transforming markets. A recent report by BlackRock Investment Institute estimates extreme weather — the fires, hurricanes, floods, and tornados that have been front-page news all summer — could clip more than five per cent from economic activity by 2050, even as the low-carbon transition evolves.

Blackrock estimates investment in the energy system will increase by US$3.5 trillion during the 2020s, and up to US$4.5 trillion by the 2040s, with low-carbon investments accounting for up to 80 per cent of the total. Current and future investment decisions need to factor in the various effects of policy, manufacturing production, consumption patterns and capital allocation during the transition to a low-carbon world.

Most countries are seeking to electrify and decarbonize their economies. Under the previous administration, the United States was a laggard in this regard, but the Joe Biden administration has taken a leadership position and made some important changes to address global warming.

Last year, two major regulations were passed, including the Inflation Reduction Act (IRA), which provides subsidies of more than US$500 billion in the form of tax credits, grants and loans to fund clean-energy projects and address energy security, and to encourage businesses to transition to lower-carbon sources of energy. Similar initiatives such as the Green Deal Industrial Plan have been passed in the European Union.

Interest in clean energy was given a boost recently due to geopolitical risks, particularly Russia’s invasion of Ukraine and the disruption of the flow of oil to Europe. Globally, investment in clean energy technologies, including renewables, electric vehicles (EVs), nuclear power, low-emission fuels, heat pumps and efficiency improvements, is rapidly outpacing the spend on fossil fuels such as coal, oil and gas.

The latest tally from the International Energy Agency (IEA) is that for every dollar invested in fossil fuels, US$1.70 is invested in clean energy. Five years ago, they were at par. Falling costs for clean energy products, such as EVs, together with proactive policies, will increase consumer demand and transform investor preferences. According to BlackRock, more than 50 per cent of the total global energy demand by 2050 will be from lower-carbon energy sources, up from one-fifth today.

Many companies are poised to benefit from the clean energy transition and some of them are in Canada.

For example, Stella-Jones Inc. produces pressure-treated wood products including railway ties and timbers for commercial railroad operators and wood utility poles for electrical utilities and telecom companies. We believe it stands to benefit as utilities are planning their biggest spending increase in decades to replace aging equipment, prepare for a surge in power demand driven by EV adoption and strengthen their systems to withstand severe weather patterns linked to climate change.

Altius Renewable Royalty Corp. is a renewable energy royalty company whose investments create gross revenue royalties and royalty-like structures related to wind, solar, battery storage and other types of renewable energy projects. Altius has 33 renewable energy royalties representing 2.1 gigawatts of renewable power on operating projects and an additional approximately six GW on projects in construction and development phase across several power pools in the U.S.

Computer Modelling Group Ltd. is a computer software technology company that develops and licenses reservoir simulation software and related services. The energy transition, specifically carbon capture and storage, hydrogen storage and geothermal processes, is a growing business for the company, contributing 22 per cent of software revenue in the quarter ended June 30, 2023, up from 15 per cent as recently as the quarter ended Dec 31, 2022.

Aecon Group Inc. provides construction and infrastructure development services to private- and public-sector clients and is positioned to harness opportunities from the transition to a net-zero economy. Sixty per cent of its revenue in 2022 was tied to sustainability projects, including utilities (grid modernization, energy storage, etc.), civil and industrial (water distribution and management, hydroelectricity, etc.), nuclear (small modular reactors, refurbishment and decommissioning, etc.) and urban transportation solutions (light rail transit, high-speed rail, etc.)

And, finally, NFI Group Inc. is a global bus and motor coach solutions provider with 450 years of combined experience across its portfolio companies. Its clients are taking the lead in switching to EVs from diesel-driven ones. Putting supply-chain-related disruptions during COVID-19 behind them, NFI is ramping up production to meet demand from a record public-market bid universe that is projected to be more than 21,500 units over the next five years based on the procurement outlook compiled from its customers fleet replacement plans.

Uncovering small-to-mid-cap companies such as NFI that are well-positioned for the energy transition can be a worthwhile exercise.

Global electrification and decarbonization trends offer many positive outcomes for the planet’s flora and fauna, certainly, and for investors. In terms of businesses, we believe there will be both direct and indirect beneficiaries. In particular, we see the energy transition as a huge opportunity for small-to-mid-cap companies. This is a recent trend.

SMBs have few or no legacy hangover issues related to relying on high-carbon sources to run their businesses. Thus, we believe they are better positioned to build revenue models on clean energy. The Exxons and Suncors of the world have deep pockets, but, at the same time, it is harder for them to rapidly transition their business models to the new energy environment.

There are a lot of moving parts in determining where the next great investment opportunity in clean energy may be. Government policy is a big factor as are relative costs and consumer preferences and trends. Wise investors should consider looking at good-quality, under-the-radar companies at reasonable valuations that can quickly pivot to the changing energy landscape.

Aman Budhwar, CFA, is a portfolio manager at PenderFund Capital Management Ltd.


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