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What is driving value in the energy efficiency sector today? - Tomas Freyman
The total value of energy efficiency deals in 2011 was more than twice that in 2010, helped in no small part by two energy efficiency deals that ranked amongst the largest Cleantech deals completed in Europe in 2011. Schneider Electric purchased Telvent for $1.4bn and Toshiba purchased Landis+Gyr AG for $2.3bn. This increase in deal volume is a trend that is expected to continue as corporates and governments come to better understand the demand side of energy and the opportunity inherent in meet the target of a 34% reduction in greenhouse gas emissions by 2020 (against a 1990 baseline).
Despite some bumper deals, it has not been all plain sailing for the Cleantech sector. As at March 2012, the WilderHill Clean Energy Index (ECO)[1] is down 27% over the past 3 years versus the NASDAQ Composite Index being up by 102% over the same period. However, in Q4 2011, of the top 5 performers in ECO, two were energy efficiency companies (Ameresco rising 35% and AO Smith rising 25% over the quarter). The energy efficiency and storage sub sector was the best performing within the index.
For investors, the asset class may provide an opportunity based on certain broad fundamentals. Energy costs are expected to continue to rise over the coming years and we are likely to be in the second half of a world recession which should bode well for energy service solution companies targeting energy intensive corporates; especially those that face tight margins. Many of these corporates may begin to be in stronger positions to make bold strategic decisions around their energy strategies like Tescos and Morrisons have done.
Furthermore, of all the buildings that are standing in the UK today, 90% will remain so in 2035. The retrofit opportunity is, therefore, one of the greatest opportunities we have today. In the US, banks such as Citigroup and Bank of America have allocated funds towards efficiency projects as has the European Commission through its recently launched European Energy Efficiency Facility. For the financial sector, this is an attractive investment opportunity as energy savings can be typically underwritten via energy performance contracting. The assets are particularly low risk and are long-term in nature, making them attractive for pension funds, life-insurance companies and sovereign wealth funds that are looking for assets to match their long term liabilities. A bonus for equity investors is that the payback periods can be three years; with simple lighting upgrades delivering IRRs of nearly 20%.
So you may ask why aren’t more CEOs and CFOs investing in energy efficiency projects? Part of the answer lies in the fact that energy costs still represent a relatively small portion of corporate operating expenditure. On average for a FTSE 100 company, total energy spend is approximately 2% of revenue. However, with average net income margin being approximately 16%, reducing these costs by even 25% translates straight to the bottom line, which can be material for many FTSE 100 companies. In many of the discussions we are having, corporate minds are increasingly being focussed by the risks and opportunities associated with commodity and energy prices, regulatory changes and corporate reputation.
As with any sector characterised by innovation, change and entrepreneurial businesses, the road from initial concept to market success is a tough one. The ability to access funding within the Cleantech and Sustainability sector, to move from proof of concept to production reality, to protect intellectual property and create a strong, “back able” management team are all essential for success. However, for those businesses that have managed to move from surviving to thriving, there has emerged an increasingly solid investment case. Financial and trade investors are increasingly seeing the investment opportunities and the strategic market consolidation. Hence, the dramatic increase in the amount of investment into opportunities that provide solutions for energy security, energy efficiency, demand side management and lower carbon, resource efficient innovation.
It should be no surprise then to see Toshiba and Schneider Electric making these large investments and thereby positioning themselves as global energy efficiency leaders. Conversely it helps technology solutions and smaller service companies to better understand the wider context in which they operate and the opportunity they have ultimately to maximise value for their shareholders.
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[1] The WilderHill Clean Energy Index (ECO) is a modified equal dollar weighted index comprised of publicly traded companies whose businesses stand to benefit substantially from societal transition toward the use of cleaner energy and conservation.
23 May 2012
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