Podcast Summary
Understanding Climate Tech in Public Markets: Climate tech in public markets is a growing but volatile category, with various types of funds or portfolios, but defining what constitutes a climate tech company remains a challenge.
Climate tech in the public markets has seen significant growth and volatility in recent years. While climate tech as a category has surged during certain market conditions, it has also experienced significant downturns. Shanu Matthew, a portfolio manager and research analyst at Lazard, explains that climate tech can be categorized into various types of funds or portfolios, including climate solutions providers, sustainability portfolios, and ESG funds. The challenge lies in defining what constitutes a climate tech company versus a non-climate tech company. For instance, a utility company like NextEra Energy, which is the largest owner-operator of solar and wind in the country, also operates traditional utilities like Florida Power and Light. As of now, there isn't a clear and definitive way to track climate tech performance in the public markets as a standalone category. Despite these challenges, understanding the public markets' perspective on climate tech is crucial as it has significant implications for the broader health of the sector, funding environment, and valuations.
Investing in climate tech companies in public markets: A challenge: Despite underperformance, long-term investment in climate tech companies in public markets requires careful consideration due to factors like interest rates, energy prices, regulatory subsidies, and valuations.
Defining climate tech companies in public markets can be a challenge due to its broad scope. This narrows down the potential investment universe significantly, leading to a highly concentrated portfolio. Over the past few years, climate tech indices like the S&P Global Clean Energy Index and MAC Global Solar Index have underperformed the broader S&P 500 index by around 40-50%. This underperformance can be attributed to the normalization of factors such as increasing interest rates, normalization of energy prices, uncertainty around regulatory subsidies, and a decrease in valuations. However, it's important to note that the 2018-2020 period saw significant growth in climate tech companies due to a low-interest-rate environment, high energy prices, and regulatory subsidies. Overall, investing in climate tech companies in public markets requires careful consideration and a long-term perspective.
Impact of rising interest rates and inflation on clean energy sector: Rising interest rates and inflation negatively impact clean energy sector, increasing costs for consumers and companies, lengthening payback periods, and decreasing net present values, leading to lower valuations. Election uncertainty also contributes to stock price volatility.
The clean energy sector, particularly companies focused on solar and wind, have been disproportionately affected by rising interest rates and inflation due to their reliance on external financing for consumer purchases and capital-intensive business models. These factors increase the overall cost for consumers and companies, lengthen payback periods, and decrease net present values, leading to lower valuations. Additionally, uncertainty surrounding the US presidential and congressional elections is already impacting the share prices of public cleantech companies. These trends were evident before the Inflation Reduction Act (IRA) was passed, but the IRA's passage caused a temporary surge in stock prices, followed by a decline due to the aforementioned factors.
Impact of U.S. Election on Clean Tech Tax Credits: Investors weigh potential election impact on clean tech tax credits, focusing on renewable energy's continuity while assessing risks for biofuels, green hydrogen, and EVs
Investors are considering the potential impact of the U.S. presidential election on tax credits for clean tech companies, but they are not necessarily writing off the entire sector due to uncertainty. Some tax credits, like those for renewable energy, are seen as less risky due to their history of continuity across different administrations. However, tax credits for sectors like biofuels, green hydrogen, and EVs, which require more government support to become profitable, are viewed as more sensitive to election outcomes. Market participants are trying to understand the specific implications of different election scenarios and are not necessarily avoiding the sector altogether. There is a general awareness that the White House and Congress have different levels of power to impact tax credits, and there is a risk of a sector-wide sell-off if investors overreact to election uncertainty without considering the differentiated risks within the sector.
Political headwinds impact growth in climate tech sectors: Political attitudes towards renewable energy and shifts in investment trends can significantly impact growth in climate tech industries like solar and EVs, requiring investors to consider these factors when underwriting growth rates.
Political headwinds and uncertainty can significantly impact the growth trajectory of industries, particularly those in the climate tech sector. For instance, the solar industry can be negatively affected by a president's antagonistic attitude towards renewable energy, creating noise and uncertainty that can impact overall growth. Another sector, such as electric vehicles (EVs), experienced explosive growth in recent years but is now facing a slowdown due to revised growth expectations and decreased investment from OEMs. As a result, EV companies have had to adjust their production targets and outlooks, leading to more cautious market forecasts. Overall, investors need to consider the potential impact of political and market factors on industries and companies when underwriting growth rates.
Lithium market price volatility causes significant pain for equities: Despite current challenges, long-term demand for lithium continues to drive upward growth, but price volatility and economic factors impact equity performance
The lithium market, driven by the EV sector's growth, experienced a dramatic price increase from under $10,000 to over $80,000 per metric ton between 2020 and 2022. However, prices have since crashed back down to around $13,500-$15,000 per metric ton. This volatility has led to significant pain for lithium equities, with tier 1 producers like Albemarle, SQM, and Arcadium Lithium experiencing declines of 40-50% or more. Even the lowest-cost producers are guiding towards negative free cash flow this year due to committed CapEx spending. Despite the current challenges, the long-term demand for lithium is expected to continue driving upward for the next decade. The supply-demand balance and pace of this growth are important factors, but the underlying macroeconomic drivers have not disappeared.
Market growth varies within sectors: While some companies within renewable energy and electric vehicles sectors may experience robust growth, others might face challenges due to market oversupply or regulatory hurdles. Investors must understand each market's nuances to identify where economic value lies.
Despite the robust growth in sectors like renewable energy and electric vehicles, not all companies within these sectors will experience similar growth or success. For instance, in the lithium market, while demand is projected to grow at a 15-20% CAGR through the end of the decade, current supply outpaces demand, leading to lower prices. Conversely, in the solar sector, despite its rapid growth, the performance of individual companies can vary greatly. For example, utility-scale solar saw significant growth in 2023 due to regulatory catch-up, while residential solar faced challenges. As public market investors, it's crucial to understand the nuances of each market and where economic value accrues.
Utility-scale solar market growth varies, residential solar market faces challenges: Utility-scale solar market growth is uneven, with some regions seeing strong momentum and others facing delays. Residential solar market has seen growth but now faces net metering policy changes and oversupply, leading to inventory buildup and decreased demand.
The utility-scale solar market is experiencing varying levels of growth, with top performers seeing strong momentum and demand, while others are facing delays and high single-digit growth rates due to interconnection, permitting, and transformer issues. On the other hand, the residential solar market has seen significant growth in the past few years but is now facing challenges, including a dramatic change in net metering policies in California and oversupply in the supply chain leading to inventory buildup and a decrease in demand. Companies like SolarEdge and Enphase have seen a significant decrease in revenue due to inventory buildup, and the near-term outlook depends on how quickly the inventory channel is digested and when demand will inflect.
Investor focus shifting towards executing climate tech companies and climate adjacents: Investors are favoring climate tech companies with strong execution and faster growth, while also showing interest in climate-adjacent businesses for stability and less cyclical investments.
The climate tech market is experiencing a period of transition, with investors shifting their focus towards companies that are executing well in the current market and companies that are climate adjacent. The former group, which includes companies with faster top-line growth and better execution, is seeing a flight to safety from investors and trading at wider premiums or higher multiples. The latter group, consisting of incumbent businesses with underappreciated tailwinds related to decarbonization or climate change, is attracting investors looking for more stable and less cyclical investments. Additionally, traditional water companies are also seeing increased investor interest due to their climate-adjacent nature. Overall, this trend reflects a broader macro public market that has been up, but with many climate tech categories cooling off after a hot period. The question now is where the money dedicated to this theme will go as the sector experiences bifurcation.
Investor outlook for climate tech sector remains challenging but long-term growth potential is attracting investors: Despite near-term challenges, investors are taking a long-term view on climate tech sector and positioning themselves to benefit from its growth potential
While the outlook for the climate tech sector and public markets remains challenging in the near term, many investors are taking a longer-term view and looking for opportunities to capture the multi-year growth potential of these sectors. According to John Sean New Matthew, a portfolio manager and research analyst at Lazard, recent estimate revisions from Wall Street analysts suggest that conditions will remain challenging for many businesses in the sector. However, Matthew also expects to see a more rational view towards valuation in the coming period, with investors taking selective bets on subsectors they believe have resilience or are approaching an inflection point. Overall, despite the near-term challenges, many investors are positioning themselves to benefit from the long-term growth trends in the climate tech sector.
