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A wind farm operated by Enel. After outperforming the wider utilities market through 2020, pure-play renewables developers have lost some of their edge as the market corrected. |
Equities in the European power and utilities sector have been a compelling story of late.
Amid falling bond yields, a recovery in power prices, improved investment discipline, and more recently the growth of environmental, social and governance funds, European utilities have outperformed the broader market by more than 40% cumulatively since 2017, according to James Brand, utility research analyst at Deutsche Bank.
A bull run through 2020 drove pure-play renewables stocks like Danish wind developer Ørsted A/S and France's Neoen SA well above the wider utilities universe in the early stages of the coronavirus pandemic. But in the first months of this year, these companies have experienced a plot twist, losing most of their edge over integrated players as part of a market correction that saw green stocks sold off.
Analysts point to a few reasons for this correction, including the recovering bond market and a lack of liquidity that meant clean tech stocks approached what some observers called bubble territory. "The main concern was that ESG investors were indiscriminately investing in what few renewables there are," said Elchin Mammadov, senior utilities analyst at Bloomberg Intelligence.
Money looking for green stocks will soon have more options. Clean energy-focused exchange-traded funds, for example, largely try to follow the S&P Global Clean Energy Index, which is made up of companies in the utilities, information technology, industrial and energy sectors, according to Lueder Schumacher, head of European utilities research at Société Générale. "All of this money was chasing more or less 30 companies, some of them with limited free float," Schumacher said.
That is about to change, however. To reduce concentration and improve liquidity, S&P Dow Jones Indices is widening the constituency of the Clean Energy Index to 100 from 30, among several changes confirmed on March 24. The changes will be introduced on April 2, and before then some in the market are holding out and awaiting clarity, Schumacher said.
Concerns over returns
The green stock sell-off is also partly a result of growing concern over the sustainability of future returns in renewables. "A few events early in the year got people scratching their heads," Schumacher said. One was the renewables auction in Spain, which yielded record low bids at €25/MWh. The second was the U.K. Crown Estate's seabed lease auction, which saw many incumbents tap out due to sky-high option fees. "It's an interesting trust exercise; you are down a billion before you even get to [bid into the contracts-for-difference] auction," Schumacher noted.
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The market correction similarly dragged down listed renewables investment funds, with the likes of Greencoat UK Wind PLC, Bluefield Solar Income Fund Ltd. and Aquila European Renewables Income PLC losing their edge over the S&P Global BMI Utilities Index. In the early weeks of the COVID-19 pandemic, the funds had outperformed the benchmark and the wider market, with their share prices showing resiliency against the broad economic uncertainty. While this trend was inverted in the second half of the year, most of the listed European renewables funds posted growth in their net asset values in 2020.
One exception is U.K.-based investor Foresight Solar Fund Ltd., which saw its net asset value decline by 7.3% year over year to £582.2 million. The company attributed this to lower power prices in the U.K. and Australia — the same rationalization given by JLEN Environmental Assets Group Ltd., which experienced a 1.4% drop in its net asset value in 2020.
Foresight Solar Fund also slowed down on M&A, making only two acquisitions totaling 125 MW during 2020. As decarbonization targets mount and demand for green power assets rises, utility-scale solar will become more central to countries' energy mixes, the investor said in its annual report. "As a result, the pricing environment for operational assets with high levels of contracted revenues in both the U.K. and Europe is set to remain competitive, presenting modest investment opportunities."
Integrated advantage
Why did the correction come when it did? "Buy the rumor, sell the news," Mammadov said. Supportive big-picture trends such as the European Green Deal and the prospect of a Democratic U.S. president in Joe Biden helped buoy renewables valuations. "When those trends played out, people started to say, 'Okay, what's next?'" Mammadov said.
After two years in the sun, "this was one of the sectors where people could take profits, and people did," Schumacher said.
Financial markets are also beginning to understand the implications of merchant power price exposure, as government subsidies expire, giving give way to more volatility and downside risk, Mammadov added.
Over the past year's economic turbulence, one business model proved particularly sturdy: While European utilities outperformed the market as a whole, "the most striking gains were from high quality integrated utilities with renewables pipelines," Brand said.
Francesco Starace, CEO of Italian utility Enel SpA, sees valuation advantages for the integrated business model and a multi-technology portfolio which allows businesses to better absorb external shocks and optimize risks and returns.
Mammadov agrees. "Purely from a risk perspective, we don't know where the value will be in 10 years' time. As a utility it's better not to be focused on one part of the value chain," the analyst said. Putting all of this into perspective, though, the renewables story still looks promising with companies continuing to outperform the wider market. "There's still huge growth, don't get me wrong," Mammadov said.
S&P Global Market Intelligence and S&P Dow Jones Indices are owned by S&P Global Inc.