What we are looking for
An attractively valued renewable energy company.
All eyes are on central banks these days, with economists predicting that policy interest rates will be roughly two percentage points lower in Canada and the United States by mid-2025, according to the latest Reuters poll. Lower interest rates are a boon to most stocks, but a recent survey of fund managers by Bank of America named renewable energy and biotech as the top beneficiaries of U.S. rate cuts.
For renewables, this is unsurprising given the economics of clean energy projects. With traditional energy, fuel costs are spread across the entire operating life of a power plant. With solar and wind power the fuel is free; nearly all of the costs of the projects are upfront – making them much more attractive in a low rate environment.
Returns in the sector lagged as rates rose (and companies were also hit with supply chain issues for equipment), but prospects are looking sunnier with forecasts for rate cuts in the months and years ahead. In the summer of 2022, the price-to-earnings ratio of the S&P Global Clean Energy Index reached 75, compared with 21 for the S&P 500. But by late last year this had dropped to 21 for the Clean Energy Index, with the S&P 500 trading at a multiple of 24, prompting a search for value in the renewables industry.
More about London Stock Exchange Group
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The Screen
- We start with a universe of companies in the GICS renewable electricity or the TRBC renewable IPP subindustries, which are part of the utilities sector, or the TRBC renewable energy industry, which is part of the energy sector. (GICS, being an older classification scheme, has no renewable energy equivalent.) We are looking at those headquartered in North America.
- To get a sense of which names might be attractively valued we use the LSEG StarMine Relative Valuation Model. This looks at forward and trailing enterprise value relative to sales and EBITDA, share price relative to earnings, book value, cash flow and dividend yield to give companies a percentile rank (with 100 being the best value). For this analysis we use all broad-sector peers to see how these renewable names compare with their fossil-fuel energy and utility peers in terms of valuation, and screen for those in the top 20 per cent (i.e. above a score of 80).
What we found
The screen yields five companies with four U.S. names and one Canadian, with the lone Canadian company – Canadian Solar – getting the best valuation score. According to the LSEG Renewables Dashboard, Canadian Solar has 77 active renewable energy facilities across 15 countries – with the United States, Brazil and Mexico being its three largest – and 43 more facilities in the pipeline.
The screen also shows the inherent limitation in using only the GICS industry classification scheme, which is the most commonly used in the investment industry. As mentioned earlier, being an older scheme, GICS doesn’t necessarily reflect the economy of today, which can be especially stark for relatively newer business activities like renewable energy. Canadian Solar is classified as a semi-conductor company. It would thus be compared with companies making chips for generative AI, rather than other clean electricity producers. Cardinal Ethanol is classified as an oil and gas company, rather than a clean ethanol company. Traditional oil and gas companies generally trade at lower multiples, so Cardinal wouldn’t appear as attractive a buy when compared to this peer group. To the extent that investors are using these outdated peer groups to identify value companies, renewable energy plays like Cardinal might be an underappreciated diamond in the rough.
Hugh Smith, CFA, MBA, is Director, Analytics at London Stock Exchange Group.
Hugh Smith, CFA, MBA