Green Too Cheap to Ignore: Will We See End of Year Rally in Decarbonization Space?

Green growth has not been immune to the macroeconomic turmoil. However, the companies with relevant energy transition solutions may start to show the benefits of the U.S. Inflation Reduction Act (IRA) stimulus in both top line and bottom lines, and would not be as exposed to a potential earnings recession. Still, since ChatGPT exploded earlier this year, it became clear that the two most transformational trends of our generation are being treated very unequally. Investors are focusing on megatech names and looking the other way when it comes to decarbonization.

Green Growth vs. Artificial Intelligence

Investors are excited about mega tech names delivering the usually incompatible promise of solid short term cash flows combined with large growth prospects. Nvidia (NVDA) passed the 100% appreciation YTD and reached the $1 trillion market cap level: Nvidia shares shot up 26% on stronger than expected quarterly results, but it was CEO Jensen Huang’s comments on expected sales for current quarter at $11 billion, more than 50% above Wall Street’s consensus estimate, that excited investors on the growth prospects for Nvidia’s GPU products as the key “pick and shovel” play in Generative AI.

At the end of the month, the market cap of Nvidia passed the enviable $1 trillion valuation; this, plus Apple, Microsoft and Alphabet, adds to over $6 trillion. Only these four companies have a current market capitalization that is more than twice the sum of the equity value of the 166 names in the iClima Global Decarbonization Enablers Index, now with a market capitalization of ca. $2.7 trillion. This is an irrefutable sign of the massive concentration due to investor confidence in only a handful of mega tech names.

Investors seem to have found a winning combination. On one hand, large tech names benefit from solid current free cash flow generation (with not much growth in all cases but Nvidia’s), balance sheets that are robust, and extremely low risk in these names not weathering the macroeconomic turmoil. On the other hand, Generative AI represents long term growth opportunities, and investors find it is easier to bet on growth taking place within megacap companies that are also seen as quality/value names.

Although predicting the size of the Generative AI market by 2030 seems like a debatable exercise, figures being quoted by many analysts are in the $1 trillion level. A report by Precedence Research estimates that by the end of the decade, the global AI market will grow to $1.6 trillion, growing at a CAGR of 38%. It seems a huge disconnect that investors are rewarding growth prospects for technology and ignoring that the market for decarbonization is already way above $1 trillion.

The acceleration of the energy transition is here: BNef estimated that in 2022 global investments into energy transition added to $1.1 trillion. The International Energy Agency at the end of May published its World Energy Investments 2023 estimating that global investments into clean energy will reach $1.7 trillion this year. These solutions include renewable energy, EVs, clean energy storage, low-emissions fuels, efficiency improvements and heat pumps. It is also important to note is that 2023 will mark the year when investments into solar energy alone for the first time will surpass the investment flow into fossil fuel.

The Reality of the Energy Transition

U.S. investors are discounting green growth prospects as they also saw extraordinary cash flow being generated by “brown value” names. The energy transition in the U.S. is real, and the IRA is an additional catalyst. Goldman Sachs’ “Carbonomics” analyst, in a report published in April, claims that the U.S. is poised for “an energy revolution.”

The IRA, which will provide about $1.2 trillion of incentives by 2032, is a solid foundation for this growth, to be multiplied by other sources of funding. Goldman estimates that the IRA’s impact could encourage $11 trillion of green investments by 2050. By 2032, the research estimates that there will be about $3 trillion of cumulative investment opportunity into the different solutions, and on average, $290 billion of investments per year in the U.S. alone. As a reference, the author points out that “over the coming decade this would represent more than two times the total investment in the U.S. shale revolution.”

The chances of a green rally in the second half of the year are considerable: In January, when it looked like U.S. inflation was showing signs of waning (before Silicon Valley Bank collapsed and U.S. regional bank troubles posed another macro risk), markets interpreted the favorable data as potential end to U.S. Fed hawkishness. Combined with China's re-opening, potentially boosting global economic growth, and oversold names had a strong share performance in the first month of the year. Our iClima Global Decarbonization Enablers Index was up 12% in the month. Rather than a broad market rally, we saw fast appreciation in specific names that had been overersold; Tesla for example was up almost 41% in January, Wallbox up by 56%, Proterra up by 35%.

A Recession or Not?

In the second half of the year, it will become clear if the U.S. economy is or not entering into a recession. While a recession is never good for equity, a slower economy will likely mean taming of inflation and the Fed may pause hikes or even be forced to lower interest rates. The reduction of long-term rates and the end of the inversion of the yield curve would benefit growth shares that have been so out of favor. That macro scenario could promote a broader growth rally, also benefiting green names.

Another scenario is that inflation figures do not improve, and Fed continues to signal monetary austerity. In that case, markets will fear a more profound deterioration of economic activity that a prolonged period of higher interest rates would generate. While that scenario would not alleviate pressure on growth names, we expect the companies in our universe that directly benefit from the Inflation Reduction Act to start to show how IRA induced growth is benefiting both top line and margins. Investors could then decouple broad growth stories from green growth, and in that case, we also could see an end of the year green rally.

Ten Companies Leading Energy Transition at Steep Discounts

Ten solid names leading energy transition and decarbonization strategies are trading at steep discounts: There is a long list of listed companies with proven technologies, solid capital structure, capable management, hypergrowth (defined as top line increasing annually by over 40%) and clear path to profitability that are facing dramatic drawdowns as investors are indiscriminate between growth and green growth.

Out of ten names that we see in this category, eight are U.S.-based or U.S.-centric, and two are Chinese:

• Tesla (TSLA)
• BYD (1211.HK)
• CATL (300750.HK)
• Proterra (PTRA)
• Wallbox (WBX)
• Plug Power (PLUG)
• Bloom Energy (BE)
• Enphase (ENPH)
• Stem (STEM)
• Fluence Energy (FLNC)

These are the ten companies that are solving some of our biggest environmental issues, from electrification of transportation to smart charging of EVs, to solving renewable energy intermittency with distributed long duration energy storage. The technologies employed by these companies are proven, potentially deflationary as they benefit from scale and learning curves, are supported by the IRA and therefore benefit from increasing adoption by end users.

Yet over the past year, markets are not rewarding the transformational potential of their products and services, and are penalizing these companies as if we were not accelerating the energy transition. Investors with a five-year horizon can put in strategic allocation to these key holdings as part of a core strategy in a decarbonization themed portfolio. A deeper look into five names gives a flavor in terms of the size of the respective addressable markets as well as the growth and moat around their operations:

Tesla is at a market cap of $610 billion, and trades at a TTM P/E of 54.4 and a TTM P/S of 6.2, while Nvidia trades at TTM P/E of 218 and TTM P/S of 35.3. Tesla is not only electrifying transportation and expanding in the clean energy storage space, but it is also the company most likely to bring autonomous driving, which is based on AI, to markets and with that, disrupt and redesign transportation as robotaxis become a sustainable and more cost-effective way of individual and family transportation.

BYD is a Chinese EV leader, and it has been in the headlines for its aggressive pricing strategy. It recently cut by 10% the price of its best selling Sedan model, which competes directly with Tesla’s Model 3 in the Chinese market. The company’s multiple models strategy also includes a sub-$11,000 EV, the Seagull electric hatchback, at half the price of the next most affordable Chinese new energy vehicle. BYD is poised to keep its market dominance in the Chinese market but is also already in a global expansion to markets such as the UK, Norway, Brazil, Singapore, Australia, Germany and Japan. Some analysts expect the company to be selling 3 million EV units by 2025, even though the company is still defining what its strategy for the U.S. market could be.

Contemporary Amperex Technology, or CATL, is a Chinese battery player and the largest manufacturer of lithium-ion batteries for EVs and energy storage systems in the world with a market share of ca. 34%. CATL recently reported 1Q23 results, with revenues up 83% year-over-year. Known for the leadership in LFP chemistry, the company this year starts producing its sodium-ion batteries with Chinese Cherry Automobile being the first EV maker to use it.

Enphase Energy, the world’s leading supplier of microinverters for solar and battery systems, brought the solar segment down in April when it announced its 1Q23 results. Although the last quarter revenue of $726 million was a 64.5% increase over the $441.3 million reported in 1Q22, sales in the U.S. disappointed. While revenue in Europe grew 25% in 1Q23 over 4Q22, U.S. sales in the same period were down by 9%. Beyond California, management pointed out that the biggest drops were seen in the states with the lowest utility rates (Texas, Florida and Arizona). The U.S. represents 65% of top line revenue, with rest of the world at 35%. Management confirmed that starting in 2Q23, they will be adding manufacturing capacity in the USA in line with IRA incentives, bringing Enphase’s global quarterly capacity to more than 10 million microinverters by year end.

Stem is an AI-based clean energy storage as a service company, and it recently reported revenues a bit stronger than consensus, but its net loss was worse than expected. In 1Q23 top line revenue grew to $67.4 million, a 63% growth over the $41.1 million reported in 1Q22. At a current market capitalization of around $647 million, Stem is trading at a TTM P/S of 1.9x. Morgan Stanley’s analyst has a price target 100% above current price. The addition of utility scale and behind the meter renewable energy sources to the U.S. grid increases the need for management, optimization and monetization of multiple sources of clean energy storage. Stem is extremely well positioned to capture the growth opportunities in energy storage.

Final Word

While it is of course impossible to predict how the macro environment will evolve through the end of the year, when there is a material discrepancy between fundamentals and valuation levels, investors at some point will realize the mispricing and see that green growth is too cheap to ignore.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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