Renewable energy stocks: Ceres Power, ITM Power and Atome Energy

Renewables stocks are back in favour as the invasion of Ukraine has put the focus very much on energy independence from Russia. In this interview with Sam Wahab, energy analyst at SP Angel, we find out what he thinks of Ceres Power and ITM Power. We’re told they’re the future, and even the big oil companies are investing heavily in alternative sources of energy. He also names his favourite renewables stock.

Lee Wild, head of equity strategy, interactive investor: Hello. With me today I have Sam Wahab, energy analyst at SP Angel. Now Sam, the renewable sector has taken a hit this year. What’s happened and why?

Sam Wahab, energy analyst at SP Angel: No, I agree it’s had a pretty rocky start to the year.  I’d say it’s probably down between 25% and 30% across many of the main constituents. If you compare that again to Q1 last year, where it had a bit of a boom, and that’s where sustainability really moved up the global agenda for a lot of these companies. They saw a massive headwind and they reached their all-time highs. I’d say it’s a number of issues, that some of which are company-specific, but many of which are through macro headwinds. In terms of where we were this time last year, there really was a scarcity of energy value in the market, and therefore we saw a bit of growth. And also, there was longer term structural growth elements to the sector, which we all saw a benefit – well, the sector saw a benefit from.

But since then, there are a number of issues that have come into play. Initially really, is issues to do with supply chain management and logistics.  The pandemic has caused a number of problems for businesses across many sectors, but particularly so here. I mean, in particular, if you look at some of the input costs that have to go into many renewable’s plays, whether it’s hydrogen, wind turbine, solar, for example, we are seeing the raw material increases. So if you look at, say, wind turbines, in particular, the cost of steel, iron, copper, have all risen exponentially, and that’s had a knock-on effect in terms of squeezing margins for many of the larger players. And that also goes to be said for fuel cell companies and other hydrogen players.  

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So they’ve always seen their margin squeezed. IRR is reduced, and that’s really led to a bit of a risk-off from the market, and this is really an emerging sector, in the first place. So it’s there, firmly in the higher risk bucket, when it comes to investing, so we have seen a corresponding sell-off in a number of the stocks – the underlying constituents. In terms of where I see the sector going, I think there is a huge amount of upside, notwithstanding from this much lower base than what we realised last year. So there are a number of selective opportunities we see within the sector, and we see that trend starting to grow, especially as we are now into an environment where we do have much higher commodity pricing. And therefore, it does come into focus where we’re going to see these additional sources of energy for consumers.

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Lee Wild: So is the renewables/green energy sector more than just another investing fad? I mean, there’s a lot of money being thrown at the sector, but is there a viable future for listed companies focused on wind, solar, water and other green energy sources?

Sam Wahab: Absolutely there is. I mean, this is a sector that’s certainly here to stay, and not only stay, it’s going to grow exponentially over the coming decades, and also in the near term. Through the course of my work, I deal with investing institutions almost every day, and what I can tell you is that, historically, there’s been a lot of buzzwords in terms of where we are with ESG. There are a lot of acronyms . It starts with ‘HSE’ and then ‘CSR’ and now we’re at ‘ESG’. And, you know, while the first two have slowly sort of ebbed way, I think ‘ESG’ is certainly here to stay, in the sense that, dealing with the likes of Amundi or BlackRock or Schroders, they’ve all got their individual ESG investing desks, sustainability investing desks and dedicated green energy outlooks.

In addition to, if you look across the public market space, there is a number of board changes where they are creating a focus on ESG compliance and compliance for the long term. So this is certainly not a fad. There’s a huge amount of capital, as you say, that have been committed towards this. At the moment – and this is only in a public company space – there is around a trillion dollars globally solely committed to green energy and ESG compliance companies. We’ve also seen a divergence away from fossil fuel-led names, and these are big dividend players, historically. The likes of Shell and BP and other European names like ENI and Total have historically had a sticky income investor base.  That’s starting to fall away in favour of more ESG-compliant companies.  

So this really is a fundamental structural change towards green energy and ESG compliance. So certainly not an issue with regards to long-term sustainability of green energy. Also, if you look at where we sit today with issues with Russia and Ukraine and how that’s driving commodity pricing, especially gas in Europe, and so to ensure that we’ve got longer-term self-security and sustainability of alternative sources of energy is going to become critical. And I think the world is really coming into focus on how important that will be, and it will only fuel the sector even further.

Lee Wild: Sam, smaller clean energy stocks like ITM Power (LSE:ITM) and Ceres Power (LSE:CWR), they’ve been especially hard-hit, certainly since they peaked a year ago.  Why is that and should investors stick with them?

Sam Wahab:  I absolutely do. I think I do see some material upside for both of those companies. ITM, for example, I think they’ve lost around 40% year-to-date, which is clearly as a result of some of the other issues that I mentioned from your first question. But also, a lot of equity markets, a lot of offers come out of the markets a year-to-date, and a lot of that has been pinned down on interest rate rises and all the issues associated with that.  And whether it’s more compelling to save capital or invest in fixed income credit, and so on. So we have seen a drop-off, especially in new energy as well as tech stocks over the last three months or so. 

In terms of ITM power, for example, I think we’re entering a phase where they are compellingly cheap, in our view, but in terms of where we see the longer-term growth within the company, they ended 2021 with a gigawatt of capacity. But there’s a view to get to five gigawatts, or at least four, by 2025. If you look towards 2030, they’ve got a compound annual growth rate potential of 85% and annualised revenues from 2030 of around a billion pounds, as we sit today. So that could clearly grow quite exponentially. Over the last four years, the company has raised around £500 million in terms of equity, and around half of that will go into some growth projects, just to get them to where I said – the five gigawatts of capacity.  So there is significant growth potential and quite stable funding outlook, so I can’t see a huge amount of equity dilution, so there’s less risk on that level.  So I do think that it certainly is, especially in the current valuation, a fairly strong buy. 

Very similar with Ceres.  I think they’ve underperformed, as we know, but that only makes the outlook and the potential equity investment that much more compelling for that particular company. I’d say the recent partnership with Bosch and Weichai that they announced quite recently is probably one of the most standout elements of the year-to-date for the sector.  And it could see them penetrate the all-important Chinese market, which clearly has huge potential for them. Also, closer to home, they’re investing, I think, around £89 million into a manufacturing facility, which could be six times larger than ITM’s one. So there is a lot going on with Ceres and quite a positive outlook for them.

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Lee Wild: Now the oil majors are generating plenty of cash from high oil and gas prices. They’re also selling unwanted assets. So apart from dividends, lots of that money is being pumped into renewable energy projects. So are you convinced by that strategy?  I mean, should the big oil companies split into separate businesses, perhaps – fossil fuels and renewables?

Sam Wahab:  It’s a very interesting question and it’s one that’s been posed to all of the majors. Over the last six months to a year, we saw one of the major investors in Shell, for example – and that’s Aberdeen – lobby that it should be carved up into renewables as well as fossil fuels. Although there is a bit of overlap between the two. I’m a bit on the fence on this particular question, because I can see merits in both strategies. But what I would say is that the majors probably will lead the way in terms of the future of green energy development and clean energy.  And potentially will end up as fully green entities in their own right.

In terms of Shell, for example, they announced last year in their green energy proposal, going forward, and how they’re going to adhere to that ESG compliance that we discussed earlier.  And yes, they intend on growing the green energy side of the business quite significantly. In fact, overall, in terms of their output, they intend to grow it by 100%. But if you actually look into the weeds of their proposal, they’re actually looking to maintain or slightly increase current fossil fuel production, both on the oil and gas side. So essentially, what they’re doing is, doubling the size of the company, but actually bolting on a greener energy platform to that. I think that’s where the world’s going.  In terms of having to finance the green side of their future, I think it’s a requirement to have the fossil fuel-led production.

I don’t think it’s going to be as simple as turning on and off a light switch, so we move from fossil fuels straight through to clean energy.  I think the world is slowly waking up to that with commodity pricing, where it sits today.  So in terms of, on balance, I’d probably think the majors will have to – for the short to medium term – have to stay where they are in terms of growing the greener side of the business, alongside their black or fossil fuel-led side of the business.  And then maybe one day in the future, split that into separate entities, as and when they achieve the goals that they’ve initially set out.

In terms of where we are with the sector, I think the companies pay very healthy dividends, as we all know, and they’ll be getting healthier and healthier, as we saw with the results from BP and Shell over the last ten days, and how they’re increasing their dividends. And many of the smaller players and independents like Genel Energy and Gulf Keystone Petroleum, are also increasing their dividends on the market and the FTSE 250, respectively. So in terms of where they are with that, they really do need to retain their increasingly greener investor base. So the likes of Shell, BP, Total, ENI, they’ve all got large financial institutions on their register, which are income-only-based, effectively.

And to ensure that they appease those and they don’t lose them – given the new ESG requirements that is in the market – they have to ensure that they have a very healthy dividend, so that those financial investors can justify to their investment committees why to hold fossil fuel-led businesses. So I think we’ll see healthy dividends for the remainder and going on into the future, but to ensure that they can finance the greener side of the business, as I say, they’ll have to have clean energy and fossil fuels coexisting.

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Lee Wild:  For investors wanting to invest in renewables – and there are lots of them – what’s the best way to go about it?  Any stocks that you particularly like?

Sam Wahab: Well I think in terms of approach, it really is individualised.  What I would say about clean energy, it’s fairly fragmented. You could go through the wind route, the solar route, hydrogen, fuel cells, or you can have a basket of all of the above. But in terms of approach, I suppose that would be tailored to the individual investor and where they see growth. I personally see growth in all four of those pillars, probably more so on offshore wind at the moment. So I think that’s quite a good way to play the market in terms of future energy needs and an ability to execute those particular projects – like Vestas, for example – I think is quite a strong buy.

In terms of companies that I personally looked at recently and SP Angel have been involved in is a company called Atome Energy (LSE:ATOM), which was listed in December last year. So a fairly new entrant to the market. And it was listed as the first green hydrogen and ammonia business on the London Stock Exchange. It’s quite a compelling investor story. The company operates in Paraguay and Iceland, and they’re looking to build energy capacity through green hydrogen and ammonia production in both countries.  In Iceland, they’ll be looking to build up to 150-megawatt-capacity plants.  In Paraguay, that’s exponentially higher at 250.  And the company has successfully signed MOUs in both countries with governments as well as leading surrounding players.  

The two countries are quite ideally located close to existing infrastructure and also close in proximity to the energy requirements as well.  So that is quite a compelling investment story, in my opinion. The management team are very able.  It’s led by the CEO – Olivier Mussat – who has a strong background in the space, as well as Peter Levine, which some of your listeners may know from President Energy. Originally, they raised up to £9 million at the IPO, six of which has already been placed in terms of equity. And then Peter Levine’s investment vehicle will extend another £3 million as and when that’s required.  So very well-funded.  

The next catalyst for them will be FID, which we expect within the next nine months. If we look on the capital availability, they’ve got around 18 months of financial headroom, so they’re very comfortable in that regard. And in terms of where their shares have performed, we’ve discussed earlier during this meeting with regards to, there has been a lot of profit being taken out of the market and Atome has been no stranger to that. What I would say is that they’ve probably suffered half of the loss than some of the companies we’ve discussed, in terms of ITM and Ceres Power.

So I do think there is a compelling investment opportunity at these levels. Personally, I think it’s ridiculously cheap and there are a number of catalysts for that company as we move into Q2, Q3 this year. And then they’ll start looking into building and ramping up as and when they get to FID, and that opens up a number of doors in terms of infrastructure financing.  Which, as we discussed, is fairly plentiful for projects such as these. So certainly is on the upper end of my investor criteria.