Ecofin Global Utilities (EGL) has announced its annual report for the year ended 30 September 2023. Over the period, the company’s net asset value was down 8.6% while the share price total return was down 21.9%. The company does not have a formal benchmark index, although for comparison the MSCI World Utilities Index fell 8.2%.
Discussing the performance, the manager noted that share prices of renewables-focused developers in particular, whose long life assets vital to the energy transition require large upfront investment commitments, came under substantial pressure, especially in the second part of the year in the US. This was because increased long term interest rates created a drop in the present value of these businesses’ long term cash flows, exacerbated by shareholders becoming more risk-averse and uncertainty about the course of energy prices. Companies in the portfolio with more diversified and inflation protected business models, such as European integrated utilities, environmental services and transportation infrastructure, performed better but listed infrastructure overall underperformed rising global equity markets by a significant margin. Sterling’s strength, particularly against the US dollar (+9%), also contributed to the NAV’s decline, as did the use of debt which contributed -0.1%.
Looking ahead, the manager added:
“At present, long term interest rates are driving equity markets and there is plenty of uncertainty on the medium-term global growth and geopolitical outlook. Many pure renewables and some utility share valuations have de-rated so significantly that they ascribe little value to growth; scepticism regarding both growth and yield at the same time is overly pessimistic. These sectors need a peak in interest rates and bond yields to stabilise the net present value of operating cash flows, the value of growth and to rekindle investor optimism. Nonetheless, with the earnings outlook we’re observing, there are compelling investment opportunities at current levels.
“Decarbonisation and electrification trends have strong momentum with key drivers such as increasing renewables, manufacturing re-shoring and energy efficiency driving investment. Corporates and consumers will continue to replace carbon-emitting energy sources with renewables, ensuring renewables growth at a reasonable rate of return. Power purchase agreement (PPA) prices have been increasing in Europe and the US to reflect, and more than offset, higher capital expenditure and financing costs, according to LevelTen Energy. This implies better pricing power and higher internal rates of return today than in 2020. Utilities are forward selling power for the next few years at prices which are significantly higher than those embedded in brokers’ forecasts which mostly assume that power prices will revert to historical levels.
“We continue to take advantage of the diversity in EGL’s investment universe. The portfolio now has more exposure to electric transmission and distribution with, for example, SSE, National Grid, Terna-Rete Ellectrica Naziona, a Rome-based pure play high-voltage transmission owner/operator, and Edison International, one of the largest pure electric transmission and distribution companies in the world. These businesses are highly regulated, have some upside protection to inflation and interest rates via their regulated return on capital models and are key enablers of the decarbonising of the grid. They are spending capital on interconnections to newly built renewables assets and to manage the consequent loads on grids. Environmental services and transportation infrastructure services add some economic sensitivity but debt costs are generally well hedged, revenues (tolls, for example) are mostly inflation-linked, changes to allowed returns on capital effectively offset rising bond yields, and valuations are low.”
EGL : Rising rates weigh on returns for Ecofin Global Utilities