3 Apr 2020
We have been working from home now for more than two weeks and it is going surprisingly well. Our technology team has done an extraordinary job, working around the clock to ensure that all our systems are running very smoothly and that the business-continuity plans are working extremely well. We are communicating well as a team and across the organisation, using technological resources that help us do that. So we consider ourselves in these difficult times to be blessed to work for an organisation that has these plans in place. We are thinking about many friends and colleagues around the world for whom, through this crisis, life is probably not quite so easy.
That is right but, of course, it doesn’t in any way address the longer-term issue — which is that the world has a huge job ahead of it to transition from an unsustainable system, using too much fossil energy and emitting too much carbon, towards one that will be based on much cleaner energy resources, more efficient industrial production and more efficient buildings. While the planet gets a slight reprieve in the short term, the pace of the transition in the long term still needs to accelerate rapidly.
No. Interestingly, the oil price is really not important for the pace of the energy transition. Going sector by sector, in order to decarbonise, we need to ‘green’ the electricity grid. It is probably not widely understood that a tiny low-single-digit percentage of global electricity is generated from oil, and the cost of doing so is high. Renewables are dramatically cheaper than oil, basically regardless of the oil price. So even at US$20 a barrel, oil is not a viable solution to generate electricity.
by country, because gas prices vary hugely regionally, with gas in the US multiple times cheaper than it is in Europe or Asia. In the US, gas prices have been fairly robust because a lot of gas is associated production from oil. As oil production slows, gas supply slows and the gas price stays fairly stable.
In Asia and Europe, there is a transition mechanism in many markets from oil to gas. But in Europe, as I said, because of low interest rates, renewable energy is so much cheaper and the direction of policy is so firm that there is absolutely no sign of that reversing. In Asia, coal is mostly on the margin and there isn’t really a direct link to the oil price. So it is hard to see the oil price slump impacting the power-generation landscape.
The next obvious area to think about is the electrification of vehicles, which is a big theme for our strategy. In Europe, 80% of the fuel price comprises taxes. So when we fill up our car, we will notice only a minimal impact from the decline in oil prices. In China, the oil price is limited at a low of US$40. So car owners there will see a little bit of a decline in prices at the pump, but after a certain point any cost savings go to the government, not consumers.
In the US, of course, the reduction in oil prices has a bigger impact on gasoline prices. But Europe and China are driving 80-90% of the market and all the growth. As well as being small, the US EV market is dominated by Tesla. And at the high end of the EV market, car-purchase decisions are not driven by running costs. People don’t spend US$100,000 on a Tesla to save US$1,000 on the fuel. It is about the brand and what the car says about you as an individual.
So overall, the move in the oil price hasn’t changed our decarbonisation forecasts in any significant degree across multiple sectors.
We are very slightly ahead of our benchmark year-to-date [at the time of recording], with the portfolio in many ways acting as you might have expected.
Utilities, which represent about 20% of our portfolio, has been a very defensive sector. Utility companies have been exceptionally strong, with many of them flat to down 5% year-to-date, so they are doing their job in the portfolio. The more cyclical names, particularly our electric-vehicle exposure, have been very weak as global auto production has shut down. We talked about the oil price having limited impact on electrification, but the coronavirus definitely has had an impact. If global auto factories are shut, then that will delay the launch of EVs. But we really think it doesn’t change the trajectory [of the transport sector]. It just pushes out EV sales by maybe one or two quarters.
We have been going company by company with a fine toothcomb and looking through the credit and liquidity analysis. We spoke to all 24 companies in our portfolio during March. We have analysed their covenants and their credit agreements, and we have engaged with management to encourage them to reach out to their banks and renegotiate those covenants now. Most have and they have exceptions for coronavirus within those covenants, to the extent that companies have them.
We have made some changes to the portfolio based on that analysis. They are fairly minor changes. We exited one position where we think the recovery will be more difficult, and we have been selectively slowly adding to cyclical names that have significantly underperformed, where we expect to see really horrible results next quarter and probably in the following quarter, but we expect a significant rebound thereafter.
We also think that, for companies that were well-positioned from a competitive advantage perspective, this crisis will allow them to gain a march on their competitors and potentially gain even more market share going forward. Many of them have more than 100% upside in our valuation models.
Our single worst performer this year is a company called Aptiv, a US auto supplier. The stock is down almost half this year. But Aptiv is growing 10% faster than global autos. So even if global auto sales decline 10% this year, Aptiv’s revenue should be approximately flat. It doesn’t mean that Q2 and Q3 won’t be terrible, but we expect the rebound to be very sharp. We recently spoke to the senior management. They see product launches being delayed perhaps a quarter or two, but they see their competitive position even stronger coming out of the crisis. So we think it is just an exceptionally attractive time to buy some of those businesses if you take a 6-12 month view.
That is a good way of putting it. Today, clearly the focus is on coronavirus and that has meant climate legislation is being delayed. The EU is due this year to implement the Green Deal. Those votes have been put off, partly because simply no one is sitting in Brussels. So, in the short term, we would expect the pace of regulation to be delayed slightly. We would also expect the build-out of some of the cleaner-energy capacities, whether in EVs, energy efficiency or even power, to be slightly delayed, by a couple of quarters.
Having said that, the level of stimulus put in place by governments around the world is unprecedented. It has been implemented multiple times faster than it was in the Global Financial Crisis and its size, as a percentage of GDP, is also unprecedented. In the eurozone, monetary stimulus is 30%+ of GDP and fiscal stimulus is 17%; in the US, the numbers are similar with a slight bias towards monetary policy.
As those programmes are rolled out, we expect in many places in the world (Europe probably first and foremost) for decarbonisation to be front and centre in terms of the focus of that fiscal stimulus. Coming out of the crisis, we would not be surprised to see the pace of climate-related policy actually start to accelerate.
Of course, the region that hasn’t announced huge stimulus to date is China, but the government has significant control over the financial system and will be dealing directly with banks. China was, of course, the source of the big fiscal stimulus that accelerated the recovery out of the Global Financial Crisis. We are seeing early signs in China that stimulus may well focus on decarbonisation. That gives us a great deal of optimism around the long-term future for the strategy.
We look at our portfolio today and we see it as an exceptionally attractive time to buy an incredibly well-positioned group of companies with strong competitive advantages, and that stand to benefit from accelerating structural growth as we move out of 2020 into 2021. Having analysed the companies’ positions and their ability to survive a liquidity crisis, we think the portfolio is significantly more attractive than it has been at any time since we have been running the strategy.