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April 22, 2021

Are “Green” investments overvalued?

Anne-Claire Abadie
Portfolio Manager, Environment specialist

After enjoying an exceptional financial year in 2020 and reporting stratospheric earnings at the beginning of the year, “green” stocks exposed to the Environment and energy transition have recently suffered a rather sharp market consolidation, which has particularly affected the clean energy sector. What is your view on valuations in the industry? Are Green stocks already too expensive? Does the recent sell-off mark the beginning of a turnaround or rather an opportunity to invest in the sector?

__How did this sudden consolidation arise?__

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Green indices have largely under-performed since mid-January, notably due to concerns over the rebalancing due to take place within the S&P Global Clean Energy index. This market index, tracked by three ETFs weighing almost 12 billion dollars in assets under management, only includes 30 stocks and is heavily impacting stock prices: on some days, ETFs have accounted for over 25% of daily trading volumes.

With fears of rising interest rates and hopes of an economic recovery, investors have rotated into Value sectors. This shift has triggered profit taking on the segments that performed best last year: Green investments, and renewable energies in particular.

__What are the earnings prospects for these companies?__

Do we expect environment and transition-related companies to generate growing profits in years to come? Is it legitimate to refer to hyper-growth? Answers to these questions will need to be qualified as they vary between market segments and individual companies, as the following examples demonstrate: * The growth in installed solar capacity is expected to reach around 90% over the next 5 years and the volume of electricity transmitted should double by 2050$$Sources: IEA, Fieldtrip Kepler.$$; * Electric vehicle charging stations are expected to grow between 35% and 40% per annum over the next 5 to 10 years, starting from a very low installed capacity base$$Sources: IEA, Fieldtrip Kepler.$$; * The pace of property renovation should treble according to the European recovery plan; this will have a considerable impact on corporate turnover growth; * However, in a segment such as water infrastructure, earnings growth figures tend to be more aligned with GDP growth, even if needs are rather different in the United States due to the country’s ageing infrastructure.

In terms of earnings growth, our expectations range from over 50% for a number of dynamic segments and their upstream value chains (charging stations for electric vehicles, turbines for wind energy, electric component manufacturers…) to much more modest growth rates, for the next 5 years.

Within the sub-sectors of sustainable construction, we are expecting net earnings per share (EPS) to rebound by around 20 to 60% in 2021, followed by a normalisation of earnings growth at around 10-15% per year with disparities between companies according to their regional footprint, their exposure to the renovation or construction industry, and their product mix.

The circular economy sector, viewed through the lens of waste industry companies, could also enjoy a similar rebound. On the bicycle value chain, the pace of EPS growth stands closer to 15 to 20% in 2021 – despite the very high demand – due to tensions within the supply chain, but can range between 5 and 10% in the electric infrastructure, energy services or water infrastructure segments.

__How is this reflected in the portfolio of Sycomore Eco Solutions?__

The outlook varies greatly from one segment to another, but the average EPS growth expectations for Sycomore Eco Solutions stand at around 30% for 2021, which is consistent with the pace observed in the tech sector. By selecting companies with business models that contribute actively to the environmental and energy transition, the fund benefits from a broad diversification both in terms of segments and expected performance patterns. Although we can assume 2021 to be a rather peculiar year, the fund’s earnings growth should come in at around 20% in 2022, with similar figures expected in following years based on the same portfolio.

''The fund comes with no income of performance guarantees and carries a risk of capital loss.''

__What main arbitrage movements have taken place since the beginning of the year?__

At the beginning of 2021, we chose to trim our exposure to pure renewable energy players considering their rich valuations: with stock market prices rising at a faster pace that secured capacities, valuations were factoring in increasingly distant projected growth, with increasingly high margin errors. Although the Gigawatts are very likely to be effectively installed, there is more uncertainty on post-2030 parameters, including on electricity prices, profitability, counterparty strength or contract durations.

We have therefore chosen to strengthen themes such as construction (Wienerberger, Saint-Gobain, Owens Corning, Sika), the circular economy (Véolia Environnement, Biffa, Aurubis) and electrical suppliers (Rexel, Nexans) which are more cyclical and display much more reasonable valuations, particularly in light of the rebound potential in 2021 and the support these industries will enjoy with the recovery plans.

These arbitrage movements, carried out within the environment industry – which extends much further than the flagship renewable energy players – help to differentiate our performance patterns with those of ETFs in market turnarounds such as these. While some ETFs recently posted losses of almost 15% year-to-date, the Sycomore Eco Solutions fund remained in positive territory and is up +7.5% over the same period (index$$MSCI Daily Net Total Return Europe. Source: Bloomberg as of 01/04/2021. e$$: +8.9%). Over 5 years, the fund rose by over 11% on an annualised basis (index$$MSCI Daily Net Total Return Europe. Source: Bloomberg as of 01/04/2021. e$$: +7.92%).

__Does renewable energy still offer opportunities?__

Yes, naturally. Windows of opportunity are emerging with index rebalancing issues, but selection is the key. Valuations on hydrogen as an energy carrier, which has been highly popular, seem difficult to justify. We have therefore chosen an indirect positioning for the portfolio by investing in players within the hydrogen value chain, such as companies developing fuel cell batteries or tanks (Plastic Omnium for example).

__What is the best way to position the portfolio on Environmental considerations?__

The “green” transformation has begun and there will be no turning back. There is no doubt that investors should be exposed to this sector, but not any old how. As far as the environmental theme is concerned, we are firm believers in an active investment approach. The sector remains relatively concentrated but more and more companies are gradually entering the market: historical players are transforming their business models and native pure players are going public through IPOs.

The goal of active management within an Environment strategy is to discriminate between companies that will be able to retain their position as leaders, gain new market shares and generate profits, and those that are merely contributing to a stock market wave.

During market sell-offs such as the recent downturn, it is important that we identify stocks offering attractive entry points in order to invest for the next 5 years. We never take a short-term approach.

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''Past performance is not indicative of future performance. The opinions and estimates given constitute our judgement and are subject to change and are subject to change without notice, as are assertions about financial market trends, which are based on current market conditions. market conditions. We believe that the information provided in these lines is reliable, but it should not be considered exhaustive. These data or forecasts have been calculated or made on the basis of public information that we believe to be reliable but which However, we have not independently verified this information. Your attention is drawn to the fact that any forecast has its own limitations and therefore no commitment can be made Your attention is drawn to the fact that any forecast has its own limits and that consequently no commitment is made by SYCOMORE Asset Management as to the realisation of these forecasts.''

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Are “Green” investments overvalued?

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