Arvind Kothari, smallcase manager -; Founder, Niveshaay Investment Advisors

5 Jul 2022 , 05:14 PM

How do you identify stocks that will benefit from energy transition and green energy adoption?

Post COVID-19, we witnessed a very strong trend in clean energy ETFs worldwide. The idea was to identify financial opportunities from the renewable energy sector development which is a large emerging global trend and there wasn’t any instrument designed in India to properly play on it. We met the best entrepreneurs working in this space in our country. Our scuttlebutt approach helped us to identify few companies in this space. The idea of green energy small case was generated from a visit to a solar module manufacturer in Surat. Our green energy smallcase plays on clean energy, emerging electric vehicle sector, improving energy efficiency either through reduction in electricity consumption or having recyclability quotient. Here, also our core approach of second order thinking on identifying companies remain the same.

Would you say India is just at the beginning of the energy transition journey? If yes, what according to you, are the key challenges?

State and national governments are at forefront trying to make a difference. This perception is based from a mixture of past favorable policies, regulations, incentives and innovations in the power sector. The pace of adoption might differ in different countries but we believe, it is expected to be one of the hottest sectors in the coming decade. The momentum of adopting the green energy has built up in the last 4-5 years and the next 5-6 years might be the accelerated phase in renewable energy sector in India and globally too. The main driver of this is the diverging cost of capital. In 2019, the European Investment Bank (EIB) announced that it would end financing for fossil fuel energy projects. They will instead increase their support towards clean-energy projects. Similarly, many private investment banks, including Deutsche Bank, Morgan Stanley, Citi Bank have also tightened their Fossil Fuels Policy. Additionally, big private equity firms are now increasingly putting their investments into decarbonization technologies. Continuing cost declines confirm that competitive renewables are a low-cost climate and decarbonization solution that aligns with short term economic needs and keeping the long-term sustainable goals intact. The more these technologies are deployed, the more their cost could fall. 

Coal versus Renewable Capacity Additions FY18 to FY22 (in GW)

Source: CEA, MNRE, IEEFA calculations * Till January 2022

Read more at:
https://economictimes.indiatimes.com/industry/renewables/view-private-sector-driving-renewable-energy-wave-in-india/articleshow/90724802.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Above chart clearly indicates that India’s energy transition journey is moving at a good flow with an integrated and connected approach. Yet, there are few challenges on its way:

â–ª Inflation and increased interest rates: The upfront cost of renewable energy capital (to set the whole project) can be expensive. Inflation and increase in interest rate will further add to the costs, reducing the return on investment leading to short-term hiccups in adoption to green energy.

â–ª Supporting infrastructure issues: Existing energy grid infrastructure like transmission lines etc are largely set up for conventional sources. Upgrading the infrastructure and providing storage solutions for renewable sources will take time and incur huge investments.

â–ª Missing elements in the value chain: The dependency on imports for raw material requirements could pose a threat to the industry. For instance, solar industry is heavily dependent on imports for the procurement of solar cells. Introduction of duty on solar-cell and other raw materials have increased the prices of the modules making it difficult for the players in the industry.

â–ª Regulatory risks: Government policies and support can hugely influence the renewable energy sector and its expansion. Any change in the policies or withdrawal of support with a change in government can be challenging for the industry.

Is it fair to say that in India, large-caps and mid-caps have been focused on driving up their sustainability quotient? Share some insights on how smaller entities are doing the same?

It is fair to say that in India large caps and mid-caps are driving the sustainability quotient. Being, larger in size, their contribution in the overall pie would be larger. Nevertheless, small companies are also playing a critical role in supplying the raw materials to the larger ones. For instance, smaller companies like Borosil Renewables are in the business of manufacturing solar glass since the last decade trying to make it big in the emerging solar adoption trend. Similarly, Navitas Solar manufactures solar modules. Their scalability happened when the adoption trend accelerated driven by economics in the last 2-3 years. When we invested in Borosil Renewables in 2020, the stock’s market cap was around Rs1,300 crore. Currently, the market cap stands at ~Rs7,900 crore. Apart from clean energy, sustainability is also driven by other industries like fashion and plastic. Brands/companies are leaning on the term ‘circular economy’ at a time when they are literally getting premium for the products on account of sustainability quotient. The use of recycled polyester (pet bottle recycling) by leading brands such as Zara and H&M are some of the key aspects of sustainability initiatives in the fashion industry. Likewise, smaller companies often allocate some part of towards either installing solar plants or some waste recovery plants depending on the industry they cater to.

Given the looming power shortage and the fact that we recently started coal imports, how realistic are our net zero ambitions?

Achieving zero emissions means releasing no greenhouse gases in the atmosphere- that is practically not possible. Achieving net-zero emissions means that some greenhouse gases are still released but this gets offset by removing an equivalent amount of greenhouse gases from the atmosphere. The most feasible pathways to achieve net-zero emissions include:

â–ª Generate electricity without emissions by adopting renewable sources like solar, wind and hydro. In the last decade, the installation in the renewable space increased 2.5x to reach 147 GW.

â–ª Move towards electric vehicles.

â–ª Use of energy efficient motors/technologies in manufacturing.

Many governments and businesses have set up a target to be net carbon emissions by 2050. India plans to achieve net zero carbon emission by 2070. The road towards achieving this is going to be a bumpy one. Sometimes, events like the COVID-19 and the Russia-Ukraine conflict leads to acceleration in green energy adoption while the other times, inflation and interest rate increase leads to delayed adoption. To achieve this larger goal, such short-term hindrances are likely to occur but it will even out in the long run.

If you had to enlist top 2-3 regulatory/policy measures that would really propel green energy adoption, which will these be and why?

PLI scheme announcement by government will bring an additional investment worth Rs30,000-35,000 crore into solar photovoltaic cells and modules manufacturing in India. As India has been importing 70-80% of solar cells and modules from countries like China, Taiwan and South East Asian countries. This would reduce the dependence on imported modules and create a reliable supply chain for module manufacturing in India to achieve Indian government target of 300-350 GW capacity of solar power in India by 2030.

PLI scheme for Advanced Chemistry Cell (₹18,100 crore), PLI Scheme for automotive sector (₹25,938 crore) and Faster Adaption of Manufacturing of Electric Vehicles (FAME) (₹10,000 crore) will enable India to shift from traditional automobile transportation system to more efficient Electric Vehicles (EV) based system.

Biofuel Policy 2018 aims to increase the usage of biofuels in the energy and transportation sectors of the country during the coming decade. The ethanol blending rate was around 4-5% in 2018, which reached 10% in 2022. And, now the government is targeting a blending of 20% ethanol in petrol by 2025-26.

In recent times, regulators have become quite proactive with more focus on “impact investing”, detailed disclosures by ESG schemes, BRSR, among others. How do you view these measures impacting ESG investing?

Beginning with FY23, top 1,000 companies are now mandatorily required to file detailed report on Business Responsibility and Sustainability Report (BRSR). that include almost 40 key performance indicators (KPIs). It is expected to cover all listed companies in the future. These are positive signs as for ESG-focused funds', universe of stocks would increase. This report will be a good starting point to begin research on any ESG compliant company.

But, a fund manager or investor can’t rely solely on these reports. They have to do their own due diligence before investing.

Share with us some companies/sectors that you like within the theme of energy transition

Solar, wind and electric vehicle sector will be at the forefront of this transition and within these sectors one can find interesting ancillary
opportunities that would benefit from this transition:

â–ª Peripheral play on electric vehicles

The battery management system (BMS) uses shunt resistors. BMS monitors battery in the car. For EVs, the application of shunt resistors is much more important and critical as BMS plays a very important role. There are only 4-5 low TCF Shunt Resistors manufacturers across the world.

â–ª Ancillary play on solar industry

Solar glass required in manufacturing solar module is a technical and critical product. In India, there is only one company that has successfully developed solar glass over time and now is the market leader with substantial capacity additions coming in next 2-3 years. They can benefit more with adoption of dual glass solar module that are more energy efficient. This trend would take time to get adopted in India.

â–ª Second-order play on wind energy

In wind energy sector, there is a tough competition between wind turbine producers to manufacture taller wind turbine that increases energy generation. There is a company that is well placed to benefit from installation of these taller wind turbines as to install, they require crane with higher tonnage capacity. This has created a demand and supply mismatch in favor of crane rental companies.

â–ª Niche market play to the emerging broad trend of EV in 2-wheelers

In automotive sector, adoption of electric 2 wheelers is faster compared to other segments in industry. As electric vehicle requires more energy efficient parts, automotive LED headlamp suppliers to 2 wheelers having higher value are expected to perform better than conventional lamp with same margins You will find mix of such companies in our green energy smallcase.