Morgan Stanley Morgan Stanley published a report entitled Key Investor Debates Likely to Drive Stocks in the Coming Year and I read all 75 pages so you don’t have to. By far the most stunning data point was provided by U.S. electric utilities analyst Stephen Byrd: “Clean tech stocks have surged in 2020, with our coverage up between 60% and >600%.” The worst performers in the pure play, clean power technology sector were higher by more than 50 per cent.
There is a good chance I lost a bunch of readers with that first paragraph. Renewable power and other ESG-sensitive (Environmental, Social and Governance) investments don’t generate huge page views for us at The Globe and Mail. Many readers perhaps prefer the comforts of the established dividend-paying giants of the stock market, or the technology and mining sectors.
But that resistance to delve into ESG investment opportunities could be coming at a cost to portfolios given their strong performance. And it comes as a bit of a surprise given the ease with which asset management firms are raising billions of new investment through ESG investment vehicles this year (ESG investment inflow chart posted on social media here).
The global transition to renewable power is certainly not slowing. Mr. Byrd has short-term concerns about the clean energy sector, notably profit margins for solar panel manufacturers and excessive optimism regarding U.S. clean energy legislation. On the whole, however, he sees significantly more upside for renewable energy stocks in large part because of continued capital inflows from ESG investors.
Mr. Byrd’s top stock choices for 2021 are AES Corp. and American Electric Power Corp Ltd. In the first case, the analyst believes the company’s renewable power business is not yet fully reflected in the stock price despite a more than 90 per cent appreciation in the past year. He sees the possibility of a spin-off of the renewables operation that will unlock shareholder value.
American Electric Power has not enjoyed strong performance in 2020, but Morgan Stanley expects management to restructure operations to emphasize its growing wind power business. His 12-month price target implies 20 per cent upside from the current price.
Those resistant to joining the ESG bandwagon will be happy to hear that Morgan Stanley as a firm is bullish on oil stocks too. Energy analyst Martin Rats sees oil producers as a direct beneficiary of the post-pandemic economic recovery.
In a Monday research report, Mr. Rats noted that the free cash flow yield for U.S energy stocks will exceed the market average in 2021 for the first time in over ten years. Despite this, the sector trades at a 45 per cent discount to the market by EV/EBITDA (enterprise value to earnings before interest, taxation, depreciation and amortization charges).
Morgan Stanley also upgraded the Canadian oil sector recently thanks to capital discipline and attractive valuations. Mr. Rats’ top Canadian stock picks are Suncor Energy, Canadian Natural resources and MEG Energy.
I strongly suspect that most Canadians will own exposure to renewable power or other ESG investments eventually. Hopefully it happens before ESG stocks are fully valued and it’s too late. Just like the Morgan Stanley research department, ESG and oil investment bullishness can easily co-exist in investment portfolios.