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Dear Investors and Friends,
Much has been written about the Coronavirus and its impact on the economy and investment assets. Like the rest of the economy, the Green Economy has not been immune from the virus. Our general newsletter covers our perspective and can be read here.
In this issue and going forward, our commentary will pertain to all of our low carbon investment strategies, which include: Green Economy Folio, Green Income Folio, and our Fossil Fuel Free Folios. For any folio specific inquiries, we welcome you to reach out.
Fossil Fuels vs Clean Energy
Gone are the days – and they have been gone for a while – where peak oil meant peak oil supply. It now means peak oil demand. And when demand for an oversupplied commodity drops, its price craters. I also recall a number of years ago there was much talk about the relationship between cheap oil and the demand for renewable energy. The thinking was that cheap oil is bad for renewable energy, because it makes renewables less price competitive. But what was true then, is true now: oil is mainly a transportation fuel and renewables are mainly used for electricity generation. So cheap oil does not make renewables less appealing.
What about natural gas? Yes, natural gas competes with clean energy, partially on the basis of price. But renewable energy projects are priced on 20+ years of future revenues and are less dependent on the spot price of natural gas. Moreover, there are many state incentives to build out clean energy infrastructure in the US and some future administration will likely close ranks with the states and other countries and set national targets.
So, going into this pandemic, one might have theorized that renewable energy can survive when the broad energy sector collapses. But the proof is now in the pudding. A chart tells a thousand words:
The fossil fuel divestment movement has raised awareness in corporate board rooms, on investment committees of pension funds, and among trustees of university endowments about the need to decarbonize the economy and portfolios. Initially it was a tough sell, that was being opposed by many consultants to these asset owners. But today, at some level, it seems like a moot point. The energy sector makes up less than 4% of the broader market and it really does not matter very much whether you exclude it from your portfolio. So perhaps mental energy is better spent debating other things.
The Post-Pandemic Economy
Every investor has to ask: how should I change the makeup of my portfolio, given that the pandemic has altered the landscape? I am not talking about the risk level of the portfolio, assuming your portfolio had some recession resiliency pre-pandemic. Rather, are your risky assets today still attractive from a potential upside perspective, or should you take risk elsewhere? To answer this question, you have to consider which industries are likely to return to “business as usual,” which now have impaired futures, and which are now more attractive than they were before. In this mental exercise, it makes sense, in my view, to have a bias towards things going back to “normal,” so as not to fall prey to the moment and overinterpret the change that might be upon us. Specifically as it relates to our low carbon investment strategies, I am considering the following changes that might be afoot:
Travel - I don’t know of anyone who is planning to fly cross country or internationally on a business trip anytime soon. There are some fall conferences that have not yet been canceled, so perhaps people’s travel appetite will pick up in the next few months. But it is hard to ignore the question: “is it really necessary or can we just do a virtual meeting?” It certainly has become more acceptable to stay put. I think that is a good thing. A giant time, money, and planet saver if we could just stop moving around all the time.
Leisure travel is more likely to return. But perhaps popular routes will change. All of this will be disruptive to the airline industry in unknown and unanticipated ways. Airline stocks have rallied recently because there is an uptick in travel. But one should not lose track of the fact that travel fell off a cliff and that airlines cannot operate below 70% of capacity indefinitely.
Airlines of course do not feature prominently in our portfolios. But we are interested in what happens, because the alternative-to-travel theme is investable. Right now, video conferencing and other work-from-home “WFH” technology providers are a bit too popular for our liking. They may have to give back a little in terms of their stock prices, as investors turn their attention elsewhere. But long-term, there is an investable theme in the replacement of business travel and the WFH paradigm shift and we are keeping a close eye on these companies.
Real Estate - Real Estate Investment Trusts (REITs) comprise a segment of the market that is still down substantially, even after a two-month stock rally. The worst performing areas of the REIT market are retail, hotels & leisure, and office space. The latter is potentially the most exposed to disruption; big companies are signaling that pretty emphatically. Facebook, for example, is allowing future hires to work from home indefinitely and big Wall Street companies like BlackRock have questioned the need for so many employees to return to subways and elevators to arrive at their Manhattan offices. Hotels and the private rentals market are facing an uncertain future, as well, though perhaps shorter lived. Companies in this sector are not waiting it out to see how it goes, but have made significant staff cuts. Airbnb recently laid off 1,900 employees, or 25% of its workforce. These types of layoffs have spillover effects on urban rental markets. For example, rents in San Francisco are down 9% year-over-year (source: Zumper), as demand for labor subsides and urban density living is losing its appeal more broadly.
Given the possibility of an impaired medium-term future, one should think twice before attempting to ride the REIT rebound all the way back to previous highs. We have modest exposure to REITs as they aren’t disqualified from low carbon portfolios on the sector level and some have interesting sustainability metrics. For now, however, we are treading lightly, as it is hard to weigh low prices against possible impairment of growth prospects.
Transportation - Public transportation is facing an unprecedented assault. Ridership is down across the board and one can hardly blame commuters. This will be a win for the car. As you may have heard from me before, I believe electric cars are likely to take over the automotive industry within a decade. So a favorable environment for cars in general and electric cars in particular, bodes well for the likes of Tesla. Despite having missed out on much of Tesla's rise due to valuation and profitability concerns - not without occasional bouts of regret - I continue to prefer lower profile companies that have a future in the electrification of cars, but no investor fan base.
Recycling - Amazon is firing on all cylinders, and so are the manufacturers of single use products & packaging materials, as consumers have accelerated the shift towards online shopping and have stepped up the use of food delivery services. Smarter packaging, reusable materials, and recycling are all industries that will see greater demand and we expect to increase investment in these areas. Our biggest holdings in this sector are Covanta Holdings (waste-to-energy) and Enviva Partners (wood pallets), in addition to exposure to recycling and waste management companies with high environmental scores.
Supply Chains - Whether it stems from anti-trade sentiment, geopolitical tensions, or the realization that supply chains are too vulnerable and singularly reliable on China, the pandemic is forcing US corporations to reassess their supply chains sooner rather than later. We have soured on the shipping industry and continue to focus on supply chain issues as we screen our investable universe for stocks to consider for our portfolios.
eBay: a Green Social Distancing Stock
Shifting gears, I would like to highlight some of our recent stock research on eBay; not a usual suspect in green stock funds. As I write this, I can picture several of my tech industry friends cringe and wonder if the 1990s are alive at JPS. And if you are not cringing, you might be wondering what eBay has to do with the Green Economy. What follows is an excerpt from an article by Tom Konrad, CFA, our research analyst who has “unearthed” eBay:
Of the few survivors of the dot com bust, eBay (EBAY) is a perennial also-ran. It owned the market for consumer-to-consumer (C2C) transactions in 2000, but has since repeatedly lost market share. Nevertheless, the company remains a profitable business that enables the sustainable reuse of easy to ship items while returning cash to investors.
In the early 2000s, eBay lost sellers to Amazon’s (AMZN) marketplace, which had the advantage of getting listings in front of a larger group of buyers, and has since added more services for sellers, such as delivery services through Amazon’s impressive logistics arm. More recently, specialist competitors like Etsy (ETSY) for crafts, and Poshmark for fashion have attracted younger users who prefer an app-based interface.
Many sellers prefer eBay for its lower fees compared to Amazon and other competitors, and its pure C2C model means that it has no inventory or warehouses, and its operations are not disrupted by trying to maintain social distancing. Other sellers list on multiple platforms, but offer better prices on eBay because of the lower transaction fees.
This is why I believe that social distancing is an opportunity for eBay to claw back some market share from Amazon. The stories of third party sellers being second class citizens on Amazon’s platform have been prevalent for years, most notably Amazon using its data to directly compete with third party sellers in any category that it starts to see as particularly profitable. Sellers can succeed quickly through access to Amazon’s legion of buyers on its Marketplace, but if they become too successful, they will likely find themselves competing with Amazon itself.
Sellers discovered another problem with their reliance on Amazon when the company decided to prioritize the delivery of “essential” items in March. While prioritizing life saving items over toys and knick-knacks is likely a good use of Amazon’s overtaxed warehouse workers, this is small consolation to a small online seller who needs the income to buy their own essential items. These frustrations will likely lead sellers to be less likely to trust all their eggs to Amazon’s basket.
Looking Forward - eBay’s revenues, and number of sellers and buyers have been basically flat in recent years, and the company did not expect that to change when it issued its guidance for 2020 at the end of January. The company did expect single digit earnings per share growth, driven mostly by share repurchases.
Those share repurchases and the new dividend were motivated by activist investors who have forced the company to start returning value to shareholders in the absence of growth. The company now has a new CEO and two new board members nominated by the activists. They have also led eBay to consider the sale of some of its properties, including the very fortuitously timed sale of StubHub for $4.05 billion (approx $5/share) in February. Further shoring up the balance sheet, eBay followed this sale by refinancing and extending the term of $1 billion of its senior unsecured debt with lower interest notes due in 2030.
Before the crisis, the expectation had been that eBay would use its strong cash position to invest in its platform, and accelerate its stock buybacks. The new reality means that eBay is in a good position to be a consolidator by buying up less well prepared rivals.
Sustainability - “Reduce, Reuse, Recycle” is not just an alliterative list of sustainable actions which I incorporate in my personal life, it’s also a list of investing themes I try to incorporate in my portfolio. For reduce, I have stocks that incorporate energy efficiency like Hannon Armstrong (HASI) and Ameresco (AMRC). For recycle, I have Umicore (UMIF), Schnitzer Steel (SCHN), and Greystone Logistics (GLGI). The essentially anti-consumerist nature of reuse makes it a particularly difficult investing theme to participate in.
I’ve wanted to include eBay or another C2C marketplace as the first “Reuse” stock in my portfolio for a long time, but until recently, eBay’s valuation and lack of dividend have kept me away. The recently initiated dividend and stock decline have changed that. Combine that now with potential opportunities to claw back market share from Amazon and potentially purchase distressed rivals, and I’m buying. [Editor’s note: the pause button was hit as eBay has recently shot up, but toe-dipping is warranted].
In terms of eBay’s prospects, the company is cash rich, and its operations are unlikely to be disrupted by the pandemic. It may even see some upside. The loss of income for too many people in this crisis will lead some to explore new ways to earn cash. Selling off unneeded stuff on online platforms is an easy and quick option, especially people who want to avoid in person transactions.
A Greener and More Equitable Economy
In summary, we believe the Green Economy is weathering the pandemic storm quite well. But then there is the other storm: protests are filling the streets of this country to a degree not seen since the civil rights era. Outrage and calls for justice are gripping our country as the result of yet another senseless killing of an unarmed black man at the hands of police. Will the moment pass, or will we seize it? The jury is still out. However, there is an undeniable shift in public opinion that these are not isolated events but systemic in nature.
If 10 years from now we have not succeeded in flattening the curve on climate change, that will be a failure. But a far greater failure would be if we still not collectively treat black folks like they matter. Words are powerful, but actions more so. At JPS, we have to strengthen our screening of holdings on social criteria, give intentional consideration to black owned businesses when we select vendors, and pursue a more diverse applicant pool for our next hire. Let us build a green economy that is more inclusive, because the alternative is not acceptable.
I welcome you to contact me if you have any questions or would like to learn more about our low carbon investment strategies.
Jan Schalkwijk, CFA – Portfolio Manager