The world is pushing toward a clean energy future and Wall Street is following along for the ride. But should you invest in renewable power stocks right now? Here’s what one big North American energy company is doing and what it says about the broader clean energy sector.
Hot, hot, hot
Shares of master limited partnership (MLP) NextEra Energy Partners, which invests heavily in clean energy assets like solar and wind power, are up 175% over the past five years. Parent NextEra Energy, a giant U.S. utility with material clean energy exposure, is up 155%. Real estate investment trust (REIT) Hannon Armstrong Sustainable Infrastructure Capital, which helps finance renewable power projects, has seen a stock increase of 190% over the same time frame. And Brookfield Renewable Partners, another clean energy-focused MLP run by Canadian asset manager Brookfield Asset Management, is up around 170%. Over the same period, the S&P 500 index, using SPDR S&P 500 ETF Trust as a proxy, has gained roughly 95%.
Those are pretty impressive numbers for sure, and they highlight the fact that the renewable power sector has been outperforming. That’s great, but the problem is that hot sectors tend to draw increasing competition. That, in turn, brings down the returns as more companies are competing over projects — which is exactly what Canada’s Enbridge (NYSE: ENB) is warning about recently.
During Enbridge’s fourth-quarter 2020 earnings conference call, management explained:
As everybody knows, renewable valuations these days are frothy to say the least, so that’s good for the value of the business. But it also means that returns are being crunched down on new opportunities. So it’s nice to have a backlog like we do of construction and development projects, and we’re not going to stretch our investment criteria on risk or return.
In plain English, the company is saying that it won’t lower its investment standards to chase new projects. It can do this because it already has a stable of offshore wind projects in Europe it’s building over the next few years and opportunities to invest in solar for its own use in its pipeline business. It has several years’ worth of spending locked at risk/reward levels it believes are worthwhile.
There’s no need for Enbridge to “stretch,” as management noted. The flip side of this, however, is that other companies investing in the space may in fact be doing just that. As an example, in a recent auction for offshore wind projects in Europe, BP, an integrated oil giant trying to shift toward clean energy, paid 65% more than the second-highest bidder for projects. It paid 85% more than peer Total was willing to shell out. Although this is just one example, it highlights the froth that Enbridge is warning about. And it suggests that stocks caught up in the clean energy frenzy may be riskier than investors think, even if there’s a huge long-term trend here.
But you don’t have to invest in companies that are caught up in the clean energy hype on Wall Street to get exposure to the sector. Both Enbridge and Total are examples of companies using their legacy businesses to push into clean energy. Their clean energy segments are relatively small today, but they are expected to grow quickly. And neither one is particularly well-loved right now, with Enbridge’s shares down around 3% over the past five years and Total’s up just 5% or so.
Meanwhile, dividend investors will appreciate Enbridge’s 7.1% yield and 26 years’ worth of annual dividend increases. While Total doesn’t have the same increase streak behind it, management has stated that it believes its dividend is sustainable at $40-per-barrel oil. It has a 6.7% yield. Both companies have been investing in renewable power for quite some time, too, so they aren’t newbies by any stretch of the imagination. These two energy stocks are basically getting little to no credit for the clean energy shifts taking shape in their portfolios and that could be an opportunity for investors to buy into the sector on the cheap.
A contrarian view
You can follow along with the rest of Wall Street and chase hot names in a hot sector, but Enbridge is clearly warning that discipline in the arena is loosening. For investors that prefer to do things their own way, you might want to look at other companies that are looking to grow in the clean energy space but that have older, dirtier businesses that are distracting investors from the changes taking place. That list includes Enbridge and Total, but there are others, like Royal Dutch Shell and the aforementioned BP, though its overzealous bidding for offshore wind power projects should probably make you consider other options. The key point, however, is that you don’t have to chase expensive stocks to invest in renewable power — there are other options if you are willing to look for them.
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Reuben Gregg Brewer owns shares of Enbridge and Total SA. The Motley Fool owns shares of and recommends Brookfield Asset Management and Enbridge. The Motley Fool recommends BROOKFIELD ASSET MANAGEMENT INC. CL.A LV and NextEra Energy. The Motley Fool has a disclosure policy.