Energy Values: First, select your shade of green

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The energy can be renewable. That doesn’t always seem to apply to investor enthusiasm. Green energy stocks have swung from high to low like the tip of a wind turbine blade. Still, they play a growing role in the portfolios of private investors.

But what is the best way to participate? Through “pure green” energy groups? Or through companies that are in the process of transformation?

Two years ago, investor enthusiasm for companies following climate-friendly policies reached feverish levels. The problem was that too much capital chasing too little big business pushed the stock too high. Actions like those of Denmark Orsted he dropped when his power output was disappointing.

Orsted sold its oil and gas operations years ago to become the world’s largest wind farm operator. Its shares are now trading at what green investors would see as a depressed level. The shares are worth 13 times estimated cash earnings, defined as earnings before interest, taxes, depreciation and amortization.

Shares in British energy group SSE are even cheaper, at nine times forecast ebitda. This is because you are exposed to both the old and the new energy economy. The FTSE 100 company builds and operates renewable energy infrastructure, such as offshore wind farms in the UK. It also owns power grids in Great Britain. Its thermal business operates gas-fired power plants and methane storage facilities.

A group dedicated exclusively to renewable energy like Orsted is easy to understand on an operational and ethical level. But its shares, and consequently its cost of capital, are likely to be volatile. A mixed energy company like SSE is more opaque, but it’s also a more stable proposition. You can finance your green expansion internally using cash flow from “dirty” hydrocarbon-related businesses.

SSE has resisted pressure from US activist Elliott to spin off its renewables arm in the hope of an increase in value. Former boss Alistair Phillips-Davies can now feel justifiably smug for holding out.

SSE’s diversified structure helped it through 2022 when the Russian invasion of Ukraine rocked energy markets, its full year results this week showed

Its thermal generation business was the biggest contributor to adjusted annual profit before tax, rising 89 per cent to £2.2bn. Gas-fired power stations help meet Britain’s demand for electricity when renewables such as wind and solar units cannot.

Despite the country increasing its share of wind and solar assets, gas-fired power plants remain the main source of energy. Last year they counted 38.5 percent of Britain’s electricity generation mix.

Ironically, earnings growth in SSE’s renewables business was held back by insufficiently stormy weather conditions last year. A UK windfall tax on low-carbon electricity generators cost it £43m. Less diverse companies like Orsted have recently it went bad.

SSE wants to expand its three units. It upgraded investment plans to spend £18bn by 2026-27, half of which will go to networks. Previously, SSE had targeted investment of £12.5bn by 2025-26. The strong performance last year also means that SSE will no longer have to sell a stake in its electricity distribution network business, which takes electricity from the national grid and transmits it to homes and businesses, to finance its investments.

Not everything has gone well. SSE must cope with rising supply chain costs. Wind turbine manufacturers have increased their average sales prices by more than 33 percent since the end of 2021 to offset increases in input costs for steel and copper. In fact, £2bn of SSE’s upgrade to its investment plan represents supply chain cost increases. New power projects in the UK also face long delays in Secure network connections.

Stocks have done well so far this year, rising 12 percent. Its shares trade with a forward earnings multiple of more than 12.5 times, cheaper than some European peers such as Iberdrola by 16 times, as well as National Grid by 15.7 times. The icy wind of breakup calls could return. But for now SSE has done enough to silence its critics.

Drahi marks more shares in BT

SSE could be out of the eye of the storm. But there is interference on the line from another company in the UK, BT.

Israeli tycoon Patrick Drahi, owner of Sotheby’s auction house, increased his stake in BT to 24.5 percent. A mandatory 30 per cent bid trigger, according to the UK Procurement Panel, is in the offing.

But Drahi’s holding company, Altice, could not easily acquire BT. Has the wheel dealer, who favors the use of debt for takeovers, softened into a middle-aged rentier, content to cash in on the UK telecoms group’s 5 per cent annual dividend yield?

Altice argues that BT offers long-term value. He says he has no plans to bid for BT, with a few notable exceptions. These include a recommendation from the board or an offer from a third party.

UK officials approved an increase in Drahi’s shareholding to 18 percent. Her interest now hovers just below the 25 percent threshold that would trigger another review. The UK would likely block an outright buyout of BT by a heavily indebted foreign buyer, even if BT directors agreed and Drahi was able to finance the deal. The UK would hardly be more interested in Drahi buying BT’s broadband unit, Openreach.

Altice says Openreach’s fiber construction is what draws Drahi to BT Group. That represents more than half of BT Group’s earnings before interest, tax, depreciation and amortisation, giving it a possible value of more than £20bn.

With 37,000 employees, many of whom are part of BT’s pension plan, Openreach looks doubly hard to knock out. BT only expects its pension scheme, which is running a £3.1bn shortfall, to be fully funded by 2034. Trustees there have leverage and can demand shortfall reduction in the event of a takeover. That would drive up the cost of buying any part of BT.

Drahi’s equity interest is equivalent to a blocking interest. But it’s hard to see how you could sell it without a viable alternative offer. It consists mainly of cash shares, some acquired during the choppy trade after BT filed mixed full-year results last week.

Add Drahi’s participation to the participation in BT of the German Deutsche Telekom and you get to a 37 percent overhang, says New Street Research. Neither party can easily sell to the other.

In philosophy, Occam’s razor insists that the simplest solution is usually the correct one. That would mean that Drahi simply expects BT to roll out fiber quickly and profitably, boosting its share price.

The tantalizing possibility remains that it has a side bet on M&A activity that changing circumstances could trigger.

Lex is the FT’s concise daily investment column. Expert writers in four global financial centers provide informed and timely opinions on capital trends and large companies. click to explore