The changing nature of environment industries

Environmental investment opportunities are growing and larger companies are starting to make inroads into this exciting and fast-growing segment of the global economy

Green investment has moved firmly into the mainstream over the past few years. The investment universe, previously the domain of small technology start-ups, is now a rapidly developing area of the global economy with spectacular growth prospects.

Large corporations are being forced to adapt to the accelerating problems of climate change, the depletion of natural resources, water shortages and growing mountains of waste. Governments have responded with reams of legislation, leading to a fertile breeding ground for forward-thinking companies to develop products and services to address these pressing issues.

Those stepping up to the plate are not just small businesses with unproven technologies, but established companies such as General Electric - making green investment a viable alternative even for the risk-averse.

Ten years ago there were just a handful of fund managers dedicated to investing in environmental companies and they struggled in hard times when returns were volatile and investors were not convinced by the prospects. Then the fuel cell sector enjoyed its time in the sun. Investors pushed valuations sky-high on hope rather than substantiated business plans. A poster child for the sector was Ballard Power, whose shares surged to almost $130 in 2000 but crashed back down to below $10 as reality kicked in. The continuing fallout from the dotcom bust made investors understandably wary of any stock that relied on new technology.

Happily the landscape has changed considerably since then and investment opportunities have proliferated. Five years ago, around 200 'pure play' companies, dedicated to implementing business plans based solely on environmental products and services, were identified. That has since grown to around 500 companies, and their total market capitalisation has increased from £50bn to £250bn, so there is now a very sizeable pond in which to fish.

This has in part been stimulated by the regulatory climate, which is increasingly favourable to environmental stocks. Germany is an example of a country that has built markets with effective legislation. It has a system of feed-in tariffs, which place a legal obligation on utilities to purchase electricity from renewable energy producers. The tariff rate is guaranteed, and determined for each technology, to ensure profitable operation of the installation. Because of government support for the scheme since 1990, Germany has become a world leader in renewable energy, generating billions of dollars a year in exports, creating in the region of a quarter of a million jobs, and saving around 100 million tonnes of CO2 annually.

Consumers and investors have also played their part. An increasing awareness of climate change issues has driven demand for environmental products and services, prompting producers to step up supply. Mainstream companies have recognised the trend and are scrambling to address this new and growing market.

Put simply, environmental markets are maturing. Many original investments were pre-revenue, making them significantly riskier than established businesses. Those have now grown into solid, profitable companies, such as Danish company Vestas Wind Systems, one of the biggest renewable energy providers in the world, with 28% share of the wind market. Another fantastic growth story is Canadian company Bioteq, which treats effluent from mining waste and extracts re-usable materials such as copper.

Environmental businesses have also become obvious targets for big companies looking to bolster their green credentials, which can provide a swift and lucrative exit for the early-stage investor. GE recently took a 20% stake in French wind energy company Theolia, while Scottish & Southern bought the European arm of another wind group, Airtricity, in a deal worth €1.45bn.

But medium-sized and larger companies are not just buying into the sector. They are increasingly important developers, manufacturers or operators of environmental products and services. Big business has woken up to the potential to generate more attractive earnings growth and return on capital by focusing on high-growth environmental markets. And the size of these companies means they can achieve economies of scale and apply a relatively low cost of capital. While some can rightly be accused of 'greenwashing', there are a number of producers and suppliers doing very exciting things in terms of mitigating their environmental impact and fighting climate change.

Spanish group Acciona, for example, has transformed itself from a construction company into a renewable energy power producer. The company has enjoyed a re-rating based on its purchase of EHN and a 21% stake in energy company Endesa. This focus is set to continue with current plans to spin-off Acciona Energia in combination with Endesa's renewable energy assets in the first half of 2008. This combination would have installed capacity of approximately 5.5GW, based on 2006 figures, making it a world leader in renewable energy production. The company is enjoying startling growth rates for an entity of its size, boosting adjusted earnings by 55% in 2006.

US industrial gases group Praxair, with a market capitalisation of over $25bn, has significant exposure to environmental markets. It supplies a range of gases to the water and wastewater treatment sector, emissions testing, insulation and incineration markets to name just a few. Praxair has earmarked the energy market and the supply of hydrogen to the refining process (for fuel desulphurisation) as areas of strong growth, while the promise of large-scale CO2 sequestration remains a good long-term opportunity.

With these companies and many more, investors can balance the security offered by large, established businesses, with the staggering growth of the environmental sector.

Investment opportunity aside, the fact that mainstream companies are developing green products and services is a profoundly positive step for the environmental cause. Start-ups will always be the first to jump on new business opportunities. Their involvement is vital in terms of discovering what is profitable, demonstrating what regulation is needed and building a viable marketplace. But the involvement of big business takes the industry to the next level. Only with the financial clout and resources of large companies can we reverse the damage wreaked upon the planet over the past few centuries.

Categories: SRI | Equities | Investment

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