Canadian renewable energy stocks have been on a tear for the past 10 months, rising to record highs as investors anticipate steady growth in wind and solar power and concerted efforts to combat global warming. But the gains are raising questions about lofty valuations.
Innergex Renewable Energy Inc. (INE-T) has risen 113 per cent from its pandemic lows in March, and the stock is more than 40 per cent above its prepandemic high in February. Brookfield Renewable Partners LP (BEP-UP-T) is up 114 per cent from its lows, Northland Power Inc. (NPI-T) is up 137 per cent and Boralex Inc. (BLX-T) has surged 193 per cent.
This is terrific news for investors who saw a compelling opportunity in renewable energy before the recent boom began. The falling cost to produce wind and solar energy has underscored the sector’s long-term viability and ensured expansion for years to come – with or without government help.
Now, though, investors are faced with a difficult question: How should they navigate a sector that is already reflecting a lot of optimism?
James Bradford, founder and senior portfolio manager at Toronto-based Vivid Capital Management, repositioned his Vivid Energy Fund in late 2019 to take advantage of the shift toward renewables. Even though his fund delivered a return of nearly 116 per cent in 2020, he has steered clear of Canadian renewable energy stocks.
“It’s likely a crowded trade, which is probably why you are seeing the valuations that you are. I’m not invested in any of these companies for that exact reason,” Mr. Bradford said.
Instead, he’s more focused on companies producing the commodities that will drive a lower-carbon future. He mentioned Vancouver-based Deep-South Resources Inc., (DSM-X) which holds the Haib Copper deposit in Namibia; and Toronto-based Canada Nickel Co. Inc., (CNC-X) which is developing a nickel project in Ontario. Both stocks trade on the TSX Venture Exchange.
But some long-term investors in the renewable energy space aren’t dissuaded by the recent gains.
Stephen Takacsy, chief executive and lead portfolio manager at Montreal-based Lester Asset Management, has owned Boralex and Innergex shares for 10 years. He trimmed his positions in the two stocks by about 20 per cent this month, but only because the stocks had become overweighted in his portfolio after the recent gains.
What’s more, he used the proceeds from the sales to buy more shares in Algonquin Power & Utilities Corp., (AQN-T) a renewable energy producer whose share price has not yet fully recovered from the pandemic sell-off.
“We see these as long-term core holdings. The growth prospects are much greater than your typical, traditional utilities,” Mr. Takacsy said.
He added that the sector is delivering rising dividends and international expansion. Plus, it’s benefiting from a massive money flow out of the fossil-fuel energy sector. Valuations – though high – could be reflecting potential takeovers, driving his belief that investors can still do well if they buy on dips.
Some observers believe that the recent rally is no obstacle to further gains, as long as investors maintain a longer-term horizon.
Justin Strong, an analyst at Bank of Nova Scotia, looked at valuations among Canadian renewable energy stocks by comparing enterprise value (market value of the shares plus debt and cash) with EBITDA (earnings before interest, taxes, depreciation and amortization).
He found that the sector looks okay when one compares the current value of the companies with future profits several years ahead. Based on an average of 5-per-cent growth in EBITDA each year, valuations decline by 21 per cent for the group by 2025.
Northland Power offers a strong case. Though the stock trades at about 15 times EV/EBITDA, Mr. Strong expects that growth in new offshore wind farms will bring the valuation down to 12.5 by 2023. By his estimation, that is considerably cheaper than the offshore wind assets of a global peer such as Denmark’s Orsted A/S.
No one is arguing that these are cheap, out-of-favour stocks. But sticking with this momentum play may have some appeal.
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David Berman