Perennial Partners discusses investment opportunities in the energy transition

Sam Berridge, Portfolio Manager and Resources Analyst at Perennial Partners, discusses the importance of gas for renewable energy and Perennial’s approach to investing.

Tim McGowen: We’re talking today with Sam Berridge, who is the Portfolio Manager and Resources Analyst with Perennial. Sam, there’s obviously a lot of market interest in this clean energy transition as we witness the emergence of a global climate change focus by both governments and investors around the globe. Now, gas is always in the conversation, but probably misunderstood. So, where is gas positioned in regards to the energy transition, particularly as the market positions itself away from oil and coal to cleaner alternatives like solar and wind?

Sam Berridge: Yeah, I think you’ve hit the nail on the head, Tim, with the word “transition”. I mean, this has always been a transition. There’s never been any suggestion it can be sort of a cold turkey abrupt shift from the form of power generation that’s been with us for over 100 years to something that’s completely new. I suppose the crux of it is how fast do we want this transition to happen? Because if we want to start decarbonising today, then gas is absolutely critical to facilitate that transition. Or we could wait 10 to 15 years and maybe we get a better battery or some other better technology will be viable by then. But right now gas is all we’ve got. Batteries can’t do the job that gas can, and gas is 50 per cent better than coal. And the reason why it is key is because of the intermittency of renewable. And any rational observer has been able to observe that since forever. But there’s still various parts of the media and NGOs and political entities which refuse to acknowledge the intermittency of renewables being a clear limitation. For instance, we had the Victorian Energy Minister come out recently and say that they’re going to back up their renewable generation with more renewable generation by way of offshore wind. I mean, if I was running a power-intensive business in Victoria and heard that, I’d find it as reassuring as a warm seat in a public toilet and I’d be reconsidering my power supply options. So, other than having half the emissions of coal, the best thing about gas is that you can turn it off. And people seem to think just because you introduce a little bit more gas into the grid, it’s going to be running 24/7. That’s not the case at all. The reason why gas is so critical to the transition is that you can ramp a gas turbine up from somewhere between 30 minutes to a few hours, so it’s compatible with the intermittency of renewables. And if you can manage that intermittency, that means that you can bring more renewables into the grid and lower your total emissions materially compared to the status quo.

Tim McGowen: Now, Sam, have you uncovered any sectors of interest from your analysis of commodity requirements for the energy transition?

Sam Berridge: Yeah, certainly. I mean, it is a massive sector and there’s many tangents to it. And other than looking at the obvious, which is the commodity demand requirements to meet the renewables transition for the batteries and the cars, etc, there’s a few other sectors which have come up as being of critical importance, and certainly have some investment opportunities within them. And the one that’s front of mind at the moment is energy distribution or the grid, and this came to prominence just after the election, when we had this East Coast power crisis and Labor quickly committed $20 billion to expanding the grid up and down the East Coast. And the reason why that’s so important, and the grid is a bottleneck to this energy transition at the moment, is because you’ve got renewable power projects on the East Coast at the moment which are only able to feed in maybe 50 per cent of the power that they produce because the grid is not able to take more of it in. And there’s many reasons for that, but part of it is because when you have a centralised power generation network, then you have a big fat cable sitting just where the power plant is. And that goes to a skinnier cable and to a skinnier cable, and then that cable gets narrower and narrower and narrower as you get to the periphery of the grid. But it’s at the periphery of the grid where a lot of these renewable projects are being built. So, when you start trying to force bulk power back up the other way, it doesn’t work. So, there’s a huge amount of spend required to make the grid more flexible, both at the macro level for power generation, and then at the micro level, at the household level, on the assumption that electric cars are going to become much more commonplace in Australia. And we saw all this in the ’80s because when air conditioners started to be rolled out right across suburbia, the grid really struggled to keep up with the power demand. So, we’re going to see exactly the same thing all over again, with the key difference being that EVs consume or require about four times the grid capacity that the air conditioners did.

Tim McGowen: And what’s your approach to investing in an emerging sector to ensure that capital is preserved as well?

Sam Berridge: Just because you have a rapidly growing sector and it’s a sector of a great interest, it doesn’t necessarily guarantee profitability. And we’ve seen this many, many times as, you know, new sectors sort of bloom into prominence and capital is thrown at them, sometimes unquestioningly, and a lot of that capital is destroyed. You know, there was a boom a few years ago of looking at geothermal power generation in Australia. There was lots of money raised and spent on that, and it came to nothing. And even around the world, we saw huge losses taken amongst some of the solar panel manufacturers, which is certainly a booming industry which continues to grow. But, eventually, they had their margins eroded by cheaper products coming out of China. So, you know, we look for the core building blocks of any good businesses is that there’s some core IP there, there’s a moat around it, and high barriers to entry, and sustainable growth at a decent margin. And hopefully with low capital requirements.

Tim McGowen: Can you talk us through a couple of stock examples?

Sam Berridge: Yeah, sure, Tim. I suppose, just sticking on that distribution thematic for a while, I think there’s one company which I find particularly exciting is GenusPlus (ASX:GNP). The ticker for that one is GNP. So, these guys are specialists in building power networks both for remote areas and also for utilities. This stock has grown its revenue at a rate of about 70 per cent KGA over the last four years. So, looking at FY22, they should report revenues next month of around about $400 million, generating about $34 million worth of EBITDA, their net cash. And they’re one of three companies which are able to solve this distribution problem that the East Coast faces. But there is so much work here. There’s going to be plenty to go around, so I don’t think this is a situation where you’re going to see companies cutting each other’s throats as they compete for market share. There’s bucket loads of market share, so I think margins are going to remain quite healthy. And then once those power networks are expanded and built out, there is a huge tail of maintenance activity, which Genus will also pick up. So, it’s not just a company that you get the sugar hit of the EPC work or the construction work, and then you’ve got a question mark over future earnings. There is a long tail of annuity-style earnings which this company will pick up as this grid is expanded, both at the macro level and after that at the household level.

Tim McGowen: Sam, thanks for your time.

Sam Berridge: Pleasure, Tim. Thanks very much for your time. Thank you.