For those investors focusing on sustainable investing, we at Cheviot continue to see companies involved in energy efficiency offering interesting investment opportunities at reasonable valuation. Energy efficiency is the fastest and cheapest way to lower energy consumption and contribute to a low carbon economy. The energy efficiency sector is growing at around 10% annually and is expected to reach over $1 trillion by 2020. This sector includes improvements in buildings (such as insulation and lighting), industrial efficiency, (such as productivity gains and improved process performance), and transport efficiency (such as railways and electric vehicles).
Lighting accounts for 16% of electricity consumption in the UK and 19% globally, therefore efficient lighting is key to reducing both energy consumption and carbon emissions. For example, Philips is a global leader across most segments of the lighting market and stands to benefit from the shift from inefficient incandescent lighting, where a very high proportion of energy is lost, to compact fluorescent or LEDs (light emitting diodes). The company is a leading global manufacturer with a focus not only on lighting but also in medical imaging equipment, consumer electronics and domestic appliances. The company, led by a new management, has recently embarked on a landmark corporate change programme to improve business processes, cost structures and returns. While the short term environment remains challenging, valuation is supported by a strong balance sheet and above 5% dividend yield. For us at Cheviot, Phillips is a company that we look at for both our global thematic investment proposition, the Climate Assets Fund, and client portfolios with a focus on sustainable investing.
Productivity gains by reducing energy consumption
We estimate that as much as 80% of energy is lost between its production (in power plants) and its consumption (in end devices such as lights and consumer electronics). As such, companies that offer energy efficient solutions to both industries and consumers are set to benefit by the need to achieve better use of resources and improve productivity.
Energy efficiency and productivity have always been a factor driving product replacement cycles. During the recent economic downturn, capital spending was decreased substantially and is due for major increases. Barring a double dip recession, we expect investment in energy efficiency to rebound as industrial players look to reduce costs, expand capacity, increase productivity and reduce energy consumption. One way to gain exposure to this trend is Emerson Electric, for whom energy efficient products and solutions are central to over 50% of its portfolio. Emerson is a diversified, global manufacturing and technology company. It offers a wide range of products and services for industrial customers in the areas of process management, climate control technologies, network power, storage solutions, motor technologies and industrial automation. Its technology leadership fuels a market leading new product pipeline, with new products at around 40% of sales. It enjoys a robust balance sheet, strong generation of cash flows and a dividend yield of above 3%.
Another relevant company, Schneider Electric, is exposed to energy efficiency investment by levering from both building products and industrial processes and manufacturing. Schneider is a global leader in electrical distribution (medium and low voltages), secure power supply and automation and control systems. Its products are sold under multiple brands with a strong market position in power distribution and electricity transmission.
The ability to implement cost effective measures to reduce emissions is generally correlated with economic growth, as it is usually cheaper to install energy efficient technologies in new builds rather than retrofit to existing plants, autos or buildings. This is the key driver for emerging economies investing heavily in energy efficient technologies. We expect heavy investment in this area in emerging markets such as Brazil, India and China, with the latter planning to invest Renminbi 2.8tr ($440bn) in high-speed train systems over the next five years, although a recent collision of two high speed trains has slowed down procurement.
Fuel efficiency and emission control
We believe transport efficiency is the fastest growing segment within the energy efficiency sector, driven by the move away from road transport to rail and the adoption of low carbon-emission vehicles.
One company that stands out to benefit from this trend is UK based Johnson Matthey, a global leader in emissions controls for the auto industry with over a 30% market share in auto catalysts. The company is set to benefit from emission legislation initiatives across the globe particularly in bus and truck applications. At the other side of the pond, American BorgWarner is a leading global supplier of highly engineered systems and components for automotive power train applications. Its technology increases fuel efficiency and reduces emissions. The company is enjoying growing exposure to China, now the largest automotive market with sales having surpassed the US in 2009. China will continue to play a vital role in the auto industry value chain. There are already more automotive assembly plants in China than any other country in the world.
Notably, Johnson Controls is set to benefit from exposure to both the building and the fuel efficient segments. Johnson Controls is a global market leader in advanced lithium-ion batteries for hybrid and electric vehicles and energy management products and services for non-residential facilities.
We feel that within the current economic backdrop and austerity measures, energy efficiency will continue to be widely regarded as the most economical way of reducing energy consumption and carbon emission across all industries. Overall, it seems that the most significant efficiency opportunities are in the building, auto and industrial sectors.