Essex Global Environmental Opportunities Strategy (GEOS) March 2024 Update
The Anti-Bubble
…a price fall in and of itself does not necessarily reflect adverse business developments or value deterioration. It is vitally important for investors to distinguish stock price fluctuations from underlying business reality. If the general tendency is for buying to beget more buying and selling to precipitate more selling, investors must fight the tendency to capitulate to market forces. You cannot ignore the market – ignoring a source of investment opportunities would obviously be a mistake – but you must think for yourself and not allow the market to direct you.
— Seth Klarman, Margin of Safety
There has been much discussion among investment pundits as to whether we are experiencing an investment bubble in certain tech stocks. To us, the answer isn’t clear as we can see validity in points on both sides of the discussion. What seems evident to us, however, is that clean tech stocks have been experiencing the opposite of a bubble – despair, universal disdain and irrational selling. Clean energy stocks have been among the worst performing group of stocks in the market over the past two years, and this trend has continued year to date. As we have stated in these pages before, we think there is opportunity in this near abandonment of clean energy and climate tech stocks. The market seems to be signaling that there is no future for renewable energy, electric vehicles, energy storage, or autonomous driving. We think this view is short-sighted and wrong.
While we believe some of the underperformance of clean technology is rooted in macro forces and fundamentals, a large degree is due to negative market sentiment driven by headlines and psychology, not based on objective, fundamental analysis. Interest rate pressures have affected the overall clean energy sector, yet we are focused on companies that are commercially viable – free cash flow positive with services and technologies that are disruptive with adoption driven by economics. A critical attribute we seek for our GEOS holdings is companies that can operate and grow using their own internal capital given strong stewardship. Many clean tech companies came to the listed markets the past few years too early, with business models that fell flat when capital markets tightened. This is a critical juncture for the clean tech cycle, as uneconomic companies fail, and the survivors thrive.
A good example of capital stewardship and a commercially viable business is GEOS holding MP Materials (MP), the rare earth company with its operations based in Mountain Pass, CA. The key advantage for MP is a world-class deposit resource and low-cost extraction of material containing rare earth elements. Over the past two years, the company has been expanding downstream into the processing and refining of these rare earth elements extracted from Mountain Pass, thereby circumventing the need to ship the raw materials to China for processing. More recently, the company has expanded further into using some of this refined material to manufacture permanent magnets containing rare earth elements such as neodymium and parseodymium (NdPr) that are used in high-efficiency electric motors and generators. NdPr magnets are key for use in electric vehicles, factory automation and wind power industries. China controls over 90% of the rare earth and the permanent magnet markets, making MP an extremely differentiated, national champion given secular trends such as onshoring, domestic sourcing and the rise of electrification and industrial automation. MP has been spending capital the past few years to optimize production and drive volumes of the highest quality product in North America, with offtakes from Tesla and distribution overseas by Sumitomo. MP has a forward price to earnings multiple in line with the market, with the prospects for 60% growth we believe, and attractive 60% net income margins. We believe MP, with its closed loop, zero discharge processing facility is leading the path to the new age of energy. Without materials, there will be no energy transition.
At Essex, we signed the United Nations Principals of Responsible Investment (PRI) in 2020 initially, and recently received our results from our submission in 2023. We believe the deck is stacked against small boutiques such as ourselves, versus large firms that have focused ESG teams that work expressly on things such as shareholder advocacy and proxy voting, which have been strongly in vogue over the past decade. We have been stating consistently that a focus on solutions investment has greater impact or can at least complement shareholder advocacy. Interestingly, as ESG has been hit in the headlines, the market is also recognizing the power of investing in solutions that solve environmental and social problems. For a small equity investment firm, we were ranked by the PRI with strong marks for climate policy, solutions alignment, and ESG integration. We also believe it is time for the ESG community (of which I have been a part of for over 30 years) should move the focus from buying or engaging with companies that are flawed, to investing in companies that are saving the world – it is that simple. Such companies solve social, environmental and economic problems, while tied to strong and long-term secular growth themes.
Overall, the fourth quarter earnings season was positive for GEOS, yet some stocks were punished if they lowered guidance for 2024. A great example is Symbotic (SYM), which provides e-commerce warehouse automation, to enhance profitability and productivity for operators. Symbotic is a $25 billion market capitalization company with $500 million in cash on the balance sheet and a backlog of $25 billion and total addressable market of over $500 billion. SYM is growing revenues almost 100% and expanded its EBITDA margins over 700 basis points last quarter. Symbotic provided revenue guidance for 2024 at consensus, but the stock traded down the day after earnings almost 30% given EBITDA guidance a bit below the Street. We immediately added portfolio weight, given the fundamentals are stronger for the firm. We sold Watts Water Technologies based on valuation, and purchased Xylem, the diversified water solutions company, based on what we believe will be higher sales to the commercial and municipal channels with improving organic growth.
Clean tech is in an anti-bubble, the antithesis of the few stocks driving the US indices currently. As the clean tech fundamentals grow stronger, and market sentiment remains poor, we observe opportunity. In coming weeks and months, we will continue to address and demonstrate the fundamental state of clean technology, communicating examples of solutions that are scaling and commercially viable. These companies are profitable, with businesses not dependent on government policy. Clean tech and the energy transition is thriving, and we believe will be reflected in stock price valuations.
Disclosures:
This commentary is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. The opinions and analyses expressed in this commentary are based on Essex Investment Management LLC’s (“Essex”) research and professional experience and are expressed as of the date of its release. Certain information expressed represents an assessment at a specific point in time and is not intended to be a forecast or guarantee of future results, nor is intended to speak to any future periods. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties.
This does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product, nor does it constitute a recommendation to invest in any particular security. An investment in securities is speculative and involves a high degree of risk and could result in the loss of all or a substantial portion of the amount invested. There can be no assurance that the strategy described herein will meet its objectives generally or avoid losses. Essex makes no warranty or representation, expressed or implied; nor does Essex accept any liability, with respect to the information and data set forth herein, and Essex specifically disclaims any duty to update any of the information and data contained in the commentary. This information and data does not constitute legal, tax, account, investment or other professional advice. Essex being registered by the SEC does not imply a certain level of skill or training.
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