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Climate tech’s tough year in the public markets

Lazard’s Shanu Mathew says climate tech investors are fleeing to safer stocks.

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Two major indicators of climate tech stocks — the S&P Clean Energy Index and the MAC Global Solar Index — are significantly trailing the overall market. They’ve been declining for months, down from their mid-pandemic highs when they performed far better than the rest of the economy.

So what happened to climate tech investments in the public markets? And what do these investments tell us about the coming year for climate tech?

In this episode, Shayle talks to Shanu Matthew, portfolio manager and research analyst at Lazard. They cover topics like:

  • The macroeconomic factors behind this underperforming sector, like higher interest rates, election uncertainty, and the Russian invasion of Ukraine
  • Trends in specific industries, like EVs, solar, and lithium
  • Investors moving funds into (and paying more for) climate tech stocks with consistently higher performance 
  • Analysts’ expectations for climate tech stocks in the the near- and long-term

Recommended resources

  • Shanu Mathew: Cleantech FY23 Recap And FY24 Outlook
  • Catalyst: How has US industrial policy impacted climatetech investment?

Catalyst is supported by Antenna Group. For 25 years, Antenna has partnered with leading clean-economy innovators to build their brands and accelerate business growth. If you’re a startup, investor, enterprise or innovation ecosystem that’s creating positive change, Antenna is ready to power your impact. Visit antennagroup.com to learn more.

Catalyst is brought to you by Atmos Financial. Atmos is revolutionizing finance by leveraging your deposits to exclusively fund decarbonization solutions, like solar and electrification. Join in under 2 minutes at joinatmos.com/catalyst.

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Announcer: Latitude Media, podcasts at the frontier of climate technology.

Shayle Kann: I'm Shayle Kann and this is Catalyst. Give me the high level of what has happened in climate tech in public equities versus public equities in general?

Shanu Mathew: Definitely. Wild rides and accurate characterization.

Shayle Kann: This week, log into your Robinhood account and get ready to HODL your way to glory. We're day trading climate tech stocks. Just kidding. Please don't do that.

I'm Shayle Kann. I invest in revolutionary climate technologies at Energy Impact Partners. Welcome. So here's a funny thing. For all the years that I've been doing this podcast focused on climate tech, apart from some very brief interludes during the SPAC heyday of 2021, I've never really had a conversation focused on public markets and how climate tech is performing within them.

To some extent, I think this makes sense. I'm a venture capitalist and I focus my time on private markets and specifically on early stage technologies within private markets. But public equities, and to a lesser extent, bonds are the way that many, many more people interact with the business of climate tech than the stuff that I spend time on. And obviously, the performance of climate tech companies in public markets reverberates loudly back in the private sector and has big implications for the funding environment, for valuations, for the broader health of the sector and so on.

So to some extent this conversation, which is about public equities, is just to rebalance our weight a little bit and make up for some lost time. But also the journey of climate tech as a category in public markets has been pretty wild for the past few years. In the wake of COVID, the whole market, all public equities overall surged, but climate tech surged even more actually by a fair bit. And then as things cooled down, climate tech became basically ice cold. And now, what, where are we and what does it mean? Well, this was a great chat about climate tech in the public markets with Shanu Mathew who is a portfolio manager and research analyst at Lazard.

And obviously, since we're talking about public equities here, the requisite caveat, nothing in this conversation should be taken as investment advice, obviously. Okay, here's Shanu. Shanu, welcome.

Shanu Mathew: Hey, Shayle, thanks for having me on.

Shayle Kann: Let's talk about climate tech in the public markets. I suppose to start, we probably should define climate tech at least somewhat. It is obviously an amorphous definition, but as you're thinking about what constitutes a climate tech company versus a non-climate tech company in the public markets, how do you categorize them?

Shanu Mathew:m So the way that I would at least maybe bifurcate the market is you have different types of funds, portfolios that invest in climate or what I would call climate adjacent themes. And so this can include one category being climate solutions providers. So companies that sell products and services that deliver actual climate impacts or trying to deliver a positive impact on the fight against climate change and decarbonization.

You might have sustainability type portfolios that are focused on broader sustainability themes. So that could include climate among other themes like social equity or water, or resource scarcity, things of that nature. And then you have your broader umbrella, if you will, which is called ESG funds. I think this is typically how it's categorized, but this gets into a whole definitional argument where ESG technically is a toolkit to analyze non-financial factors and that can be positive or negative towards climate change in its disposition.

So at a broad level that's probably the biggest umbrella in what you often see in typically Morningstar reports or headlines in terms of global AUM. If you look at a big level, Morningstar would cite like $2 trillion AUM in ESG type funds. And then the bulk of that is largely in European capital markets like 80% of that. And then in terms of subsectors or themes within that climate would be roughly 10% plus or the largest individual subsector of the broader sustainable AUM globally.

Shayle Kann: Yeah. A while back, just for our own tracking purposes initially we at EIP built this index just because we were trying to figure out how is climate tech performing in the public markets? Is there a way to track that? There's not a great way to track that, just as one category. So we built one ourselves. And a big part of the challenge was figuring out what goes in, what doesn't go in.

We were trying to just include, as you said, climate service providers. But even there, it's murky, right? You include a company like, I don't know, NextEra Energy, right? Largest owner operator of solar and wind in the country also owns Florida Power & Light. That's a utility. There are lots of utilities, so you include every utility or none of them. Same thing with all other power providers. So we ended up mostly just going with technology companies, companies who are selling some form of technology directly in the space.

Even there it's murky. You include General Electric for example. But that was how we tried to define it just to keep it relatively narrow. And even there obviously, one person's definition of climate tech doesn't match another ones.

Shanu Mathew: Definitely. And then to your point too is that narrowness is a really good point because I mean if you break down, I focus on US public equities, and if you break down that universe of what you're calling the pure climate technology or climate service companies, you might end up with a universe of, let's call it 50 to 100 names, just using rough approximate numbers. And so that's often challenging if you were to build a portfolio and you only had 50 to a hundred names to work with.

That's typically a very concentrated portfolio because probably you're only investing in a subset of those. And so that's why you get portfolios or funds or indices that include what you mentioned some other companies that might have incumbent businesses with underappreciated climate tech angles. And that's typically what you'll see in some of these portfolios and why you might see like a GE or other industrial businesses like HVAC or electrical components into a climate portfolio. I'm using air quotes.

Shayle Kann: Right. All right. Well, let's just define climate tech companies in the public markets, however you want to and compare the performance of that basket of companies over the past few years against the broader market because that's been the interesting and pretty wild ride that we've been watching from the climate tech ecosystem. So just give me the high level of what has happened in climate tech, in public equities versus public equities in general.

Shanu Mathew: Definitely. Wild rides, an accurate characterization. And so when you think about the broader climate tech markets, the two indices that I'll use to look at them is the S&P Global Clean Energy Index, and then the MAC Global Solar Index. And what these are their baskets of stocks that are exposed at a global basis to different climate technologies as we just talked about, solar, wind, batteries, things of that nature.

So when you look at a multi-year basis, let's call it the last two years, the S&P 500, which is a not climate tech industry, but broadly used industry to assess market performances up 23%. When you look at something like the MAC Global Solar Index that's down minus 34%, and you look at the S&P Global Clean Energy Index, that's down 25%, you're talking about a 40 to 50% underperformance over the prior two-year period.

So it's been a really tough go for some of these subsectors compared to the broader overall market. And so what does that mean for the climate tech of clean technology is that when you look at the prior five-year period, you saw this really run up in performance and largely valuation versus earnings growth from a lot of the climate tech companies and sectors. And this was on the back of a few different things, right? It was very low interest rate environment. There was the period at high energy prices caused by disruptions to the global geo-economic environment which includes the Russian invasion Ukraine as well as supply chain complications from COVID.

And then finally you have the really emergence of regulatory subsidies for a lot of these sectors. So in that 2018 to 2020 period, or even call it 2021, you saw an expansion of multiples, you saw earnings growth, you saw a lot of secular momentum into these names. In that period since then, you've seen a lot of normalization of some of the factors that we just talked about. So interest rates have been on the increase and you've seen the performance of these indices in the stocks in them really decrease over the last 12 to 18 months.

You've seen valuations come down to life. You're seeing a lot of folks also talk about potential uncertainty with subsidies going forward whether it's in Europe and the removal of certain subsidies or in the US with the election uncertainty associated with a change in administration. And then you finally have normalization of some of the factors that we mentioned about. So the Russian invasion or Ukraine resulted in really high energy prices in Europe and even domestically based on the global gas benchmarks for a period.

But now they've really come down to normalize, which influences the adoption curve for certain technologies like heat pumps, like solar, like EVs. And then also from a COVID standpoint, you're seeing order growth and lead times normalized from a period where you couldn't get any product and you needed to really push forward or pull forward your orders to a period where now you're more normalizing and you have a lot of inventory to digest in these channels.

So this confluence of factors has really resulted in a really tough performance, especially relative to the broader market. And I'm sure we'll get into the different idiosyncratic factors impacting some of these subsectors.

Shayle Kann: Let's just dig a little bit more into those factors that have driven that. To some extent, I think folks who are listening to this probably understand why clean energy, which is mostly solar and wind companies here, would be especially sensitive to interest rates, but the whole economy is sensitive to interest rates and interest rates rising and inflation in fact did mute performance in the broader market until it didn't. And then the market has now been back on a boom again. So what is it that distinguishes the components of these clean energy indices to make them perform so much worse in this high interest rate environment?

Shanu Mathew: Yeah. There's a few factors. And so I think the most obvious one or the most intuitive one is that in a peer to higher interest rates, especially for products that have consumer point of purchase that require external financing. So think of a residential solar system that's financed by debt or an EV or any type of car purchase actually that you have a car loan that you purchase it.

When interest rates are higher that means the overall cost for the car, the residential solar system or whatever, the debt finance purchase is, is a lot higher. And as we all know, consumers when they see a higher sticker price makes it a lot less likely to go purchase. And it also drives up that payback period where a few years ago, it might've been seven years for a payback period was all of a sudden 10 years plus.

And that does change the calculus for the point of purchase. In terms of the broader companies in their business models, oftentimes with some of these climate tech companies, you do have what we call capital intensity, meaning that you need to spend a lot of dollars at CapEx or R&D, or et cetera to develop your product and get it to market. And so they oftentimes raise external debt to finance these, this capital spend. And so in the periods where interest rates are higher, that means a higher interest expense for them as well as a higher discount rate for their future cash flows.

And so you have these nascent businesses that are a lot of times valued on what they'll be able to generate in three, five, 10 years time. You are not discounting that higher, which lowers your net present value and results in lower valuations. And that's some of the different intricacies that are playing out in the clean tech sectors that might not be as sensitive as some of the other sectors in the market.

Shayle Kann: The other factor that you mentioned, which I haven't really talked about a whole lot yet though I suspect it's going to become a bigger topic over the course of the next few months, is the election uncertainty point. So is your view that uncertainty around... This is obviously the US presidential election and congressional elections obviously, that uncertainty around that is already affecting the share price of public companies in cleantech. It's having an effect today as opposed to we could expect it to have an effect in three, four or five months as the election really ramps up?

Shanu Mathew: Definitely. I think in terms of breaking that question down, you need to unpack what happened when the IRA passed and what happened to the names and then where we are today. So if you circle back to 2022 before the IRA was passed, a lot of the cleantech equities in these different subsectors, depending on how you classify them, were down, let's call it 20, 30, 40%, 2022 year to date before the IRA was announced as passed.

In the week that the IRA was passed and caught the market by surprise, a lot of these names actually traded up 20, 30% in that week alone. And then if you look at what's happened since a lot of the names have traded off for a lot of the factors we just talked to. So I think a lot of folks are already pricing in some type of, let's call it administration shift and pressure to a lot of these tax credits that will impact these companies.

So a lot of the, I think to your point, it's like how much more do we have to go or will markets automatically discount the day one of a different presidency that is less favorable towards cleantech companies or tax credits? I'm not necessarily sure that that's the case, but I do think that most investors in the market today are already adequately pricing some risk to these tax credits.

Said another way, if you're investing in these companies, you're not maybe necessarily writing a hundred percent certainty of achieving certain tax credits or you may not be less likely to invest in a subsector that requires tax credits to become profitable or be cost competitive with the traditional incumbent technology. So to give you an example, something like biofuels, it would be very more dependent on tax credits around the renewable fuels or symbol aviation fuel or let's say like a green hydrogen where you need that to be cost competitive with the current market product. Somewhere else, like in other areas you might be more confident.

So I think the current market view is, for example like ITCs and PTCs for renewable energy have been around for multiple administrations, both Democratic and Republican, and you might expect those to continue and you have a high degree of confidence or visibility into those staying the course. And so you might have less sensitivity in the kind of that headline risk about the election for some of those names versus others.

And so I think it ultimately depends on which tax credits you're talking about and how much you're baking that into the overall thesis. But I think there's definitely a healthy level of skepticism that these credits at least broadly presented in the IRA will be all there if the presidency switches and for example, you don't need to look too much beyond public commentary to see that an EV tax credits will likely come under concern. So that probably impacts anyone investing in the EEV value chain.

Shayle Kann: I'm interested in your view on the level of sophistication of public market investors in things like this specifically because at least from the conversations that I hear about potential impacts of the presidential election in the United States on provisions in the IRA, there's not a deep understanding often of the difference between things that the White House can do on their own along with agencies.

So for example, changing the rules around foreign products in EV batteries to make it more difficult to qualify versus things that would require congressional action like repealing tax credits that are awarded to solar or wind, or batteries, or hydrogen, or carbon capture, or whatever it is. And so I wonder whether there's a sectoral baby out with the bath water phenomenon that either could be happening already now or might be happening three to four months from now because there's just general fear about the election? Or I guess anxiety about the outcome of the election in this sector and whether that is just going to result in an overall muted impact for the entire sector even if the risk is actually pretty differentiated based on where you are within the sector.

Shanu Mathew: It's an interesting point. I think I would disagree and I think that a lot of folks are actually thinking about this. I could be biased by the fact that I've probably sat in on a few of these conference calls hosted by the south side banks on this very topic in the last two weeks alone. But it does feel that people are asking the question and are trying to get specific on a subsector level focus. What can happen under the different scenarios, whether it's just the presidency that switches, whether it's all three categories of both houses in Congress as well as the presidency switching over, what does that mean?

People are trying to probability weight the different scenarios. And I think to your point, yes, there's probably some people that probably look at the entire sector and say, "All right, too complicated and I won't touch it." And it'll have a muted impact. But I think others that are participating are really trying to get their heads around what are the potential avenues here and where are we most likely to get caught off guard or where do we not want exposure to minimize exposure to things that might drastically change day one.

The other point or data point that I would mention is a lot of times what public market investors will do is we host these expert network calls, which basically a lot of folks that you probably work with, people that are actually in these sectors or in these companies day to day out, and for example, one of the ones that we had an anecdotal caller with was we were talking to a solar developer, and one of the questions that we asked was, let's say the presidency switches, but the congressional houses don't, a risk of a broad IRA or appeal is pretty unlikely or is not even feasible.

And developers point was you can say all that all day and you guys probably know more about the different election pathways, but at the end of the day, a president can go in and it has an antagonistic attitude towards these industries. It makes my job a lot harder to get projects built. And then there's a lot of noise that can be created just around the political headwinds and noise around it such that you can influence overall growth rate. And if you think about, again, as investors, we're trying to underwrite the overall growth rate. We're trying to get really certainty around that and if there's enough that will muddy up the noise or potentially impact that trajectory, that could change review alone regardless of the congressional ability or the presidential ability to repeal some of these laws or credits.

Shayle Kann: All right. So overall performance of climate tech with air quotes as a category, as you said, run up relative to the overall market in the wake of COVID and the IRA, et cetera, and then kind of a crash back down to earth since then. Let's dive into some of the more specifically, rather than just talking about climate tech. One thing haven't talked about a whole lot on this podcast is the sort of EV market.

We've talked about what's happened to the auto OEMs overall and all the guidance changing around how many EVs they're going to introduce and sell and so on. But there was a raft of new pure EV companies that became public in the past few years. So what has happened to all of those companies?

Shanu Mathew: Yeah. It's tough to talk about it at a whole, but I think it depends on the company's ability to produce vehicles and their different volume expectations. But in general, I think the past few years, especially 2020 to 2021, you saw a hundred percent growth. In 2021, 2022 you saw 64% growth. This is the global growth rate for electric vehicles defined as battery electric vehicles and plug-in hybrid vehicles.

And then you saw 33% growth in this last year. And if we look at market forecasts, whether you look at like BNEF, Rho Motion, S&P Global Mobility, you're looking at closer to 20% growth in the overall market. So what does that tell me at a high level is that you saw explosive growth in a really nascent market, and you're starting to get into the business of law, large numbers where that growth rate will slow down. The biggest thing that's happened with a lot of the EV stocks or EV exposed stocks is the realization that growth is coming down from what I'll describe just for lack of a better term is that explosive growth in years past.

And I think the big argument or disagreement was the debate around how quickly or how steep the penetration curve would be for EVs where maybe 12 to 18 months ago, some folks had forecast that they had high conviction on that you could get 50% penetration by 2027, 2028 are now being pushed to maybe 2030 or beyond. And that's largely as a result of what you mentioned in terms of some of the OEMs pushing back their actual targets, removing their actual volume targets by a certain year, certain slowing down investments into this new EV production and things of that nature.

What you saw in the last earnings season was actually more gloomy outlooks, if you will, whether it's something like a Tesla or Rivian. Rivian talked about flat production. Tesla wouldn't really give concrete.

Shayle Kann: Tesla is between two waves. It's my favorite phrase of the last few months. "Between two waves of demand." That was what Elon said.

Shanu Mathew: Yeah, exactly. So what you saw, right, or I guess the delta is based on those prior growth rates is you went from a period of, "Hey, growth is really strong, penetration is accelerating," to now all of a sudden of a more mixed outlook and maybe a slower penetration curve. And so that has downstream implications for the OEMs. It also influences the auto suppliers which sell the different cables and chips into these vehicles.

And then also moving further upstream, the battery metals also associated with that. I mean, we can dive into lithium as well, but what you're seeing is the market is increasingly a little bit more bearish or what we call pessimistic than what they were 12 months ago. And you've seen some of the equities take some pain as a result of that.

Shayle Kann: Certainly in the EV sector, and then as you alluded to also upstream of that, I mean the other place that we've seen, I think a lot of pain has been in battery minerals, lithium and nickel in particular where prices have cratered over the past year-ish. And so I presume that has had the exact same effect on the public equities in those sectors.

Shanu Mathew: Absolutely. So lithium has been nothing short of the wild ride as you colloquially called it earlier. And so if you look at that market in terms of talk about the lithium commodity price, pre-COVID or before this vast EV growth cycle, you had prices that were sub $10,000 per metric ton. In the period between 2020 and 2022, you had prices skyrocket on the back of this accelerating EV adoption curve where lithium prices went all the way up to $80,000 per metric ton.

Since then, they've crashed all the way back down. And now we're at a level where current spot prices in China are closer to 13,500 or $15,000 per gallon. They're slightly moving back up per metric ton. So as you can see, dramatically changed the trajectory of where it was at and where it's trading at today.

So all the lithium equities, the lithium market generally operates on an index price basis where it basically means you have your lithium commodity price for a certain period. There's a three-month lag and then the companies get a realized price that's usually at somewhat premium to a certain index rate or price off the index rate. So as you can imagine on the way up, all these companies were moving earnings up, moving the realized prices up, and then that resulted in some strong equity performance. And then on the way down this last year or so, a lot of the lithium equities have taken significant pain.

So things like Albemarle, SQM, Arcadium, Lithium, these names are off considerably 40 to 50% plus in some cases on the back that the lithium price that they'll realize in the next year is a lot lower than what it was on the way up. And so again, you're seeing that near-term outlook. And if you look at a lot of what was said in this recent earnings season, a lot of the companies, so a lot of the ones I just mentioned are what we'd call tier one producers. So they have the lowest cost assets in the world.

So if anyone's making money at low prices, it'd be these folks. And a lot of them guided towards negative free cashflow this year because they still need to spend on the CapEx that they already committed for their prior development projects. And so you're seeing an area where even the best producers of the lowest cost assets in the world are still guiding to negative free cashflow, which kind gives you an idea of top quartile producers still struggling in an environment and it gives you an idea of how challenging it's been for the upstream producers in those markets.

Shayle Kann: There's definitely though an element with that space and with all commodity spaces of the solution to high prices is high prices. The solution to low prices is low prices. And so it's a difficult time for sure for all those companies, but I don't know. Nobody is arguing that demand for lithium is not going to continue to drive upward for the next decade. The pace of that and the exact supply-demand balance on a yearly basis obviously is important, but the macro that led the lithium stocks to be kind of darlings for a little while hasn't really disappeared, I don't think.

Shanu Mathew: It hasn't. But one thing you just mentioned was supply and demand. So we talked a lot about demand. We haven't talked about supply. So the last two years to give you an idea, demand I just mentioned last year was 30%, 30 to 35, let's call it that. Supply that came online in terms of lithium global mines was somewhere around the order of 30 to 40%. If we look at this year, I mentioned the growth outlooks for most reasonable market forecasters is 20%. Supply for lithium again for this year is supposed to be 30 to 40%.

So we have supply that's outpacing the demand increases. To your point, I think if you look at most sell-side banks, and when I mean sell-side bank, I mean it's the large investment banks that have equity research departments published forecast. Almost the majority of them have the market falling back into a deficit by the end of the decade. But for this year they have a surplus.

And so that's changing that lithium market and that's what's driving prices down is that you have enough supply to meet the current demand trajectory. What does that look like in the next two, three, four, five years? I think it ultimately depends on that growth curve, but I think most reasonable forecasts have the demand curve growing at 15 to 20% CAGR through the end of the decade and supply it really depends what happens now because what a lot of producers are pointing to is that they need to slow down their future CapEx projects.

So what they would've brought on 12 months ago when prices were a lot higher doesn't make any sense anymore at current spot prices. So in a few years, again, you can see that maybe rationalize, but it just really depends how quickly demand catches back up to the excess surplus. To give you an idea, the current lithium market is like 1.2, 1.3 million tons on a lithium carbonate equivalent basis, and I think most sell side banks have it at five to 15% oversupply today.

So depending on how quickly the supply comes offline and these CapEx projects are delayed, you could see that be absorbed relatively quickly should the EV demand curve continue to grow. But that's the nuances there with the supply angle on lithium.

Shayle Kann: Let's switch over to talking about solar for a minute where there are a lot of public companies, residential solar installers, utility scale, solar developers and IPPs, and then obviously on the supply side there are inverter companies and module companies and racking and tracking companies, all sorts of things. And it's a sector that if you just look at the growth of the sector globally and even within the United States, it's been huge.

We've talked about it before on this podcast market is growing super, super fast and benefited from all these IRA tailwinds in the US as well, both for installation and for manufacturing. So you would think if there was a sector that would just have been up into the right or at least tracked the S&P up into the right over the last year, it would've been solar. But I don't think that's really been the case across the solar sector either. Is that right?

Shanu Mathew: That is correct. And you hit on one of my favorite points when I feel like I am beating a dead horse when I say it, but just because there's secular momentum for a particular subsector does not mean that every company that participates in that subsector accrues a lot of value. And so when you think about our job as public market investors, a lot of times we're mapping that value chain to see where the economic value accrues. And solar is a good example of an area where you could have a diversity of results even though the broader overall sector is doing well, to your point in terms of if you look at global installation rates or capacity increases.

So when you look at the solar market, I'll bifurcate it at a high level to utility scale solar. So these larger solar projects and then residential solar. It's been a tale of two paths for those two markets in the last year or so in terms of outlooks as well. On the utility cell side, you mentioned there's different companies that are there, but you have companies like First Solar, which develop modules. You have tracking companies like Array or Nextracker, which sell tracking systems. Then you have electrical balance of system companies like Scholes.

It's been a mixed bag in terms of performance over the last year or so. So in 2023 you had a significant growth year. It was on the order of 50 to 60%, and that's from a down year in 2022. That was largely a result of different Legislative or regulatory impacts that really delayed projects in 2022 that you had to catch up in 2023. And when we look out from here, it looks like there's a mixed bag in terms of utility sale performance where you have the best performers or higher quality companies are not seeing delays, they're seeing really significant top line growth.

To give you an idea, you can look at Nextracker's recent performance or Quanta, which is an EPC company that sells into infrastructure services and engineering services to the renewable sector talking about 20% growth this next year at 20 to 30%, which means that they're seeing really strong momentum, they're seeing really strong demand curves, they're really executing on the space. When you look at some of the other companies that I mentioned, they're talking closer to a high single digit 10% type growth environment for the next few years, and this largely as a result of some of the delays going on in this utility scale sector. And that includes interconnection, permitting, transformer type issues, which I know that you've dug into in this podcast.

So really a mixed bag here in terms of utility scale solar, even though it's developing. But again, that just goes to show you that economic value doesn't always accrue just broadly across the ecosystem. When you look at the residential solar side, it's been a really challenging last 12 months and it's a really challenging near-term outlook. So from the period of 2019 to 2023, you saw really significant growth in some of these markets.

So for a three-year period of 2020 to 2023, I believe the residential market grew at something like a 30% CAGR in terms of overall gigawatts or deployed each year. And so when you look at 2024 estimates, they're all over the board given how noisy it's been. But folks are talking about potentially, I've seen estimates as high as negative 15% growth declines this year to more probably reasonably negative five to negative 10, and some people being flattish to slight growth.

So a rapid step change in the overall growth market there. And so what happened there, I'm sure some of your listeners are aware of there was that big change in net metering in California that happened, and California has 40% of the overall US residential market. So that really dramatically changed the adoption curve, if you will, in terms of new installations. The other major change that happened too was just the overall inventory levels for the supply chain.

So if you take a step back 18 plus or so months ago, you had this really rapid rise in demand for a lot of these systems with the expiry of NM 2.0 in Europe. You saw a really rapid rise in overall residential solar adoption from the Russian invasion in Ukraine really spurring up energy prices. And in that period, a lot of these residential solar companies overshipped product, Meaning that order times and lead times for these products would take sometimes six to nine months to get there.

So what do you do as a distributor or wholesaler that wants to sell these products? You start ordering more and more of those products. And then what happened now is demands normalizing as energy prices normalizes in Europe and the US, you saw these lead times shrink back down to maybe three or four weeks now. So all of a sudden you don't need to order as much product and you see what is called a de-stocking in the channel.

And so a lot of installers or wholesalers or the customers for the residential solar companies are ordering a lot less product because they already have so much inventory. And so to give you an idea, if you look at something like the recent earnings calls from a solar edge or an end phase, in the recent quarters they talked about six to 12 months of inventory that are sitting around at their customers warehouses. And so that takes a while to digest.

And to give you an idea of the scale of that impact, what that means for a year over year financial results, if you look at something like a solar edge, they went from almost approaching a billion dollars in quarterly revenue to $300 million in the most recent quarter. So dramatic decrease in year over year performance. And so what the near-term outlook looks like for a lot of those companies is when does demand inflect and are we at the bottom? And so will this inventory channel be digested pretty quickly? I think some of the companies have varying degrees, but some are saying by second quarter, some are saying by the end of the year.

And then others are really just focusing on trying to execute as much as possible cutting costs and generating cash and trying to survive until demand influx back up. It's been a really challenging market there. So, again, just a mixed bag in terms of what you see in the solar supply chain.

Shayle Kann: Just stepping back for a second, it's interesting, right? So it feels like here's... If I can encapsulate everything, we have markets that are continuing to grow basically across the board, maybe with the exception of residential solar last year, but basically every other sort of "climate tech" market is still in growth mode. EVs, renewables, like waste energy, whatever we want to talk about. At the same time, we've had a broader macro public market that has been up and yet most of the categories within climate tech are down.

However, they had run up much more than the overall market before that. So they're cooling off after a really hot period. And so maybe now we head back into level land, but the thing I wonder is I know that there is a lot of money out there that is dedicated wants exposure to this theme, whether because it's an ESG fund or sustainability or climate focused or whatever. So where is that money going now?

For all these funds that want exposure to this category, what are they buying into? What are they staying away from? Has it started to create any bifurcation within the sector?

Shanu Mathew: I think it's a great question. I think a lot of folks are asking them themselves that, but I would say I observed two major, I guess transitions in terms of how capital is allocated in these spaces to your point. And I think one is generally a flight to safety. What I mean by that is the companies that are executing, you are seeing them trade at wider premiums or higher multiples in the companies that are not seeing as much growth or execution.

So to give you examples as we just talked about, for example, trackers you saw Nextracker talk about a lot faster top line growth and better execution that trades at several multiples higher than let's say in array, which is talking about some project delays. You see the same thing in EPCs, which are engineering, procurement and construction firms where I talked about Quanta seeing significant top line growth and trading much more at a premium valuation than its competitors, such as like Amos Tech or something like that.

So what you're seeing is the companies that do really well in the current market starting to get a lot more investors pile into them because they're saying, "Hey, at least these companies are performing in an otherwise tough market." The other main angle, which I probably see more of to be honest, is folks starting to open up their aperture to look at these climate adjacent businesses.

So again, the HVAC companies that are selling HVAC systems that have broad trends to energy efficiency, decarbonization the electrical components, businesses that sell different wiring or cables or systems into the auto markets or industrial end markets. And so you're seeing companies like something called Eaton, Hubbell, and Vent type of companies see a lot more capital shift towards them or the HVAC companies like a Trane Technologies. And that's because folks are saying that, "Hey, can I own an incumbent business with a legacy cashflow stream that has underappreciated tailwinds associated with decarbonization or climate change?"

And then can I play that which is probably a little bit more stable, less cyclical and probably has less of these gyrations and the pure plays. I think you're seeing a lot of folks opt in yes on that. Another angle in the area of the public markets is this is not a pure play climate tech theme. If you consider it normally like water companies for example, have also seen a lot of investor interest just alongside the general themes of what I would call climate adjacent.

So I think it's basically a flight to safety of the folks that are executing, you're willing to pay a lot more for them than the businesses that aren't. And then in terms of opening up that aperture to look at climate adjacent businesses that are more incumbent type businesses that you wouldn't traditionally think of a climate tech but have exposure to that theme.

Shayle Kann: All right. So let's look forward for a moment. I'm curious if you look out across all the sell side analysts, what do they think is going to happen to the climate tech sector in the public markets over the coming quarters or the coming year? Is the outlook still fairly bearish because of what we've been seeing and the continuation of the trend over the past year? Or is there an expectation that things start to turn around?

Shanu Mathew: Yeah, Shayle, I think that's a great question. I would give you an actual barometer of what they're thinking of, which I would define as the estimate revisions that's happened in the last month or so. So a lot of companies reported earnings, and then you have these Wall Street analysts that project their future earnings and you can track what that does over the last four weeks, last six months, et cetera. And what you've actually seen is that estimates are coming down for forward performance, meaning that the analysts, basically the read through is that they expect the conditions to remain challenging for most of these businesses or at least are still normalizing estimates for maybe prior periods where they were a lot more bullish or optimistic on these stocks.

How should we take that in context? So I think Wall Street has a tendency to focus on the next quarter or the next few quarters relative to the next few years. And I think you really hit an important point earlier in the conversation where a lot of these sectors are still multi-year growers or even multi-decade growers in some cases. So I think what investors are asking themselves are, can I get to an understanding of what a normalized profile looks like for this business and what am I willing to underwrite?

And so what I would anticipate, and again, this is kind of a personal observation, but I think you'll probably see a more rational view towards valuation. So in the period of 2020, 2023, you saw valuations for the indices that I mentioned, 2X in some cases. You'll see a more normal premium or discount to the market in current environments, but you might see folks take selective bets on certain subsectors.

So you might have folks, I think utility scale is a lot more resilient than others. You might have folks that are really betting on that inflection point in residential solar or you have folks getting constructive on something like lithium that's been bouncing along the bottom for a while, understanding that the near term might be more challenged, but the next two, three, four years, or again if I think about 2030, I know we're reading a deficit again and I'm willing to take that bet.

So I think you're seeing folks look at the multi-year growth tailwinds for these sectors and understanding, "Hey, are we at the bottom or can I capture this inflection point and get ahead of the market on these trends?" And so that's what I expect a lot of folks are doing right now, but it definitely does not change that the near term environment looks a little bit stark, at least for the next three to six months.

Shayle Kann: All right, Shanu, a lot is going on in public markets always and the wild ride I'm sure will continue. So we'll keep everybody posted on it, but appreciate your time today.

Shanu Mathew: Thanks, Shayle.

Shayle Kann: Shanu Mathew is a portfolio manager and a research analyst at Lazard. This show is a production of Latitude Media. You can head over to latitudemedia.com for links to today's topics. Latitude is supported by Prelude Ventures. Prelude backs visionaries, accelerating climate innovation that will reshape global economy for the betterment of people and planet. Learn more at preludeventures.com. This episode was produced by Daniel Waldorf, mixing by Roy Campanella and Sean Marquand. Theme song by Sean Marquand. I'm Shayle Kann and this is Catalyst.

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