Friday Green Pitch w/ Alex Gates of Clayton Partners

Alex highlights the secular tailwinds for clean energy, his favorite screen for new ideas, and 2 stock pitches

Welcome to Friday Green Pitch, your weekly interview series with investors and fund managers seeking alpha in companies contributing to a cleaner and greener world. If you enjoy these Green Pitch interviews, please follow me on Twitter @bkaellner to continue the conversation. To kick off the series please enjoy my conversation with Alex Gates!

Alex is the director of research at Clayton Partners in Berkeley, California, where he’s on the hunt for compelling investment opportunities in sustainable businesses that have a positive impact on climate change. I first discovered Alex through MOI Global where he has presented three times, most recently on sustainable electronics manufacturer Flex Ltd.

Alex, thanks for taking a chance on my first ever Friday Green Pitch interview!

What attracts you to fishing in the sustainability pond as a public equity investor?

Our clients were increasingly interested in sustainability, and we saw a large opportunity in the theme. So about 4 years ago we began making investments in green companies and last year we started our focused sustainability strategy within Clayton Partners. We’ve had some successful investments in the clean energy space which has given us the confidence to allocate more and more capital there. 

From a top-down perspective it was really about BlackRock, Google, Amazon and other very large corporations saying “Hey, our consumers want us to be more green. We are going to push down this path to having net-zero emissions.” And then on the other side governments coming out and saying “Yeah we agree, and we’re going to incentivize all of that.”

So it’s this massive coming together of business and government interests, and if you read the reports, about $70 trillion of investment is needed to get to a net-zero economy by 2050. You’ve got this massive horizon for investment. Some people talk about it analogous to tech investing 20 years ago where it’s going to be this revolutionary theme. We’ve gotten much more comfortable with the tailwinds.

How do you find management teams that have both the skills and incentives to compound value for shareholders over many years?

People drive companies. They create the plans and execute on them. You need to find teams that have the right incentives, which you can look up via their comp plans. But equally important is the track record. If a new CEO is coming in, what have they done in the past? If you’ve built rapport with a management team over the years, it can give you more comfort when they give guidance or talk about internal investment opportunities. You can believe them because the trust has been built over time.

One of our biggest positions is a company called FLEX, which three years ago went through a management team change where the whole C-suite turned over. They brought in a CFO, Paul Lundstrom, from a company we had invested in previously called Aerojet Rocketdyne. We’d had numerous conversations with Paul and gotten really comfortable with all the margin improvement and profitability steps he had taken at that company, and it was a really successful investment for us. So when he left to go to FLEX it was on the radar immediately. 

Right before Paul joined they hired a new CEO who had run the largest electrical unit within Eaton for 10 years, and left to come to FLEX. It was unusual to see someone come from the Eaton world into the FLEX world. This CEO came from a structure where the margins were much higher and she’s talking about getting FLEX to those much more attractive margins. You can point back to her past experience and see that she’d done it before, running this $13bn unit within Eaton very successfully.

Are there other investment managers you follow to generate new investment ideas? What’s your favorite source for new ideas?

We certainly talk to other managers and build relationships with other analysts and teams out there that think like us as value investors. That’s helpful especially as we’ve gotten comfortable with their work over the years. 

Even more valuable for sourcing new ideas is that we follow a lot of management teams around. We pay very close attention to our management change screens. For example, say we’ve been following XYZ company for 7 years and really like the business model but never quite got comfortable with the management team. They always seem to have a good game plan but can’t execute. As soon as we see the press release “XYZ CEO has left and they’ve hired this new CEO with a great track record”… that idea moves to the top of the list. 

The second way we source ideas is insider purchases and compensation. The new CEO who comes in and isn’t just given a stock package, but has a warrant package where he actually has to buy some stock. In many of our investments we’ve seen new teams come in and the new CEO will just buy $200,000 or $1m worth of stock out of their own pocket. Those are the kinds of opportunities that really catch our attention and get moved to the top of the list!

What are a couple ideas on your radar now?

The AES Corporation (AES) is a big position for us and we like their prospects. Their game plan is to transition away from coal generation and focus entirely on renewables. We think they’re at the tail end of that transition, but the stock is still only trading at 13x earnings. Average utilities trade around 20x earnings, and if you look at their backlog of renewable projects it’s on par with some of the largest in the world. Given that NextEra Energy is trading at 25-30x with comparable backlogs in terms of renewables, AES could easily trade at 20-30x earnings.

We also like their ownership of battery storage operator Fluence. The stock hasn’t done well due to some execution issues, but we like the long-term prospects a lot. Fluence is a decent driver of earnings growth in the outer years, say 2024 and 2025. It’s really differentiated. AES also has 10-year partnerships with Google and Microsoft to help them reach their goals of 24/7 clean energy. So it’s incredibly differentiated from the average utility. Dealing with customers like Google provides a much better growth and pricing umbrella as opposed to filing a rate base as an average utility.

The other one which I recently pitched at MOI is FLEX. That one is incredibly undervalued. I don’t think the market has figured out how much the new management team has turned that business around. Two-thirds of their earnings come from high-reliability segments, which are much higher margin and where they want to take the business over time. So that’s really the driver, and on top of that they’re very focused on sustainability. They have this amazing EV platform, one of the best in the auto business, so that’s growing over time. 

Then they have NextTracker. In my MOI presentation I was thinking the company would go public at a $3bn valuation. What actually happened is they got a private mark from TPG at $3bn, which given the public market for renewables right now I think I like this situation better. You get this great underwritten offer from TPG and $500m in the door which they can use for growth and stock buybacks. That values FLEX’s share of NextTracker at over $5/share. 

The stock is at $15 right now so if you take out the value of NextTracker, FLEX is trading at 5-6x earnings. It’s incredibly cheap, and they’ll have an investor day coming up soon where they will provide more clarity on what they’re aiming to do. I think what they’ve done with the margins is really impressive, and I don’t think it should trade at 6x earnings. I think it deserves to trade at 15x earnings. Let’s say they’re able to earn $2/share going forward which doesn’t even include NextTracker’s contribution, then you have a $30 stock plus $5 for NextTracker. There’s your double. I think it’s one of our better ideas right now.

What advice would you give to an investor who wants to integrate their personal values into the investment portfolio?

If you’re a person who’s really concerned about the climate, in most cases your investment advisor will put you in a “green” ETF. It will probably be a cleantech ETF or ESG ETF. Both of those are fraught with a lot of different issues. On the ESG side if you’re just using carbon footprints, really you’re just buying the S&P 500 but weighted more toward Amazon and these other huge tech companies. And on the cleantech side, it’s better than it used to be but these ETFs contain a lot of unprofitable companies that have riskier business plans. 

If you’re an investor who’s really concerned about enacting change with your investment dollars it’s tough, because you’re being asked in these ETFs to make riskier bets on the one hand or on the other hand to invest in companies that aren’t contributing to real change. That’s a big reason we started this strategy.

If I were to give advice to someone looking to find investments that resonated from an environmental standpoint, I would steer them away from big tech and away from the unicorn start up companies. Focus on the more mature companies that are actually making money now to reduce risk in the investment portfolio while still making an impact. And hopefully if you’re embracing these kinds of companies, over time that’s only going to push their ability to become greener faster. 

Thanks so much for your time Alex. If folks want to connect, where can they find you?

I’m most active on LinkedIn, so feel free to connect with me there! https://www.linkedin.com/in/alex-gates-cfa-a32b3824/

Brad’s Takeaways

Independent power producers with low multiples that are transitioning aggressively to renewables may offer compelling opportunities given the 30-year tailwind of decarbonization. It also helps to have free call options like Fluence and NextTracker! While incentives are important for evaluating a management team, track record is even more important. If you really like a business model but the management team isn’t executing, keep an eye on management changes. If the new team has a history of getting the job done it could be a winner. Especially if the new CEO buys stock out of their own pocket!

Thanks for tuning in this week folks! If you know any investors/managers in the sustainability space that I should interview, please send me a message :)

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