Hermes investment manager calls out Dong Energy (CPH:DENERG) as a challenger of what constitutes ESG stock
“There is a perception amongst some investors that to invest in a company with strong environmental credentials you need to compromise; that you’ll be confined to the small cap investment universe, excluded from multi-national businesses that generally offer stability and consistency of dividends,” says Geir Lode, Head of Global Equities at Hermes Investment Management. It is one of the largest institutional asset managers in the U.K., with £24.1 billion ($32 billion) of assets under management and £169.8 billion ($225.1 billion) in assets under advice.
But, in talking about Dong Energy A/S (CPH:DENERG) the Danish utility company that floated last month and is part-owned by both the Danish Government and Goldman Sachs (NYSE:GS), he described it as a “large-cap name challenging investors’ preconceptions of what makes an ESG stock.”
Dong Energy is refocusing its business over the next decade away from traditional fossil fuels to renewable energy, and is already the world’s largest offshore wind developer. Its market capitalization of over $15 billion “allows large investors to take a meaningful participation in the transition to a low carbon economy,” said Mr. Lode, in an investment note.
Originally a traditional oil and gas company founded in 2006, Dong Energy merged with five smaller Danish power utilities. Today, the most carbon-intensive fossils fuels are seen as a non-core business segment with legacy assets being managed to maximize cash returns.
“The main focus of the company is the fast-growing offshore wind farm business which includes the world’s biggest offshore wind farm that Dong is building off the coast of North-East England,” he said.
Last week Dong Energy also won a bid to build two offshore wind farms off the Dutch coast that industry experts claim will be the cheapest schemes of their kind, reported the Financial Times. Samuel Leupold, head of wind power at Dong, was quoted as saying, “We are reaching a critical industry milestone more than three years ahead of time. This demonstrates the great potential of offshore wind.”
“Dong has a slightly different approach to its competitors in that it typically sells 50 percent of the interest in a wind farm prior to completion to crystallize the value of the project. This strategy is proving successful as it reduces the risk for equity investors whilst simultaneously increasing the visibility of the project to infrastructure investors looking for stable yields,” said Mr. Lode in his note.
Having already doubled installed offshore wind capacity from 2012 to 2016 Dong Energy aims to double capacity again by 2020, he said. The company is committed to reducing carbon emissions by converting existing coal and gas power plants to use sustainable biomass. By 2020, the company’s target is that at least 60 percent of the power and heat produced at their power stations should be from sustainable biomass. The contribution from coal, oil and gas is expected to shrink significantly.
“In Hermes Global Equities we rank potential and current investments by assessing the company’s financial attractiveness and ESG risk factors. For Dong Energy, we expect the future return on capital to be higher than that of the legacy business. The company’s financial visibility is very clear through to 2020 and we see a 15 to 20 percent upside in the share price. The company has indicated that they expect to pay a dividend this year and given the high visibility of earnings we anticipate steady dividend growth thereafter. The company is also committed to maintaining their credit rating,” he said.
“Investors may be surprised to consider Dong as a viable ESG name given its historical use of coal in energy production. However, we see ESG as not just investing in the green companies of today, but also those of tomorrow,” said Mr. Lode.
“Dong Energyis investing heavily in biomass and wind production and the carbon intensity of its production is expected to decline from 638g CO2/KWh to 260g CO2/KWh by 2020. Excluding companies with hydro exposure, Dong has the highest percentage of renewables in the energy mix of any European integrated utility company,” he added.
In keeping with the Hermes focus, he also looked at the company’s corporate governance, describing it as “strong with excellent compensation transparency, a separate CEO and chairman, high board independence, and almost 40 percent female representation on the board.”
But Mr. Lode cautioned, “There will also be risks outside of the company’s control, for example renewable energy has long relied upon government subsidies and a favorable regulatory environment.”
“The Paris COP21 agreement last year suggests that the world is committed to the green economy,” he said, “but in the face of a global slowdown or a Brexit-induced recession this resolve may be tested.”
Dina Medland is an independent writer, editor and commentator with a strong focus on issues around corporate governance, ethics, the workings of the boardroom and sustainable business. She is on the team of contributors to @ForbesEurope and is an ex-Financial Times staff member who has been a regular contributor in recent years. Further details about her background and a portfolio of work – including her commercially sponsored blog ‘Board Talk’ are available on her website http://www.dinamedland.com