Looking for investments to tap into the electrification trend, TB Amati Strategic Innovation Fund manager Graeme Bencke says he and colleagues like to invest in what they call 'enablers'.
These companies are supporters of the innovation leaders, known as 'pioneers', and "tend to have lower binary outcome risk than the pioneers but benefit from the same underlying trends".
To locate suitable companies to add to the portfolio, Bencke and the team first identify the evidence that backs up an investment theme, then they look across the value chain of the companies involved to then dig deeper and find respective advantages and challenges, and finally the companies that are worth investing in.
For the electrification trend, the manager said a "huge step up" in spending is coming in electrical infrastructure, motivated by the pressures of climate change and geopolitics, which is pushing governments, companies and households to "fundamentally reconsider their access to and consumption of energy".
He pointed to an extremely detailed recent study by Princeton University that, even in a least-impactful scenario predicted the US alone will need to spend an additional US$210bn by 2030 and around US$1trn by 2050, with spending most likely needing to double from that level in order achieve net zero targets.
The electrification trend will not only require investment in the likes of electric vehicles, renewable energy and new home heating technology such as heat pumps, but also for entire electricity networks to be upgraded, with renewable energy most often located far from where it is consumed.
Having identified the evidence, Bencke and co then looked across the power generators and grid operators, machinery and component manufacturers, construction contractors, smart grid technology providers and independent facility managers to identify the 'Innovation Cluster' of potential investments.
"By reviewing these different factors and speaking with experts from across our network we home in on those with the most attractive reward for the risk," Bencke said in a recent note.
"Here we are looking for structurally advantaged businesses with limited competition and a long potential runway for growth. Companies which meet these characteristics typically demonstrate high operating margins, have low financial leverage, and generate solid returns on capital through the cycle."
In energy transition, cable manufacturers stand out for Bencke "as they operate in a highly consolidated segment and their growth is skewed in the near term towards their higher margin, subsea revenues.
"The relatively high capital intensity and long lead times associated with new manufacturing capacity mean that barriers to entry are high."
Two pure-play market leaders are Italy's Prysmian and France's Nexans, which he said both offer "material upside with attractive risk profiles", with the latter gaining the edge in his view as a material increase in production capacity is about to come on stream in the US.
Among the specialist equipment providers, there has been significant consolidation, with the Amati team identifying US-listed Hubbell Inc as a clear beneficiary of network expansion and hardening.
All three of these businesses are 'enablers', in the Amati terminology.