PANIC JOURNAL – UKRAINE/RUSSIA EDITION PART 4: The new “Freedom Insulation” Basket

Disclaimer: This is not investment advice. Never trust any anonymous dude on the internet. PLEASE DO YOUR OWN RESEARCH !!! 

Panic Update:

As to be expected, my last “panic post” marked more or less the (short term) peak in Natural Gas and Electricity prices in Europe. Since then, prices have gone down more than -50% from the peak. Nevertheless, prices are far from normal and sustainable. Governments have already proposed action in the form of intercepting the markets.

In the recent days, I have seen more and more “models” that seem to tell us that Germany/Europe is fine for this Winter and after that everything will be smooth sailing (LNG terminals, French deliveries etc.), despite the Russian completely halting NS1 deliveries last week and not reinstating them based on phony reasons.

I actually started to build a model myself but then decided to focus on the big picture instead. As I argued on Twitter, the one big variable that will determine how Europe is doing will be the temperature.

However, independent how this winter will be, Natural Gas will be a scarce resource in Europe for some years to come. Even in the (low probability) case that there will be a quick end of the Ukraine conflict, Europe will not and cannot go back into the Russian dependency. On the other hand, switching to LNG at acceptable prices will take a few years until enough liquification, gasification and transportation capacity is available.

This recent article in the FT quotes the boss of Shell:

“It may well be that we have a number of winters where we have to somehow find solutions through efficiency savings, through rationing and a very, very quick buildout of alternatives,” he said. “That this is going to be somehow easy, or over, I think is a fantasy that we should put aside.”

Another German language article quotes several Oil and Gas executives that it takes at least 3-4 years until Russian Gas can be fully replaced.

So my base case for the coming 3-5 years will be:  There is not enough Natural Gas (ex Russia) available in Europe and Gas and electricity will remain very expensive in Europe.

The only real option: Decrease Demand

High prices decrease demand automatically unless the Governments are start manipulating prices which they are now starting to do. This will dampen the demand reduction.

Another course of action are Government-mandated savings law like closing Public swimming pools, turning off lights etc. but this is not a long term solution as people will get more and more aggressive.

Saving energy and especially natural gas in the mid to  longer term only works through substitution or better Energy efficiency.

Substitution: Heat pumps, wood, oil, LNG

Heat pumps are one way, but in the short term, significantly higher electricity use will increase the gas price and heat pumps can not easily be retrofitted into older buildings. Wood has become very expensive as well and is in many cases (apartments) no option anyway. Oil is a limited option and will not be able to replace Gas to a certain extent. The planned floating LNG terminals will only able to replace a small amount of the Natural Gas deficiency. LNG will be a mid- to long term replacement, but LNG is much more expensive than the good old Russian Pipeline gas.

Energy efficiency: Insulation

The simplest solution for saving energy without sacrificing personal wellness or negative cultural aspects is ….better insulation. The EU commission has already introduced guidelines forcing more insulation until the year 2030. As outlined in this German article, real estate owners have not been too happy and there is a lack of craftsman anyway.

Now things might change quickly. For homeowners, the break even of investing into insulation has changed dramatically and for instance in the UK, the Government at least seems to contemplate more support for better insulation. Even as the German Government is currently focusing on direct money transfers and killing free markets, in my opinion the “investment case” for insulation and energy efficiency has profoundly changed.

The new “Freedom Insulation” Basket

Health warning: I selected these stocks based on a “tactical macro idea” with only relatively shallow research per company.

Following Mr. Lindner’s (German Finance Minister) famous “Freedom Energy” speech, I hereby reveal my new “Freedom Insulation” Basket. My main criteria for the inclusion were: Strong European footprint, solid performance and significant exposure to insulation and/or energy efficiency.

Here is the “Starting 6 line up” with a total weight of ~4,5% of the portfolio at inception:

  1. Sto SE Pref shares (1,0%)
  2. Rockwool (1,0%)
  3. Kingspan (1,0%)
  4. Steico (0,5%)
  5. Va-q-tec  (0,5%)
  6. Belimo (0,5%)

The strategic goal is to gain exposure in a first step and then to refine over time and concentrate on the best players over time. I have funded the basket mostly by the sale of most German renewable positions (with the exception of Abo Wind) and a decrease in Nabaltec last week.

1. Sto Pref shares (1,0%)

Sto is a German headquartered insulation company with mostly “plastic foam” based products. The company has a market cap of 1 bn EUR, has net cash and is valued at 12,7x P/E and 7x EV/EBIT for 2022. Gross margins are at around 53-56%, EBIT margins in the high single digits and returns on capital in the “high teens”. According to the investor presentation, 90% of sales are in Europe, thereof 40% in Germany. Most of Sto’s products are put on the outside of buildings. 6M 2022 margins have been under pressure, as so far, Sto could not fully pass on input costs to customers. To my understanding, Sto’s business is less dependent on new buildings.

2. Rockwool (1,0%)

Rockwool is a Danish company that produces as the name says mostly insulation products based on Rock wool. The big advantage of rock wool is that it doesn’t burn. Rockwool has a market cap  pf ~4,3 bn EUR and trades at 14,3x P/E and 10,7x EV/EBIT. Ebit margins are historically between 10-14%, returns on capital at around 15-17%. The company has net cash and 80% of their sales are in Europe. The stock has lost more than -50% since its peak.

3. Kingspan (1,0%)

Kingspan is an Ireland based Insulation company that manufactures mostly plastic based insulation material. With a market cap of 10,7 bn EUR it is larger than Rockwool and Sto combined, and with a 2022 P/E of 16,8 and EB/EBIT of 14,7 also more expensive. Returns on capital are between 15-17%, EBIT margins quite constant at 10-11%. Kingspan clearly has the best growth record of  the big players. 80% of the sales are in Europe. The biggest issue is in my opinion that 70% of the products are used for new builts.  Nevertheless, Kingspan seems to be a high quality company that should be in this basket.

4. Steico (0,5%)

Steico is the second German company. Steico concentrates on sustainable, wood based insulation solutions. With a market cap of 1 bn EUR, Steico trades at 21x P/E and 17x EV/EBIT. Returns on capital have been historically been at around 6-8% with the exception of 2021, EBIT margins in the range of 8-10%. However Steico managed to grow strongly, doubling sales in the 5 years from 2016-2021. Despite the recent pull back, the stock was a 10x over the last 6 years or so. 6M 2022 look pretty Ok. I weighted the stock lower as besides the higher valuation, Steico products seem to be mostly used for higher end single family new builts and might not benefit as much from a renovation push as the other players.

5. Va-q-tec (0,5%)

Va-q-tec is a relatively young 155 mn EUR market cap company that has developed a technology to produce isolation panels that use vacuum in order to insulate against cold or heat. The company got famous because they produced containers that could keep Covid vaccines cool for 5-10 days without external refrigeration. This boosted the stock price, however now, the stock price is back at pre Covid levels. The company has grown 3x overt he last 5 years, results are  currently at around break even. The panels are quite expensive but can be used for a lot of other energy efficiency use cases. The stock is clearly more speculative then the classic insulation companies, but I do think that there is potential.

6. Belimo (0,5%)

With Belimo, I am cheating a little bit, because this is not an insulation company. However Belimo focuses on control valves, sensors and meters to control heating and cooling systems in order to save energy. With returns on capital of 30% and EBIT margins in the “high teens”, Belimo plays in another league, however at 36x P/E and 28x EV/EBIT, this is clearly already reflected in the valuation and results in a valuation of 4,6 bn EUR. I still like the company a lot and have it included with a small weight.

Summary:

I do think that the insulation and energy efficiency industry could represent an interesting opportunity to benefit indirectly from rising energy prices. Better insulation and energy efficiency in my opinion is the only way to mitigate the dependency on Russian oil and gas and also to decouple the economy better from energy prices and this should give a nice tailwind to this companies for the next few years. In addition it is also beneficial for the future of our planet.

The timing might not be optimal, as new built activity might slow down in the near future,but I am quite optimistic on the outlook for these companies. In addition, many of these stocks are down between -30% to -50% compared to their highs, so some slow down might be priced in.

As my other basket, this is a more “tactical” position, so the time horizon for this is ~1-3 years compared to my usual 3-5 years (or more) for “core” investments.

Disclaimer: This is not investment advice. Never trust any anonymous dude on the internet. PLEASE DO YOUR OWN RESEARCH !!! 

26 comments

  • Look up Française de l’Énergie (EPA: FDE). Six years of French gas consumption underground and cheap.

  • Well, you can also cool with a conventional heat pump.

    It is much more efficient than electric convectors as it uses heat from outside air.
    This thing (https://www.klimaprofis.com/heizen/waermepumpen/luft-luft-waermepumpen/panasonic-nordic-cs-vz9ske-r32-inverter-plus-klimageraete-set-3-kw) can on year average convert 1 KW of electricity into 6.2 KW of heat.

    You also save because you only need to turn them on for the rooms you are actually using.

    In summer we will have a lot of electricity anyways, because PV is producing a lot. But it’s true that there could be better uses of that energy.

    The electric heaters are bad, but heat pumps are a completely different story. Yes , there could be problems with the grid locally in moments when it gets very cold. In those moments people could also use their old gas heater. The systems actually complement each other as heat pumps are more efficient with warmer outside temperatures.

    • Sry this was the answer to cig.

      Additional remark: yes, memyselfandi is right. Installations by German laws is more complicated than it should be

  • My favorite hedge for the energy armageddon scenario has been Petrobras, a cheap, dysfunctional company with a massive dividend!

  • In general I agree, higher energy prices should result in more insulation (better alternative).

    Could it be, that policies (ie, a cap on households’ energy bills, like in UK) would result in the contrary effect? I think it is unlikely in aggregate, but possible for a few sun-groups?…

    • I think the measures are all short term and might even increase the mid-term problem. I do not belive that we only will need to survive one winter. It might need some time, but overall I believe in the need to really save energy

  • I agree there’s a lot to be done with energy efficiency in Europe. In addition to insulation, windows manufacturers might go with the theme, since three-ply windows have much better insulation. They are already common in the Nordics. Personally after receiving the first winter’s heating bill in the Netherlands I kept the temperature lower – never had that concern in Finland where it’s much colder but everything is just so much better insulated.

    It seems that Germany is most sensitive to availability of gas, and this doesn’t seem to be priced in yet in industries that use a lot of energy. For example Finland bought practically all its natural gas from Russia, but it use was less than 5% of all energy use.

  • Recticel now joined the Basket with a 0,5% weighting. It is a really interesting situation, not that much visibility right now. I will look at this in more detail.

  • If the energy crisis will continue, people will have ohter priorities for their money. Becaus eI don´t believe that this crisis will not bring a lot of companies closing doors, unemployment and all those nasty things.

    I just hope that the leaders in Europe, start thinking about their people/voters, and go to Russia bargain a deal. It doens´t mean they have to stop help Ukraine. It just mean that their people are more important.

    Cheers!

    • I am pretty sure that European leaders will not go to Russia to plea for a bargain deal.

      • In a sense I agree, if I look at thid right now. But the unrest/pretests and the inflation will be a real test for those leadershipa around Europe. ( being myself in Europe I´m a bit angry about this).

        Uncertain times ahead. Let´s hope everybody can do their best.

        Thanks.

  • Why did you sell the renewable energy positions, just to fund this basket or because there were a fundamental or macro change to the companies, that make this investment more atractive than ren. energy?

  • Thanks for the post. What do you think the impact on Germany’s or Europe’s industry will be given the mentioned scarcity of Gas? Don’t our heavier industries need (cheap) Gas to continue working and producing? Maybe this is actually the bigger issue vs home and public spaces heating? What do you think? Thx.

    • Some industrial use can be substituted (where it’s merely a heat source not too entangled in the equipment) directly, for those that really need gas it need not be “natural” gas, it is just methane that can be synthesized from coal or hydrogen, it’s just expensive but there is a price at which it becomes economic. That and new import routes there are quite a few options, but it does take time to build and setup all the kit.

      Other source of substitution is delocalising the energy intensive part of the process and importing the intermediary product for the next step, e.g. build aluminium or amonia plant in qatar.

      Also some savings will come from shutting down old inefficient plants that were borderline profitable on cheap gas but now will be decommissioned for good.

  • In my opinion the investment rationale described above does not take into consideration (enough) the following three main risk factors: (i) rising (or rather already high) input prices and commodity prices, repectively for the production of insulation products, (ii) declining construction / real estate investing activity (new building and renovation of existing buildings) in Germany due to rising interest rates and/or rent regulation (Mietenspiegel, Mietendeckel, Mietpreisbremse, reduzierte Mod.Umlage nach §559 BGB), (iii) significant lack of (qualified) craftsmen in Germany. All three factors could negatively impact the performance of the aformentioned companies and make me believe that the suggested “insulation play” is not the best way to take advantage of the current situation on the energy market.

    • I agree to all three points. The big question is to what extent this is priced in or not.

      And of course it might not be the best way to play the energy market in the short term. You might get more “juice” by speculating in UK fracking or Uranium.

      However I do think it could be an interesting enough risk/return profile at least based on my expectations and investment universe.

    • Insulation manufacturing is quite energy intensive (most processes including wood wool like Steico’s involve “cooking” the material at some point) as well as using oil as input material for the “plastic foam” types, so I fear it may be counter-productive if you get net savings in 5 years and need more gas/etc than it would take just heating the old buildings in the first few years during an emergency situation, unless the insulation materials are imported, but it’s quite bulky stuff and shortages in shipping capacity may last some while.

      Not so bad for the like of Steico (wood wool) or Sto (diversified and also a distributor). Kingpsan may not be in a so favourable position though maybe they can pivot insulation types (also they had some nasty cover up in “dieselgate” style after the UK tower block fire incident),

  • Very interesting article, and I fully agree with your arguments. Inevitably, the whole energy crisis will drive people to invest in a well-insulated home. Most likely fueled by government subsidies.

    Recticel is a very well positioned insulation player and listed in Belgium. The company has gone through a remarkable transformation last year with an unsolicited take-over attempt acting as the inflection point. The company used to be an industrial holding with activities in bedding, automotive interiors, flexible foams for sofas, etc.. Because of the hostile take-out offer from Greiner, the company started to sell these divisions, keeping only the PU insulation business.

    The PU insulation business has above average EBITDA margins (10-15%), grows at double digits and has quite a bit of pricing power. It’s also an exothermic production process, so they are not exposed to the gas price (other than through raw materials). In addition, the company has net cash of >€200m and hence ample firepower to fund new acquisitions.

    The company is in the final stages of a complete strategic makeover, and I believe the shares are poised to rerate towards Kingspan multiples (currently trading at a 30% discount of those) once investors have a cleaner and more simple company to look at.

  • At least in Germany it is not so easy to retrofit appartments with air conditioning. Yuu need a lot of approvals.

  • For old buildings it might make sense to use air conditioning for heating purposes. Not sure the mass will adapt to this. But they are relatively easy to build in, can heat your building very efficiently as they are nothing other than air-air-heat pumps and you will save tons of money with those gas prices.
    The disadvantage is that they give a stream of hot air which is not as comfortable as your old gas heater.
    So far, there is not much of a marketing effort to sell them primarily as heating devices. I am not sure why that is.
    On the other hand, they also go along well with insulation as insulation further increases their efficiency.

    • Is it competitive with just putting electric convectors or infrared panels? Also it may tempt users to switch on the cooling mode in summer, which reverses some of the energy savings compared to the previous “heat only” system (and competes with refilling gas storage in summer).

      The problem all the electrical heating systems have is that the grid needs upgrading, I expect some building/street/district will get occasional power cuts this winter as the (aggregate) circuits reach capacity when everybody switches on these 2kw electric heaters they bought from the DIY store when they come home from work. As everything it’s fixable in due course but may be a bumpy ride.

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