According to the US Department of Energy (2022), more than 70% of transmission and power transformers in the US energy infrastructure are over 25 years old. Increasing demand will require an estimated 60% expansion in US transmission systems by 2030 and a three-fold increase in existing capacity by 2050.
The need to expand the power distribution grid is driven by economic growth, population growth, the switch to renewable energy and the electrification of things and will see installed electricity almost double on the base case out to 2050, according to the US Energy Information Administration (EIA). The outcomes may vary depending on zero carbon technology costs, economic growth, and the oil price.
Supporting grid development is a range of policy initiatives and stimulus largely linked to the pandemic stimulus packages and driven by the shift towards decarbonisation.
The Infrastructure Investment and Jobs Act (2021) is providing US$1.2 trillion in stimulus, including US$550 billion of new federal investment in America’s infrastructure, economic resilience, internet, and other initiatives.
The Inflation Reduction Act (2022) has added US$500 billion in stimulus through spending and tax credits. The CHIPS and Science Act (2022) – CHIPS (Creating Helpful Incentives to Produce Semiconductors) – has added US$280 billion in funding for American semiconductor research, development, manufacturing and workforce development, some of which will factor in the upgrade and renewal of US electricity grids. Other funding will come from utilities, the users and operators of these grids, and the customers who ultimately pay for energy and transmission.
Small cap opportunities
While the electricity grid might seem the domain of mega-cap utility stocks, due to the complexity of the nature of this infrastructure and its underlying components, we believe that companies that contribute to the servicing, upgrade and expansion of the electricity infrastructure will also have significant roles in the infrastructure upgrade.
We believe that certain small-cap companies, due to the relevancy and competitiveness of their operations, will benefit from the potential sizeable investment in the upcoming upgrade.
Three such small caps that we think are set to benefit from potential growth in demand for their products and services from the infrastructure upgrade are:
- Atkore (NYSE: ATKR), which manufactures electrical cable and cable infrastructure.
- EMCOR Group (NYSE: EME), involved in electrical and energy infrastructure construction.
- NKT (OMX: NKT), a manufacturer of cables and cable accessories for energy infrastructure.
There is significant potential for some specialist small-cap stocks which the market may have under-appreciated. Atkore, for example, is a leading provider of electrical infrastructure, including cables, piping conduits and electrical raceways used in a whole array of construction (data centres, grid upgrades, manufacturing facilities, and office, industrial and residential new builds, and renovations). Atkore’s conduit products serve a crucial role in facilitating the underground placement of power lines, commonly known as grid hardening. By moving power lines underground, this enables the electricity grid to better withstand the effects of extreme weather events and other natural disasters, such as wildfires.
We believe core earnings are supported by the strategy’s expectation that non-residential capital expenditure will continue to increase in the US, driven by several themes, including: the onshoring of supply chains back to the US; grid upgrades; ongoing non-residential manufacturing investment; and government support.
The strategy is also seeing catalysts supporting demand for Atkore’s conduit products from some of the largest direct US federal grid investments in history. This includes the Grid Resilience and Innovation Partnerships (GRIP) Program initial $3.46bn investment (of a total $10.5bn) for 58 projects across 44 states to strengthen electricity grid resilience and reliability across the United States. We believe Atkore’s national network of manufacturing plants are positioned to capture national grid hardening and resiliency investments with the potential to drive positive earnings revisions for these segments.
Another notable US company that we think is positioned to benefit from the boom in grid investment is EMCOR. EMCOR is at the heart of the grid expansion as a constructor of critical electrical infrastructure, including semiconductor plants, biotechnology environments, and energy infrastructure. EMCOR’s electrical construction and facilities segment covers planning, installing, operating, maintaining, and protecting complex operating plants, including those required to support and maintain complex electrical energy grids.
Large scale grid related projects which tend to be long-term endeavours are expected to provide a stable and growing revenue stream while also improving margin profile for EMCOR as they optimise their operations to cater for increased demand.
Based out of Denmark and listed on Nasdaq Copenhagen, another company set to benefit is NKT which manufactures and installs low, medium and high voltage cable for the electrical grid. Founded in the 19th century, NKT is a leader in electrical transmission and distribution across 16 countries.
The pipeline of renewable energy installations has surged on rising net zero commitments and investment, driving the need to expand and upgrade transmission networks. This includes renewable energy from remote resource-rich areas to population or industrial centres. Integral to transporting power over long distances are high voltage direct current (HVDC) transmission systems due to their efficiency qualities compared to other systems.
Outlook
The most exciting aspect of the grid upgrade is that these small-cap companies have strong, largely unassailable specialisations in the manufacture, installation and maintenance of this major energy infrastructure. As a result, they are looking into decades of above-average demand growth which is hard for others to contest. We believe that the outlook for earnings and earnings growth for these small caps is largely yet to be recognised by the market, offering significant potential for unrecognised earnings growth over the coming years, backed by a rapidly unfolding world charged with renewable energy.”
By Simon Wood, Portfolio Manager, Global Small Caps
