Green stocks: 1 to buy and 1 to avoid

G A Chester discusses a green energy stock and a specialist asset manager. But which would he buy and which would he avoid?

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There was a time when investing in green stocks was largely a niche activity. Many mainstream investors believed such stocks were likely to deliver sub-optimal returns.

However, with changing political and consumer priorities, the orthodoxy has shifted. Many investors now see companies with a green agenda as likely big winners of the future. Green has gone mainstream.

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Here, I’ll discuss a specialist asset manager and a green energy stock. The valuation of one is too rich for me. But I think the premium price of the other is worth paying.

Impressive growth

Founded in 1998, Impax Asset Management (LSE: IPX) has been a pioneer in the development of investing in the transition to a more sustainable global economy. Its funds have become increasingly popular.

For the six months to 31 March, Impax reported record net inflows of £6.8bn. This, and impressive market gains of £3bn, lifted its assets under management (AUM) from £20.2bn at the start of the period to £30bn at the end. It also reported that after the period end, AUM had increased further to £32.2bn by 30 April.

Valuation

My rule of thumb for asset managers is to buy when the stock is valued at below 3% of AUM. I’d hold at up to 4%. And then sell (if I owned the stock) or avoid (if I didn’t) should it get above 4%. Impax is currently valued at 4.7% of AUM. As such, I’m avoiding it at the present time.

It’s possible I could miss out by sticking to my rule of thumb. Impax is increasing AUM at an impressive rate and could perhaps rapidly ‘grow into’ its valuation. In a recent research note, Equity Development has projected AUM to reach £72bn by 2025. However, I’m not swayed by FOMO (fear of missing out) or a current-year forecast dividend yield of 1.1%.

A green stock I’d buy

Right now, I’m much keener on investing in wind farms owner Greencoat UK Wind (LSE: UKW). The company has established a strong track record of acquiring high-quality assets since coming to market in 2013. And in its annual results, issued in February, it said: “The pipeline of potential acquisitions remains healthy.”

The UK government’s plan for a Green Industrial Revolution to achieve carbon neutrality by 2050 requires a quadrupling of current offshore wind generation capacity. And Greencoat’s increasing scale gives it the ability to invest in offshore wind farms (typically significantly larger than onshore).

Valuation

Greencoat is scheduled to announce its half-year results and latest net asset value (NAV) on 28 July. Based on NAV at the last year end, and adjusting for a subsequent placing and dividend distribution, I estimate the stock trades at around a 10% premium to NAV.

It’s not unusual for owners of physical assets that generate resilient cash flows to trade at a premium. Primary Health Properties is another example. In buying Greencoat, I do have to accept the risk of a de-rating of the stock should management fall short in identifying, selecting and executing further investments that deliver satisfactory returns. In such an event, Greencoat’s attractive RPI-linked dividend (forecast 2021 yield of 5.5%) might also be at risk.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Greencoat UK Wind and Primary Health Properties. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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