The smart grid of the future requires billions in upgrades. These stocks will benefit

Published Sun, Sep 26 20219:14 AM EDT

The U.S.' electric grid, imagined for 20th century life, is in desperate need of an overhaul as 21st century challenges wreak havoc on the industry and the customers it serves. Infrastructure is outdated, technology has evolved, and extreme weather events fueled by climate change have shown again and again the vulnerabilities of our current system. And that desperately needed upgrade comes at a stratospheric cost: by the end of the next decade, the U.S. electrical grid is facing a $338 billion investment shortfall, according to the American Society of Civil Engineers. Widespread power outages this year, including two massive events in Texas alone — Hurricane Ida and the severe winter weather that hit the state in February — have garnered national attention, and President Joe Biden has emphasized the importance of upgrading the grid. The bipartisan infrastructure bill outlines $65 billion in spending for the electrical system, which includes the buildout of transmission lines as well as research and development funding for "smart grid technologies that deliver flexibility and resilience," according to the plan's fact sheet. The proposed, and massive, spending on infrastructure will be required to fundamentally transform the grid from a centralized operation, where power flows in one direction, to an interconnected network with two-way communication. On-site power generation means houses and vehicles will constantly be sending information back to the utility, providing real-time analysis and even stored power when necessary. This communication is the basic idea behind the so-called "smart grid" — not one specific change, but rather an overarching framework that utilizes the latest technology to make the grid more reliable, efficient, safer and economical, noted Andrew Little, research analyst at Global X ETFs. Where utilities once had a constant supply of coal or gas to meet any sudden spike in demand, intermittent power creates new challenges since it's impossible to bank on constant sun or wind. Monitoring the available supply is becoming more complex as distributed power and storage becomes integrated with the legacy grid, and as customers who generate their own power act as providers. "[The power grid] still looks, in its DNA, much like it did 100 years ago," said Mark Dyson, a principal with RMI's electricity practice. "There's a broad recognition that we need to reimagine some of the basic technology and even architecture of our power grid to meet the needs of where we see ourselves today." Opportunities for investors Large-scale problems can create opportunities for investors, of course, and rethinking the grid is no exception. Given the complexity of the electrical system and the many pieces it relies on, companies across sectors and industries are involved — from the nuts and bolts of the hardware, to the software, to the wiring, to the construction crews that install new equipment. For investors looking for broad exposure in the remaking of the grid, there are several funds that track the industry as a whole, including the First Trust Nasdaq Clean Edge Smart Grid Infrastructure Index Fund . The fund trades under the ticker GRID and has roughly $570 million in assets under management. Shares are up 19% for 2021 thanks to strength in names like MicroVision , Johnson Controls , On Semiconductor and Acuity Brands . Top holdings are Aptiv , Schneider Electric , Johnson Controls , ABB and Eaton Corporation . There's also the SPDR S & P Kensho Intelligent Structures ETF ; it's smaller, with around $54 million in assets under management. The fund's top holdings are Evoqua Water Technologies , Carrier Global , Xylem , Badger Meter and Johnson Controls . For investors looking for more specialized bets, one option is Itron . The company offers advanced metering infrastructure, which helps utilities better understand consumption practices through a constant flow of data. With this information, utilities can improve operational efficiency and enhance grid reliability. They can also utilize programs like demand-response systems, which focus on cutting usage to match available supply rather than ramping up supply to meet elevated demand. For example a smart thermostat could raise the room temperature to reduce demand, while an electric vehicle could be unplugged and charged at a later time when demand isn't as high. Itron's stock hit an all-time high back in March but has declined more than 30% since. In August, shares dropped a staggering 26% in one day after the company missed quarterly estimates thanks to component constraints, which management expects to persist through 2021 and into 2022. Still, Raymond James upgraded the stock from outperform to strong buy following the slide. While supply chain bottlenecks might be a near-term headwind, the firm said demand is not disappearing, and also pointed to strength in the company's software division. "Power grid modernization — a facet of both climate mitigation and adaptation — is a theme to which Itron is uniquely leveraged among U.S.-listed companies," the firm wrote in a note to clients. Analysts at Baird are less certain, however, and the firm cut the stock to a neutral rating in August due to the lack of clarity around the supply chain problems. But the firm did acknowledge Itron's leading position. "We view ITRI as the best pure-play smart grid company, and would recommend shares for investors looking for exposure to secular trends toward efficiency, smart metering, and networking," analysts led by Ben Kallo said in August in a note to clients. Smart meters are the foundation of a two-way communication network between individual homes, buildings and other devices and the grid, and can help with everything from load control to outage notification to shifting consumption in places that have time-of-use pricing. They've been around for more than a decade but are still not in every property across the U.S. An April study from The Edison Foundation estimated that 107 million smart meters were deployed in the U.S. by the end of 2020, which is about three-quarters of U.S. households. In addition to Itron, Switzerland-based Landis+Gyr is another company involved in smart metering and grid edge solutions. And then there are the companies that make the hardware and software to actually bring renewable energy to the grid. This is done through inverters, which are often referred to as the brains of a solar system since they convert the DC from solar modules into AC current for the grid. SolarEdge and Enphase Energy are among the companies that make these specialized inverters. Both stocks are down double-digits for the year amid broad weakness in renewable energy stocks. But research firm KeyBanc recently said it sees a rebound for Enphase on the horizon. "We like ENPH's core microinverters business, where it enjoys significant market share and is well-positioned to capitalize on growth in the U.S. resi solar market," the firm said while initiating coverage on the stock with an overweight rating. For investors who are wary of focusing on one specific technology, whether it be solar, wind, hydrogen, or battery storage, Morgan Stanley said targeting the equipment makers can be a safer bet. "We are confident in the long-term trends around energy transition but the adoption of individual technologies can happen at a different pace," the firm said in a recent note to clients. "Electrical equipment's integral role in all of these initiatives lowers the risk of imperfect timing...This is a megatrend in industrial markets and we expect a significant amount of capital to chase this trend," the firm added. Morgan Stanley pointed to Hubbell and Eaton Corp. as two specific beneficiaries. As more and more elements in our lives go electric, from cars to commercial buildings, the firm believes the electrification opportunity will hit $45 billion by 2030. There are also industrial conglomerates that, recognizing the opportunity in the space, offer software-as-a-service. Emerson Electric , Honeywell and Johnson Controls are among the companies that work along with utilities on such projects as a building's management system, which helps commercial buildings manage their energy needs. While there are many ways to take advantage of the evolving grid, Cowen was quick to note that investors should maintain a long-term timeframe rather than hoping for fast gains. "We caution investors that this transition in the electric utility network will not happen overnight; it will be a multi-decade-long process providing slow and steady growth," the firm said. - CNBC's Michael Bloom contributed reporting.

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