The March Toward Renewables

In this episode of MarketFoolery, Chris Hill chats with Motley Fool analyst Nick Sciple, about the latest news from the markets. Warren Buffett makes a big new deal, and there is news of further consolidation in the food delivery space. They also take questions from listeners and much more.

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This video was recorded on July 6, 2020.

Chris Hill: It's Monday, July 6. Welcome to MarketFoolery. I'm Chris Hill. With me today, Industry Focus host Nick Sciple. Good to see you, Sir.

Nick Sciple: Great to be here, Chris. We were talking about before the show, this is my first appearance on MarketFoolery, so it's great to be in the big leagues now, Chris.

Hill: [laughs] Long-time listeners of Motley Fool podcasts are well acquainted with Nick's work on Industry Focus. You know, when Independence Day comes on a Saturday, I think it's reasonable to expect that it's going to be, sort of, a quiet business news day on Monday, that's what I was expecting, but the news fairy showed up. I love it when the news fairy shows up. So, we're going to talk about a couple of deals that are in the news. We're also going to dip into The Fool mailbag.

But let's start with Warren Buffett, who finally got out his elephant gun [laughs] and put it to work. Berkshire Hathaway is buying the natural gas assets from Dominion Energy for $4 billion. When you throw in the debt, it's actually closer to a $10 billion deal. We knew months ago that we were going to see consolidation in the energy industry, we knew we're going to see deals. Let me just start with this, Nick, what was your reaction when you saw this news?

Sciple: So, the reaction, obviously, anytime you see Warren Buffett hop into the market a $10 billion enterprise value deal, it's a big deal. This is Warren Buffett's biggest acquisition on an enterprise value basis since Precision Castparts in 2016, so obviously a big deal to see Warren Buffett hopping into the market. And when it comes to the actual acquisition; to me, this feels like a classic Warren Buffett deal. These pipeline assets, they're really monopoly at the end of the day. If you own this pipeline, you own a monopoly on transmitting these gas assets around the country. And when you look at the role that natural gas plays in our electricity infrastructure, it's only going to get bigger as the years go on.

So, I pulled up some stats today. In 2019, about 23% of electricity production in the U.S. came from coal, about 38% from natural gas. That coal number is going down and it's going to be largely replaced by natural gas and renewable energy. I know a lot of folks are excited about solar and wind and the role they can play in the market as they become cheaper, and they certainly will grow, but given natural gas' role as a power source that can come on quickly and steadily throughout the day, natural gas is only going to become bigger and bigger as a contributor to our electricity assets. And so, Warren Buffett having a monopoly on part of that distribution network in the U.S. is particularly valuable.

I think I saw a stat this morning, this brings Berkshire's control over U.S. natural gas distribution to about 18%, so a really significant part of this distribution of natural gas is going to become a bigger and bigger part of our electricity infrastructure. So, I think it's a classic Warren Buffett deal.

Hill: Yeah. And, you know, you mentioned the footprint that Berkshire is going to have when it comes to natural gas transmission. That's actually up from 8%, so that's a pretty sizable leap to control effectively one-fifth of natural gas transmissions in the U.S. Part of me was not surprised by this deal, given Berkshire's investments in energy over the years, given how important energy businesses are to the overall portfolio. Selfishly, you know, if you told me Buffett is going to make an acquisition over the weekend, whether or not I would have guessed it was in the energy industry, I would have guessed it would have been larger. I mean, it's good to have the context that you shared in terms of, look, this may not seem like a big deal relative to the amount of cash they have, and that's sort of how I was framing it, I think the smarter way for investors to frame it is the way you did, just in terms of like, look, let's measure this not against the pile of cash that Berkshire has, which I believe as of the most recent annual meeting was north of $135 billion, let's judge it compared to previous acquisitions.

And Buffett has been saying for months now, in part at the annual meeting, he doesn't see value out there. Just because he has the money, doesn't mean he's going to go out and spend it unless he sees the value here. And when you look at Dominion Energy's stock [laughs] not really getting a pop out of this, I know it's a big company, but you know, part of my read on that is, Buffett got a good price.

Sciple: Yeah. So, I saw a quote from JPMorgan today [laughs] and the way they described it was, "Not the highest we have seen gas pipes transact at." So, yeah, I think it's a reasonable price. And I think that the big thing for Buffett, when you heard him talk about airlines, what happened with coronavirus, his vision of the future of what the potential was for that industry was really significantly changed by what took place. I think when you look at these pipeline businesses, the predictability is so, so different from what you're looking at from airlines, because I think we can reasonably predict that electricity demand is going to continue up into the right going into the future, as we become more and more technologically focused, more and more electric cars, that sort of thing.

And so, I think it's really reasonable to predict the continued growth in demand for energy, and as a result, the continued growth in demand for natural gas. So, when you just look at this asset, I know it's only $10 billion of this $137 billion cash pile, this is a cash flow stream that's really easy for Warren Buffett to predict and value over time. And I think it's a deal that really makes a lot of sense. Now, would we like Buffett to go out and spend a $130 billion really quick? I think we'd all like to, it would be really exciting, but it's really hard to find these deals, spending $10 billion all-at-once, it's really, really difficult. And so, the fact that he found this deal, looks particularly attractive and it's the type of deal that I think fits Warren Buffett's investing philosophy, a very predictable infrastructure play, I like it.

Hill: Let's move from energy to the food service industry. In the wake of its failed attempt to buy Grubhub (GRUB), Uber (UBER -0.38%) is buying Postmates for $2.65 billion. Postmates is the fourth-largest food delivery service business in the United States. And it seems like, certainly from the reaction of Uber's stock, which is up 4%, 5% today, it seems like this is being well-received. They're paying less money, they're getting a smaller asset, but they're getting greater exposure to some pretty big markets, like Los Angeles and Miami.

And you know what, when you look at Postmates, which is a private company that kicked the tires on a potential IPO last year, you know, they almost needed to do this deal, didn't they, because they were out of money, otherwise they were probably looking at having to IPO in the current environment.

Sciple: Yeah. So, the rumor was that Postmates was either going to get the biggest possible deal they could get from a SPAC [Special Purpose Acquisition Company] company or they would get acquired by Uber. And it seems to have been the case that Uber gave them the most attractive deal. I think we've been expecting consolidation in this space, [laughs] nobody makes any money, so maybe if we consolidate more somebody will. After this deal, Postmates and Uber Eats together will have about a 37% market share of food delivery in the U.S. Compare that with DoorDash at 45%, and Grubhub at 17%. So, really this industry is becoming significantly more consolidated.

I think that's good for the company. From my point-of-view, I don't see the economies of scale here in this business. So, I think when you look at logistics business, like, FedEx or Amazon, the whole idea is you consolidate things in distribution centers, squeeze out efficiency that way, you really can't do that in food delivery, you've got to do this one-way trip, you have to go to the restaurant, pick up the food, bring it back to the customer. You know, there's this concept of, your margin is my opportunity. Well, the margin we're skimming here is restaurants, there's really not that much margin there. So, I think it's a positive for the industry that it's consolidated, and there's going to be less competitive pressure on price as the industry becomes more consolidated. I don't know if it makes me any more excited about investing in the industry just given, I don't think there's significant economies of scale here.

Hill: Yeah, when you look at the delivery business -- food delivery, that is -- it really does seem like a war of attrition that it's just, these businesses are trying to be the last one standing. The mayor of Miami came out this morning, announced a reclosing of restaurants. So, again, with Postmates' footprint there, you know, obviously the deal isn't going to close. And by the way, I should mention, we shouldn't assume this is going to get done. I mean, I'm more confident this is going to get done than the Grubhub deal, but it is worth remembering that [laughs] earlier this year came the announcement, you know, a lot of hubbub about, oh, great, this partnership between Uber and Grubhub. And the deal fell apart. So, until everything is signed in ink, we shouldn't assume, but it really does seem like it's going that way.

Sciple: Yeah, one thing I did want to note on synergies between these companies, I thought was interesting, is there was a quote from Dara Khosrowshahi, who's the CEO of Uber, talking about how they're going to integrate the two products. And one of the services they mentioned integrating was Postmates' subscription service, where it's $9.99 per month for a subscription that provides no free delivery on any orders over $12, which sounds great, but that's literally what DashPass is, that's literally [laughs] the exact terms and exactly what you get if you pay for DashPass through DoorDash. So, I think this is just a signal of the commoditization in this industry. I think as it gets down to a smaller number of players, maybe within certain markets where those players are dominant, they can carve out a profitable business, but I don't see these companies having tech-based margins in the near future.

One area where I could be wrong is Uber has rolled out a product where they're going to be working with a city in California, I believe, to integrate with their public transit network. I think that gives some opportunities for some software like margins, that sort of thing. One concern I have there, though, is just the history in Uber's business, when it comes to working with governments, hasn't been the most positive, but if they can build that out, I do think that has some potential to increase their margins and drive some more profitability, but we'll see.

Hill: Let's go back to energy as we dip into The Fool mailbag. Our email address is MarketFoolery@Fool.com. Question from Jaime Lugo, who writes, "Do you think oil stocks and funds, like U.S. Oil, with the ticker USO, will bounce back in the next few months or a year, or do you think this is the time where green and renewable energies like solar will prevail?"

Kind of a binary choice that Jaime is offering up there.

Sciple: Yeah, so, yes and no. I think on the front-end, I think in the near-term, it's going to be difficult for, particularly, these oil and gas exploration funds, because a lot of these shale companies have been in really difficult positioning from a balance sheet point-of-view. And there's going to be bankruptcies in the space, we've already seen a number of those, Whiting Petroleum, Chesapeake Energy, and we're going to see more. So, it's going to be really difficult for these shale players in the near-term.

Now, does that mean, now is the time where there's the inflection point and renewables are going to take the lead and it's over for oil and gas? No, I don't think it's the case, and I would actually argue that in some ways some of these renewable companies are a little bit overstretched. I think the poster child there is Nikola Motor, trading at a higher market cap than Ford with no revenue.

So, I think renewables are going to become a bigger and bigger share of our power generation going forward. However, the transition is not going to be as quickly as a lot of folks would like, and part of that is because of that intermittency problem I talked about earlier. So, when you're running an electrical grid, it's really important that there is demand for the power you generate, you need to match the power that you generate to when there's going to be demand from the grid. And one of the challenges with renewable energies like solar and wind is that they're very intermittent. And so, when the sun is out, power is being generated, but you can't necessarily align that power with demand. And so, if you don't do that, you can have voltage issues on your grid, blackouts, all kinds of problems. And so, for that reason, you can't just snap your fingers and replace power sources like coal, which are 100% renewable. You even see that in Germany where they've really ramped up their renewable production, but a lot of their existing power generation has remained in place, because you need to have that smoothness in the grid.

So, I think renewables are going to grow, but it's going to be a steady, slow transition over years and years and years and years. And I think to the extent that folks think that we're at this inflection point where all of the sudden the grid is going to shift over 100% away from natural gas and those types of energy sources, I don't think it's likely.

I do think though that coming this year, I think it's likely we're going to see some significant government investing in renewables. And so, that's probably going to support these stocks. Whether the pace of the transition to renewables supports where some of these stocks are trading today, I don't know. Those are, kind of, my thoughts on where the space is today.

I think, actually, given the pessimism around oil and gas and, you know, people are really reluctant to invest in some of these sectors, there's a chance that we overshoot to the downside and there's some value opportunities in oil and gas, but we'll see. I hesitate to predict oil prices; who knows.

Hill: I'm not going to ask you to predict oil prices, but I am going to ask, before we wrap up, for a prediction on more M&A activity, because I could see, as this pandemic drags on, as you know, whether it's Dominion Energy or any other business out there, businesses look to sort of either stave off bankruptcy or shed parts of their business so that they can remain solvent. I could see the biggest players in this space, ExxonMobil, Chevron, etc., being the longer-term winners because they have the cash to get through this. They can, like Warren Buffett, pick up some of these companies' whole cloth or assets within these companies, at a value.

So, I'm wondering; first, do you expect to see some of the biggest players in this industry make those types of acquisitions? And along with that, would it surprise you if some of the acquisitions were in renewables? In the same way that an alcohol business, like Constellation Brands has a portfolio of beer, wine and spirits, would it surprise you if ExxonMobil, Chevron, Royal Dutch Shell, any of these businesses decided to make a big play in something like solar, rather than sort of develop their own.

Sciple: Yes, I think 100% there's going to be more consolidation in oil and gas. Major players like Exxon, BP, those types of folks are going to make acquisitions where it makes sense, where there's quality assets available in the shale patch.

I do think, your point about, will these major oil and gas companies make investments in renewable? I think it is a good one. I think the main driver behind that is the rise of ESG funds, more and more investment dollars being allocated in a way where they only flow to companies that meet certain ESG environmental benchmarks. And I think, as large asset managers put pressure on these companies to meet emissions targets and to be more green, etc., we'll see those types of moves, whether it's -- I think in the case of Dominion, part of the reason they divested some of their natural gas assets is to accelerate a pledge they've made to become net-zero emission. I think we're going to see more and more of this from energy companies as institutional investors say, we're not going to give you our money, we're not going to invest in you if you don't show some progress toward these goals that we have. So, I certainly think that's a possibility too to occur in the coming years.

Hill: You can hear him every Thursday on our Industry Focus podcast. Nick Sciple, thanks for being here.

Sciple: Glad to be on, Chris.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd, I'm Chris Hill, thanks for listening, we'll see you tomorrow.