Jim Mueller, advisor for The Motley Fool's Energy Insider service, joins the show to share his approach to investing in renewable energy.

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This video was recorded on Oct. 14, 2021.

Nick Sciple: Welcome to Industry Focus, I'm Nick Sciple. This week I'm joined by my good friend and advisor on The Motley Fool's recently launched Energy Insider service, Jim Mueller, to discuss how we're bringing the Foolish investment approach to renewable energy. Jim, thank you for joining me.

Jim Mueller: Good morning, how are you?

Nick Sciple: Great to have you here with me. Always excited to be here with you. Jim, I mentioned before we started recording, I think last time I had you on the podcast, we were back in the studio [laughs]. It was back when we were in the before times, the actual real office days. But it's great to have you here with me on Zoom to talk about renewable energy.

Jim Mueller: Yeah, the before time sound some medieval, doesn't it? [laughs] It's a thing. COVID, of course, has been such a traumatic thing that it's really divided our personal timelines into two different parts, weird.

Nick Sciple: Yeah. The quote that comes to mind for me about the past year or so it's Peter Thiel when he talks about the future is really the extent to which tomorrow is different from today. If you have this long period where it's sameness forever, then to a certain extent, the future is a long way away. But if things change really rapidly, then the future is now. I feel like for the past year-and-a-half, we've been living in the future is now. I think when we talk about the future, I think a lot of people would say that renewal energy are the future, renewable energy is the future of our energy grid, making cleaner renewable energy, and maybe that ties into our main topic today. We mentioned off the bat that we just launched that Motley Fool's energy insider service that you're working on, Jim. From a high level, what makes renewable energy a compelling investment theme for you?

Jim Mueller: Well, it's the fact that there's a lot of potential still in the energy space. Renewables are primarily hydro, solar, PV, which is solar photovoltaic, and wind. But most people ignore the hydropower and just think solar and wind. I think it's a huge market. It's grown so much so far, but really it's quite small and I've got this chart that I'm going to share as soon as I can get it up. This is from REN21. They're a group that's been following the energy space for the last couple of decades almost and they put out an annual report in the summer covering what's been happening in the previous year. This is data as of the end of 2020. What I've got here is a chart showing the consumption of total energy around the world. About half of it is from heat, thermal used to heat things or cook things, about a third of it is transport, that is automobiles and trucks and trains and all that stuff, and less than 20 percent, less than 1/5 of the energy used in the world is from electricity. We think that renewables are a great, big part of it, but it's really quite small. Some numbers the chart breaks down: 2.1 percent of that 51 percent for thermal is from renewable electricity, which works out to just one percent of the total. For transport, 0.3 percent is renewable electricity, which is 0.1 percent of the total, and 27 percent renewable energy is mostly in power, but it's still roughly a quarter of all the power produced. That works out to 4.6 percent of the total world, so roughly 120th of the world, 5.78 percent, if you add up those numbers, of energy that we use worldwide, everything included, comes from renewable energy. There's still a lot of growth to grow forward for this. There's a lot of tailwinds behind this space and that's why I think it's a compelling space to invest in now.

Nick Sciple: When you think about energy, the power turning on is really a key component to all these things we do today. We talk about how we're talking on Zoom today, you really need energy to do that if you're at five percent and it theoretically you're going to go up to 100 percent. One other thing to mention is power demand goes up year-after-year because we like to do more things and watch more Netflix or any of those things. You have a small portion of a very large and growing market that renewable can capture.

Jim Mueller: Yeah, the thing though is that as energy needs go up, is being fulfilled by fossil fuels, by coal and oil and natural gas. Renewables, even though they're growing and keeping pace, the share of fossil fuel based energy hasn't started falling and we really need that to happen if we're going to avoid major effects from climate change. That also ties into this tailwinds. More and more people around the world are realizing, hey, this climate change thing is real. We're getting droughts when we didn't have droughts, we're getting floods and major storms or hurricanes are stronger or typhoons are stronger, and so many companies are getting onto this, I don't want to call it a bandwagon, but I guess it is by definition.

Nick Sciple: Trend maybe.

Jim Mueller: A trend, there we go, and pledging to get more and more of their energy from renewable sources, and we're talking large world spanning companies like Apple, for instance. There's a lot of tailwinds, but if you think we're going to get rid of fossil fuels in the next five years, no, that's not going to happen. It's going to take several decades before we fully transition away from the use of coal and natural gas and oil.

Nick Sciple: We tell the story about, this truly is a long-term investment trend. I think most folks would agree that renewable energy is going to grow overtime. The pace of that, who knows? When you think about investing in that trend, one the places that, how you decided where to look and the places to avoid.

Jim Mueller: When we're picking the companies to launch the energy and start a service, Ben Ra, my colleague on that service, is a fantastic analysts. He and I, we're looking at companies that have a direct connection to the renewable space, but they don't have to be solely on the renewable space. For instance, we have one company that has only a smart part of its revenue coming from renewables that we think is going to become bigger as renewables grow larger. But then on the other hand, we have another company and we're going to discuss it, that is 100 percent tied to renewable solar panels. We were looking for companies that have a direct connection to renewables, growing connection to renewables. The renewable spaces is so wide, it encompasses not just electricity generation, wind and solar, but also technology that makes use of electricity smarter. The so-called smart grid that is slowly growing out or changing from fossil fuels to electricity for transportation, big uses, diesel for things like train engines and truck engines, and all kinds of transportation. Not just the Teslas of the world with electric vehicles. Those are coming, but there's more to that story than the Teslas of the world.

Nick Sciple: Looking for emerging niches in renewable energy, are there any specific trends or sectors that, you know what? I just don't want to touch in real time.

Jim Mueller: Well, the ones we don't really want to touch, even though we might end up with one of them, is like the oil and gas explorers. If we go that route, we'd want to a company that is actually making real effort to go into renewables and not just greenwashing their name or their PR stories or stuff. We also don't want companies that are subject to commodity pricing. That means we're not going to do a solar manufacturing because today they are commodities and their prices have dropped and the manufacturers have no control over the press on that. Because a buyer is just going to go to the next guy. We avoid commodity. We want companies that have some pricing powers, some competitive advantage, and a tie at high to and growing tie to the renewable space.

Nick Sciple: I think one thing when we talk about thematic investing is where does this fit into our portfolio? I think no matter how excited they are about renewables, nobody, we would say, probably not a great idea to have all of your portfolio in the energy sector, all of your portfolio in solar. When you think about constructing our portfolio around themes like renewable energy, how do you think about that?

Jim Mueller: Well, yeah. Please don't go all in on this. We think it's a growing space, but don't hire whole portfolio to it. There's a couple of ways to think about it. You can just arbitrarily choose a number like 10 percent. Or you can look at, I think there's 11 broad industry sectors, and was it, GICS, G-I-C-S? Was that a global industry?

Nick Sciple: Classification?

Jim Mueller: Classification systems centers, something like that. There's 11 of those, and one of those is energies, that's nine percent. Or you can look at the S&P 500. The market cap of the energy companies in the S&P 500 is 2.3 percent, I think is latest number. You could say two percent of my portfolio will be this, or somewhere in between. I think a single-digit, high single-digit exposure to this space would satisfy that, and then you'd have several investments within that. We're going to be growing the energy inside our service from an initial, I think it's 10, up to about 25 positions over this year or so.

Nick Sciple: Keep it a portion of your portfolio.

Jim Mueller: Yeah.

Nick Sciple: Certainly something to think about. One other thing looking from a broad top down on this industry, there's lots of government involvement, whether that's emission standards in Europe or increasing conversations around bills that could be passed in the US. This for investing in companies, or how do you think about that?

Jim Mueller: Well, trying not to make that the linchpin of the investment thesis. It's a nice to have, but we don't want it to be the reasons of investing in a particular company. It has the tailwind government spending, whether it's through like tax breaks or direct investments or mandates like the recent announcement by the US administration of more offshore wind production. Those are nice to have, but we're not looking at companies that require that in order to succeed. We want a company that has real business underneath and doesn't need a boost from the government or any government, just to make it.

Nick Sciple: Companies that maybe could benefit from government actions and notwithstanding that still can continue to thrive. I think that sets the stage for what we're looking for in the sector, how we're thinking from a broad brush strokes, where we now we can drill down into how we think about particular investment, things that stand out. I ask you to bring maybe one company that stands out to you in this renewables space as attractive to use or what company is that?

Jim Mueller: I'm going to share one recommendation from a service that we put out. We launched the service that we could go, so it's little earlier, but I was assured that I could talk about this. It's a company called Shoals Technology Group. It's on the Nasdaq under the ticker, SHLS, so Shoals. What they do, they are the 100 percent solar panel company that we have in this portfolio, but they don't make solar panels and they don't make inverters. Inverters, that is. Solar panels are where the sun's shining on that and it gets converted into electricity. Inverters take that direct current and convert it to that alternating current, AC, that the grid works on. But to get between those two, you need a whole bunch of wires, you need cables, you need switches, you need fuses, you need all kinds of hardware, and that's where Shoals place, they provide that. That stuff is called the electrical balance of system, or eBOS, so they provide solutions. Everyone provide solutions [laughs] enabled by this hardware and they sell it to the contractors building these sites. You also need them when you have energy storage, battery storage on those sites as well, because you need to get the energy from the battery into the integrated system as well. They make their products here in the US. They have a couple of plans in I think it's Tennessee and Alabama. I think that's right. What they're doing is basically plug and play stuff. It's easier to use on their new system, the BLA, which stands for Big Lead Assembly, that's what it is. You don't even need an electrician to install it. You just have these modules that plug together. What they are doing, even though the hardware is more expensive it's easier to install and that saves on the labor costs. The overall cost of buying and installing the eBOS is less and that's a win for the manufacturer, and it means that the cost of electricity that they're producing goes down so that they can sell it at a lower rate and that helps the customers, so it's a win-win-win kind of thing.

Nick Sciple: When you told me about this company, I was really interested on this thesis of we're making installations easier because a couple of months ago, I think, maybe a month or two ago I did a podcast with Jason Hall where we talked about the Department of Energy had put out a report; the solar energy futures report. One of the things they talked about in that report, and it makes sense when you think about it is you hear all the time solar panel costs are coming down. They're steadily decreased year-over-year going back the better part of some decades. What that breaks out to is as the solar panel costs have come down, the overall costs of actually putting solar energy into the field have become more increasingly made up of the labor costs of installations. I had a quote from that report. There's different markets there's residential, there's commercial. Residential soft cost, that's like labor, things like that as a share of total system costs have increased from 50 percent in 2010 to 64 percent in 2020, and the commercial market, it's gone from 33 percent soft cost to 55 percent over that same time period. Where the costs really are showing up in their system increasingly is on the labor side of the market. This business is really designed around how can we keep labor costs as low as possible? They can extract super normal profits because they are focusing on that really key component of the market, which I think is fascinating.

Jim Mueller: The overall cost of installing a utility-scale plant is called levelized cost of electricity, LCOE. For solar and wind that is now competitive with coal. If you're going to be able to new coal plant or a new solar plant or new wind plant, it's all going to cost you pretty much the same. A lot of that as you were saying come from lower prices of all the hardware, especially the panels or the turbines when we talk about wind. To get the further cost savings, you want to start working on some of those soft costs, the labor, the installation. Great thing about the BLA, the Big Lead Assembly, is that it doesn't require electrician to install it. You can use a general contractor because of that plug-and-play thing. You don't need electrician to actually connect the wires correctly, and put the crimps on and the caps on and make sure it's all waterproof and all that. That's all done with the manufacturing of this and all you need is know where it goes and what parts to plug in to which parts and so on. A general contractor is a lot cheaper to use on the labor side than a specialized contractor like an electrician. That's where BLA, I think it really helped drive. It took a few years to get solar installation, the constructors to use them because it's a new way of making all these connections, the tried and true way is you bury all the cables, which means you have to dig the trench and you hire the electricity you lay cables, you fill in the hole and you make all the connections. But the BLA is above ground. It runs above ground, which does expose it to weather, but I am pretty sure the company has tested that out. It's not going to be damaged by ice or snow or if it is, it's easy to fix. It doesn't require digging up the trench to figure out where the break is. By saving the cost for the company, and the installer. It took them a couple of years to get the first few sold, but now they're selling faster. Just in the last quarter, they now have I believe 13 new sites that are switching to the BLA system.

Nick Sciple: This big story of making installation easier, which makes customers willing to pay a little bit higher price, which helps drive profits for the company. When you look at the type of financials that this business is delivering, what really stands out to you there?

Jim Mueller: Well, it's profitable from one thing [laughs] which is nice. It's growing as free cash flow. I would like to see cash positive companies, and the margins are going up. The margins from 2018, they were 27 percent gross margin and 11 percent operating margin. In the most recent quarter they were 44 percent gross in 24 percent operating, so the margins are going up. That's great for cash flow generation, which is the basis of the valuation of a company. They are generating more cash and I think they're going to be more valuable in the future than what they are now.

Nick Sciple: One last thing to maybe mention with them, we really like to see high insider ownership and there is a lot of insider ownership with this company, but there's also a little bit of a special structure here that is worth noting. What can you tell us about that?

Jim Mueller: Yes, the Founder, Dean Solon. He is the Founder and CEO. He still has a 40 percent stake in the company. But they're in, not really restricted stock but you can have some think of it. They're not publicly traded. If he wants to cash out then the company is going to have to issue new shares in order to exchange them with him, so that's on a one-for-one basis, so that he can then sell the shares into the market. They went public earlier this year and a fair amount of money there was used to cash part of his holdings out, along with a few other insiders. Over time, we're going to be diluted as that happens, assuming it does happen. But hopefully not to a great extent. I believe the company will grow fast enough to overcome that dilution.

Nick Sciple: Just one of clarification. Solon is the former CEO, he is the founder of the business. I think he stepped down as CEO in late 2019, still was involved with the board and he's a very significant shareholder and you'd imagine very engaged with operations when you own 40 percent of a quite large company.

Jim Mueller: He loves to tanker and he's involved in a lot of the innovations that they are bringing forth. Their long-term, I think it was the Chief Technology Officer, is now the CEO and he's been for the last couple of years.

Nick Sciple: Also a significant shareholder, I believe, as well. Any final thoughts on Shoals for folks? It's really a business that's solving a problem in the market that is increasingly growing, large insider ownership and a real thesis to grow with a new product.

Jim Mueller: One of the interesting things is that with the lockdown from COVID, everyone was thinking, that's going to have bad things for the renewable energy sector and we're not going to be building it as much. Actually, more capacity was added last year than it had ever been added before, even with the lockdown. It's going to take a bit of an effort, I think. More effort than [laughs] in a worldwide pandemic to knock this really back on its feet. I think it's a fairly resilient industry at this point as it continues to grow and as we continue to switch over.

Nick Sciple: Maybe some last, last thoughts. We talked about Shoals how to bring a Foolish investment approach here, we talked about how renewable is really something we see growing in the future. But there are some uncertainties about the rate at which that takes place. Maybe to conclude, I got a couple of final closing questions for you. Number 1, what are you most certain about when it comes to [laughs] renewable energy over the next five years?

Jim Mueller: It's going to continue to grow and probably continue to grow at a faster and faster pace. Countries worldwide, China is the biggest investor in renewable energy, US I believe is second. Various countries in Europe are in the top 10. But it's going to continue to grow as we need to get away from the carbon-based electricity and fuel, sources of energy writ large, not just electricity for the world. As EVs grow, there's going to be need for a lot of work on the grid because I saw a recent article, I think it was from The Washington Post, said that EVs are their future, definitely. But that means more electricity needed beyond what we just used to run our houses and our businesses, and so the grid needs a lot of work and we've got an investment involved in that as well. There's a lot to the renewable energy space, not just EVs, not just solar panels and wind, there's a lot involved folks, and it's going to take a long time to get us to where we need to be.

Nick Sciple: I ask you, what are you most certain about? Last question for you then is, what is your biggest question over the next five years in renewable energy?

Jim Mueller: Who's going to pay for it? [laughs] That's why government bills and funding promises are to some extent needed to really get this going because businesses, of course, when they invest, they want to see a return on their investment. But it's going to take several years for that return to come in and the government can be used to prime the pump, so to speak. If the governments around the world are willing to invest more and more on that and help get it up and running to where the business are feeling comfortable to take over. That is what's needed. But I think that's also probably the riskiest as political wins shift and change over time.

Nick Sciple: We'll see what happens, Jim. Thank you so much for joining me to talk about what's going on over there with this energy insider service.

Jim Mueller: My pleasure and I hope everyone learned a little bit of stuff.

Nick Sciple: I know I did. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show for Jim Mueller. I'm Nick Sciple. Thanks for listening and Fool on!