Morningstar - Q1 2024 - 15

Investing in Climate
Adaptation
These companies
stand to benefit from
a warming climate.
Leslie Norton
SUSTAINABILITY MATTERS
For all of society's efforts to curb global warming-
including the recently concluded COP28
United Nations climate summit-temperatures
will continue to rise for at least another
century. Global temperature is on track to rise by
2.5 degrees Celsius to 4.5 degrees Celsius by
2100. After the hottest year on record, we're
likely to see continued fallout, including increased
risks of wildfires, droughts, floods, and what
scientists call " disruptive inundation. "
These certainties don't mean we stop trying to
cut emissions. But they do mean we need
to adapt to the warming climate-which creates
opportunities for investors. Climate adaptation
is the industry built around creating resilience in
our infrastructure as the planet warms.
3 Major Climate Adaptation Themes
Home Depot HD and Lowe's LOW are oft-cited
beneficiaries of climate adaptation, on the
thesis that people must rebuild their homes after
an event such as a hurricane. But there are
even better examples and themes.
HVAC
More air-conditioning systems will be needed to
keep buildings comfortable in areas that didn't
previously need them, and longer summers means
that replacement rates for existing AC units will
rise. Those needs will increase as cloud computing
and artificial intelligence require large server
farms with intense cooling needs. Companies that
could benefit include Trane Technologies TT,
Johnson Controls International JCI, Watsco WSO,
Lennox International LII, and Daikin Industries DKILF.
Water
Droughts and water scarcity are rising. New
Orleans recently declared a state of emergency
after saltwater flowed into the droughtstricken
Mississippi River, threatening the city's
drinking water. More capital will be spent
on water treatment, pumps, and pipes. Possible
beneficiaries: Xylem XYL, Primo Water PRMW,
Zurn Elkay Water Solutions ZWS, Pentair PNR,
Core & Main CNM, Mueller Water Products MWA,
and American Water Works AWK.
Engineering
Governments and industries need to make
infrastructure more resilient. As every port in the
world faces rising seas, governments will need
to step up their disaster warning and flood defenses.
Companies that could benefit include Aecom ACM,
Tetra Tech TTEK, Stantec STN, and Arcadis ARCVF.
How Big Is the Climate Adaptation Market?
Rising temperatures could cut into economic
growth, but spending on climate adaptation
measures can offset that. The World Economic
Forum sizes up the market at $2 trillion by 2026.
That estimate is too small, says Chris Goolgasian,
director of climate research at Wellington
Management. " It will be in [multiples of] 10, 20, 30
trillions of dollars, " Goolgasian says. Consider
the $750 billion Inflation Reduction Act, the
landmark 2022 law promoting renewable energy.
Spending was initially proposed at well over
$1 trillion. " A big section of the cut was adaptation
spending, " Goolgasian says.
Goolgasian expects to see new legislative
initiatives from many different jurisdictions for
such things as protecting food infrastructure,
coastal dredging, and building and infrastructure
hardening. In 2022, for example, Florida
passed the Home Hardening Sales Tax Exemption
to help Floridians reinforce their homes with
such things as hurricane-resistant glass. Toronto is
offering subsidies to homeowners to protect their
homes against basement flooding.
Other Climate Adaptation Beneficiaries
Building Materials
Tony Tursich, a portfolio manager at Calamos
Investments who specializes in sustainable
equities, likes Kingspan KGSPY, an Irish buildingmaterials
company that has made innovations
in insulated panels and high-insulation roofing
that incorporates photovoltaics. " It's exposed to
long-term secular growth, " Tursich says. Kingspan
also harvests and manages rainwater and is
auditing the city of Sydney's rainwater harvesting.
Tursich also likes Saint Gobain CODYY, which
makes fire- and impact-resistant glass.
Efficiency Experts
Tursich is a fan of Prologis PLD, the REIT that
leases warehouse space to customers like
Amazon.com AMZN. Prologis is the second-largest
corporate producer of solar energy, which
runs on warehouse roofs and helps customers
be more efficient and reduce energy use.
Power Generation
U.S. power demand growth has stagnated
because of efficiency gains in appliances
and lighting. That will change as heating and
cooling needs rise and electric vehicles gain
traction. " We're moving back to trend, "
says Matt Breidert, portfolio manager at Ecofin.
Breidert is a fan of Constellation Energy CEG,
which operates the largest fleet of nuclear power
plants in the United States.
Green Bonds
These are bonds that raise money for climaterelated
projects. " Climate adaptation is becoming
an integral part of mitigation, " says David
Zahn, head of sustainable fixed income at Franklin
Templeton. According to the United Nations,
adaptation costs in developing countries could
reach $300 billion every year by 2030.
One U.S. example owned in Franklin Municipal
Green Bond ETF FLMB is a 5% Alameda,
California, bond maturing in 2048 that raised
$17.5 million for embankments, a seawall,
and other improvements to protect the district
against a sea level rise of seven feet.
" Global warming is going to happen, " says Zahn.
" You can argue what the cause is. Ocean levels will
rise, and we need to adjust. " K
Leslie Norton is editorial director for sustainability
with Morningstar.
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15
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