The TSX Composite Index is showing signs of a bull run as the market rebounds over hopes of easing inflation and return of demand. As the recovery begins, some sectors could see the long pending growth return. Now is the time to get exposure to two stock market sectors that could benefit from the secular trends of renewable energy and electric vehicles (EVs).
Renewable energy sector
The last decade saw the shift to renewable energy picking up as climate change effects hurt global economies. Most major economies aim to achieve net-zero emissions by 2030 and some by 2050. The 2030 deadline might seem far, but it is an aggressive target given the significant dependence on oil and gas. The pandemic and global energy crisis shifted the focus to oil and gas. But with economic recovery, there will be a growing need for energy security, and the demand for electricity will be bolstered by the EV and artificial intelligence revolution.
Renewable energy stocks
TransAlta Renewables (TSX:RNW) and Algonquin Power & Utilities (TSX:AQN) can harness the green energy momentum once they are out of the macro crisis. Algonquin acquires interest in a project, transitions it into renewable energy, and sells it while securing the contract for its maintenance and operations. TransAlta Renewables develops and operates wind and solar projects in North America and Australia. All its power output is contracted, with averaged capacity-weighted contract life of 12 years.
Higher interest rates impacted the profitability of both companies as the acquisition of new projects became unattractive. Algonquin resorted to restructuring by reducing capital spending and dividend payments and is selling assets to reduce debt. TransAlta has stalled the acquisition of new projects till the macro environment improves. However, its two major contracts are expiring, and the new ones cannot replace the cash flows from the expiring ones. Hence, TransAlta has lowered its 2023 estimates.
Once interest rates start easing, financing will become less expensive, and the two companies could once again return to capital spending. The contracted electricity will keep cash flows coming, from which they can pay dividends. The restructuring will only make these companies more efficient and enhance their profits when macro conditions stabilize.
TransAlta and Algonquin stocks have slipped 16% and 30%, respectively, towards the end of 2022, making them an attractive buy at their current price. You can also lock in attractive dividend yields of over 7.5% and 4%, respectively.
Another hot sector waiting for a rebound is automotive as the EV momentum returns. The EV momentum gathered pace in 2021 when the world was recovering from the pandemic. But the frequent lockdowns in China created a semiconductor supply shortage. The Russia-Ukraine war spiked lithium prices. These supply issues are easing, but the high-interest rate is affecting demand.
Once the economy recovers with no other unexpected surprises, EV momentum will return. Tesla stock has already rebounded 60% from its December 2022 low. Auto stocks focusing on EVs could see a significant rebound.
Auto components maker Magna International’s (TSX:MG) stock slumped 12.5% after the company reported weak 2022 earnings. However, the company is hopeful to see a recovery in sales towards the second half and grow its revenue at an average annual rate of 6.8%. This guidance is subject to change depending on the macroeconomic environment. But if light vehicle production picks up, Magna will benefit as it has secured contracts from several automakers to supply components and third-party manufacturing services.
If Magna realizes the pent-up EV sales, the stock could surge over 30% and cross the $100 mark as it did in the 2021 EV momentum.
How to invest in these hot Canadian sectors
The above stocks are risky but have strong growth potential. When building your Tax-Free Savings Account portfolio, set an amount aside for growth stocks. It should be the money you don’t mind losing in the short term, with hopes it could grow 30–50% in two to three years. Invest the rest of your portfolio in lower-risk large-cap stocks that give stable returns.
If you are confused, you can adopt the 30:30:30:10 ratio; 30% for growth stocks, 30% for dividend stocks, 30% for large-cap stocks, and 10% for alternate investments like gold and REITs.