Investing in Liquid Assets

Population growth is driving higher water demand, while changing weather patterns are decreasing the supply of fresh water across the world. These issues are driving utilities and regulators to consider numerous options including new infrastructure (reservoirs,  water pipelines, desalination) and new operating models to achieve higher levels of water efficiency.

As the world population is set to increase to 9 billion people by 2050, water demand is expected to increase by more than 50%. To meet the increasing demand for fresh water, particularly coming from emerging economies, we anticipate significant investment from both the private and the public sector alongside important government and political
support around the world.  We believe these projects will provide attractive investment opportunities.

Rising water infrastructure investment

The world’s water demand and supply imbalance has been well documented in recent years with the Global Water Intelligence (GWI) identifying that an investment of USD 1 trillion is needed globally for water infrastructure and water preservation by 2022. This is expected to create a USD 500 billion infrastructure market growing at 6% per annum.

Desalination

Desalination, the process of converting salt water to drinking water, remains very energy intensive with a significant carbon footprint. As water is heavy and incompressible, specialist pumps, piping and innovative technologies are required to deliver fresh water to where it is needed. After purifying the water, alternative uses need to be identified for the leftover salt. Nevertheless, within the right conditions, desalination is a viable alternative to provide fresh water to coastal areas and zones prone to drought.

According to GWI the global annual spending on desalination will rise 60% to USD 16 billion by 2020. Currently, there are about 14,500 desalination plants operating worldwide, with another 244 plants under construction.   In the UK for example, Thames Water opened the first large scale desalination plant in London in 2010, designed to supply 400 thousand homes or one million people with fresh water. However, the plant is only operational during periods of drought, as running costs still remain high.

Global manufacturers of desalination plants include General  Electric  (industrial conglomerate, United States), Befesa Medio  Ambiente (Abengoa’s business unit, Spain), Suez Environnement (water supply & distribution, France), Hyflux (water technologies, Singapore) and Acciona (industrial conglomerate, Spain).

Agriculture

Agriculture is a very thirsty industry, currently consuming more than two thirds of the world’s fresh water.  Agricultural water uses include both irrigation and livestock rearing. For example, cattle consume around 95 to 190 litres of water per day (compared to 150 litres per day per person in the developed world) depending on age, weight and the season.

When it comes to growing cereal crops, farmers using conventional ways of irrigation can waste up to 40% of the total water withdrawals, particularly in developing countries.  Therefore, efficient and economic irrigation is fundamental to conserving water in the agricultural sector. Lindsay Corporation, for example, has developed central pivot mechanized irrigation with very low rates (around 5%) of water waste.

Manufacturers of irrigation and agriculture equipment include Jain Irrigation (irrigation equipment, India), Kubota (agriculture machinery, Japan), Lindsay Corporation (irrigation equipment, United States) and Toro Co (industrial machinery, United States).

Water utilities

With budget constrained governments we are seeing more and more involvement of the private sector to supply water and dispose of wastewater across the world.  There is an increasing need for water utilities companies worldwide to focus on cost savings and customer service in order to thrive in this newly competitive marketplace.

We have seen increasing regulatory support for water utilities, particularly in emerging markets. Compania de Saneamento Basico do Est de Sao Paulo (SABESP), in Brazil, operates water, sewage and industrial wastewater systems and provides sanitation services. Early in the year, the Sao Paulo water regulator (ARSESP) published SABESP’s new tariff methodology proposal. The tariff will encourage capital spending and all operating costs will be inflation-linked, which is very positive for equipment suppliers, in our view.

Conversely, in the UK the regulatory oversight is getting tighter. The water industry regulator (OFWAT) is set to introduce competition to the UK water business, and customers will soon have options to switch suppliers.

The water utility segment includes companies like American Water Works (United States), Pennon  Group (United Kingdom), Aguas  Andinas (Chile), Hera (Italy), Veolia Environnement (France) and SABESP (Brazil).

Water conservation technologies

There is an array of companies offering solutions to preserve and conserve water not only for industrial users but also for the household. In the UK, for example, we use more water per person per day than in Germany - 150 litres compared to 110 litres.

Both a growing population and a significant increase of the usage of water per capita are driving the adoption of once considered luxury technologies into everyday life. For example, Geberit has developed behind-the-wall cisterns for the residential and commercial sector, reducing water flush volume by about a third. The company is a beneficiary of rising living standards and demand for environmentally friendly products for both property enhancement and development.

Companies involved in water products and technologies to drive water conservation and preservation include Torishima Pump Manufacturing (Japan), Ecolab (United States), Geberit (Switzerland), Itron (United States), Kurita Water Industries (Japan) and Pentair (United States).

Mergers & Acquisitions (M&A)

Despite the weak fiscal situation of many governments, on the whole the corporate sector across the world remains financially strong with cash balances being used for increasing dividends, shares buy-backs and acquisitions. This is clearly illustrated by the growing number of M&A deals that we have seen, particularly within the smart metering and flow control segments.

When it comes to water measurement and monitoring, smart metering is a sensible and cost effective way to reduce water consumption and improve water usage.  We have seen a clear drive to ramp up smart metering programmes, notably in Europe.  Several global industrial groups have shown interest in this space with Toshiba, for instance, acquiring Landis+Gyr (Switzerland) last year. Recently, UK based Melrose made a cash offer to acquire Elster – a German manufacturer of gas, electricity and water meters and related communications, networking and software solutions.

In March, Pentair Inc (United States) agreed to combine with Tyco’s Flow Control division in what we see as a transformational deal for the company. Pentair’s current CEO will head up the new combined company and Pentair’s investors will own 47.5% of the new entity. We believe Pentair will be well positioned now to benefit not only from the increased demand on water but also from the increased demand on energy, infrastructure and efficient industrial process resulting from the growing population and wealth of developing countries. Further, the merger with Tyco significantly expands Pentair’s exposure to international markets and high growth regions.

Portfolio  construction

The water industry includes a very broad range of companies like water utilities, pipe manufacturers, specialty chemical producers, measurement, monitoring and testing firms, equipment manufacturers, irrigation companies and membrane manufacturers, just to mention a few.  From a portfolio construction point of view, the diversity of the water industry is attractive, in our view.

The Climate Assets Fund, Cheviot’s sustainability strategy, invests in a diverse global range of water stocks from defensive utilities to growth companies involved in innovative water technologies. This allows us to position the Fund according to where we are in the economic cycle. The Fund invests in five sustainability themes (energy, food, health, resources and water) with the water theme currently representing nearly 20% of the portfolio.

We use a variety of asset classes to gain exposure to the theme: equities, bonds and occasionally private equity. For example, Thames Water, in the UK, is a private company with no publically-traded equity. However, there are several bond issues trading on the London Stock Exchange. The company supplies water and waste water services to 8 million people in London and the Thames Valley.