Blue is the new black: water as a long-term investment.

Water scarcity is one of the biggest threats that the world could face in the near future. Most people think that this issue is only related to a lack of infrastructure in poor regions. However, it is a global issue as countries like China, India, Australia and even the USA are also affected by this problem.

In 2015, the World Economic Forum even designated water scarcity as the largest global risk in terms of potential impact over the next decade.

Population growth is one of the major factors leading to the exponential increase in water demand over the world. Currently, the world population is 7,6 billion and the United Nations projects the world population to reach 10 billion in 2055, this will undoubtedly increase pressure on water demand.

At the same time, less than 1% of the water on earth is considered fresh and accessible and this figure is not expected to rise, unless desalination becomes possible on a large scale, but what about the regions with no access to seas or oceans?

Also, population growth will indirectly trigger demand for industrial and agricultural products which are currently the two most water-consuming industries.

To briefly sum up, demand for fresh water will considerably increase in the next decades while water supply will not increase unless effective, scalable and sustainable initiatives are undertaken. So, considering that the entire water market is worth $600bn annually, and that the demand will increase in the future, it seems obvious that the water market offers incredible long-term investment opportunities.

The reference when it comes to water related investments is the S&P 500 Water Index, it gives exposure to 50 companies from around the world that are involved in water related businesses, going from companies operating Water Utilities & Infrastructure to companies operating Water Equipment & Materials.

In terms of performance, the S&P 500 Water Index is slightly less performant than the traditional S&P 500 Index on a 3 years scale, with a respective 8.60% and 10.87% 3yr annual returns. However, the S&P 500 Water Index is far more performant than the S&P 500 Oil Index on a 3-year period.

Considering the long term nature of the investment, it is safer to invest in a diversified portfolio to get exposure to the whole water market. One of the vehicles for this type of investment is the ETF (Exchange Traded Funds) or OPVCM (SICAV/FCP), like BNP Paribas Aqua Classic, Palatine Or Bleu, Amundi KBI Aqua, KBC Eco Fund Water Cap and JSS Sustainable Water Fund. These funds offer moderate risks rates while giving fair yearly returns and optimistic evolution over a long term period.

Review of one of the largest water equity fund. 

According to BNP Paribas Asset Management, the investment policy for BNP Paribas Aqua Classic is to achieve over a minimum investment period of 5 years, an annualized performance similar to the benchmark index, the MSCI World in euro, dividends reinvested, through an investment in shares of companies meeting extra-financial criteria of socially responsible management and related to the theme of water.

The fund has an outstanding amount of €1.767,19M and its portfolio is globally shared between mid (49%) and big caps (31%), composed by Suez SA, Danaher Corp, Veolia Environnement SA, Ecolab Inc, Ferguson PLC, Seven Trent PLC, Agilent Technologies Inc, Xylem Inc, Rexnord Corp and Georg Fischer AG with holdings going from 2.80% (Georg Fischer) to 3.69% (Suez SA).

In terms of performance, Aqua Classic is underperforming compared to the average performance of the category on the short term (1 year) with a difference of -2.07%. However, the fund is performant over a larger period with a difference of +7.40% on a 3 year period and 19.9% over a 5 years scale. Overall, the fund is well performing, with an annual performance above 11.5% since 2013.

Nevertheless, the fund is positioned at 88.7% in developed countries so it will probably not get the full potential of increasing demand on emerging markets due to urbanization and changings lifestyles, even if companies like Veolia are also operating in emerging markets.

Overview of a leading company in the water industry: Veolia.

Veolia Environnement operates through three business units: Water, Energy and Waste. It provides over 100 million people with drinking water each year and its wastewater division is one of the world’s largest.

Water is Veolia’s largest business line at 45% of revenue. The water division is active in all stages of the water cycle from supplying drinking water to collecting and recycling wastewater but it also includes projects like the desalinization of seawater. The company has a strong presence in the EU, North America and Asia. Regarding Veolia’s customers, 56% are municipalities and 44% industrial companies.

Concerning Veolia’s financial performance, its Sales increased in 2015 by 4.5% on the previous year to €25 billion before decreasing in 2016 by 2.3%. Growth has been strong in Asia (+7.9%), which counterbalanced the fall in Europe (down 2% in France and 1% in wider Europe) and North America due to weakness in energy prices. The cash flow from operating activities also grew by 51% between 2012 and 2016.

Regarding the debt, the rating agencies Strandard & Poor’s and Fitch maintained their “stable” perspective over Veolia’s long term debt with a BBB rating, and a 1-year default probability estimated at 0.0032%.

Looking at the share price forecasts, analyst ratings are optimistic with a target price at €22.07 (actually €19.40). There is currently 563.4M outstanding shares of which 274.9M are detained by 544 institutional investors like Franklin Templeton Investment (7.01%), Velo Investment (4.63%) or the French public institution Caisse des Dépôts (4.62%). In this case, the diversity of the stakeholders is a good point as it allows to avoid major governance issues.

Finally, Veolia’s strategy is refocusing the company geographically and concentrating its operations on less capital intensive areas. The company also sold or is still trying to sold its stakes in subsidiaries (e.g: Veolia Transdev) to reduce debt and try to achieve a saving objective of €600 million over the 2016-2018 period. Veolia also sees prime opportunities for expansion both in under-developed African cities, in Latin America and in Eastern Europe with an emphasis on the privatization of water and waste management operations.

 

Mattis Maurinier

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