Investors looking for a return that will keep pace with a more inflationary environment, should look again at water utility stocks – according to Pictet Asset Management.
Simon Gottelier, senior investment manager of thematic equity at Pictet told Morningstar on Tuesday that there was a buying opportunity for investors in this sector. “Many of these stocks have attractive yields of 3 to 4%. Also they are trading at attractive valuations relative to three or five years ago.”
He said many investors are looking for stocks that offered some protection against inflation in a post-Brexit world. Some investors may be looking to invest in infrastructure on the anticipation of increase on UK government’s infrastructure spending. But water utility stocks might be a good alternative, as they are trading on much cheaper valuations than infrastructure funds, Gottelier said.
Brexit Impact is Limited on Utilities
Brexit has created political and economic uncertainty for many UK-based businesses. But utility companies may be insulated from some of these changes, and some have the opportunity to outperform other sectors, Gottelier added.
“The regulatory change on the horizon, as the UK is transitioning out of the European Union, is arguably more limited for utility companies” said Gottelier. In such an uncertain environment, water utility companies have a number of characteristics that appeal to investors: these are steady, and forecastable business, he said.
“I think these utility companies are very well managed businesses, with high quality management teams in place. They are aware of the risks of inflation and the levels of gearing.
“The UK market is characterised principally by pretty benign regulation that leads to a relatively high degree of forecast stability in terms of cash flows and profits,” Gottelier added.
Investments Needed to Sustain Existing Water Infrastructure
By 2050, up to 4 billion people across the world could be living under ‘severe’ water stress, up from 1.2 billion today, according to data from the Organisation for Economic Co-operation and Development. With increasing demand, coupled with severe climate change, over $1 trillion will need to be invested in water infrastructure globally each year, Pictet wrote in a published note.
This presents a very strong investment opportunity in water infrastructure, especially in developed economies such as UK and the US, said Gottelier. He added that as both emerging and developed economies all need water he believed this was a sustainable long-term trend. According to data provided by Pictet, 70% of the world's available fresh water used to support agricultural production, implying importance of developing water infrastructure on industry development.
Andrew Bischof, senior equity analyst with Morningstar echoes Gottelier’s views, saying much of Britain's water infrastructure is more than 200-years old and could require major upgrades during the next decade. Bischof projects that the UK-based United Utilities Group (UU.), one of 11 UK water utilities, will invest roughly £800 million annually during the next five years in its water and wastewater system to address these needs.
United Utilities Group yields 4% currently and the stock is rated two-star by Morningstar analysts, meaning analysts believe it is trading higher than its shares estimate values. Bischof forecasts the company will continue to grow its dividend above inflation as it continues to refinance its long term debts.
Another UK-based water company Severn Trent (SVT) offers 3.6% yields at the moment and this stock makes up 2.9% of the Bronze Rated Pictet Water’s portfolio, the fund that is co-managed by Gottelier.
Aware of Debt Risks in Utilities Group
Despite their attractive yields, Gottelier warned that investors need to be aware of the fact that utility companies do carry a lot of debt; and many have taken on more index-linked debt in recent years. But he added: “They are all potential takeover targets by infrastructure funds and large global utilities groups.”
Water Utilities Investment Trend in Emerging Markets
Gottelier said investing in water utility companies also had a more global focus.
He pointed out that the urbanisation of China is driving the need for new investment in water-related infrastructures in this country.
“Between now and 2050, about 550 million people in China are expected to move from rural to urban areas. This leads to increased investment – often from Government – to maintain and improve existing infrastructure.” He said similar trends also applied to India and Brazil.
But utility companies in emerging markets are more cyclical relative to those in developed markets. Heavy debts and corporate governance issues in China are also worrying. But Gottelier said in Pictet’s portfolio, they only invest in state-owned utilities companies in China where they understand their management styles and balance sheets.
