Summary
The UK water utilities market faces several well-publicised challenges, but beneath the surface, Lazard Asset Management believes there are opportunities to be discovered. Here, we outline why we’re invested in the sector and why the publicly listed assets stand out from their privately-owned counterparts.
As an essential ingredient for human survival, essential services such as water and sewage are compelling choices for infrastructure investors – especially in regulated markets with booming populations, such as the United Kingdom.
Consumers of the global press will know that UK water assets have faced their fair share of challenges, with sewage and water leakages chief among them. For a long time, UK water assets received insufficient investment and as a result the cost of providing services has increased substantially. Given this, we don’t believe that the sector should be avoided altogether.
UK water companies have quite a distinct profile, in that most have been privatised, and are heavily regulated; however, there are still three public water utilities available to invest in, in this primarily private universe. Regardless of ownership, top performers in the sector are incentivised for their operational outcomes by water utilities regulator Ofwat (The Water Services Regulation Authority), while poor performers are penalised.
We have seen companies like private equity-owned Thames Water’s debt balloon to £14.7bn. It has risen to the extent that its parent company can no longer meet its interest payments.
At the other end of the scale, three better-managed, listed UK water stocks have emerged as attractive opportunities, with the right pricing to offer investors an attractive return.
Why we like public UK water assets
We find value in all three listed UK water stocks: Pennon (PNN), United Utilities (UU) and Severn Trent (SVT). United Utilities and Severn Trent have earned Output Delivery Incentives by providing some of the best operational performances in the sector.
Severn Trent
Source: Severn Trent
Pennon, United and Severn benefit from stable regulation, inflation-linked returns and inelastic demand, all of which are prized among the Lazard infrastructure team. Water companies compare favourably – even with other infrastructure sectors – because the resource is always needed. We also take a long-term view of this critical asset, which will need to expand its infrastructure to serve growing populations and their needs. The UK’s Office of National Statistics predicts that there will be 70 million people living in the UK by the middle of 2026, all of whom will need water.
We should stress that no UK water company is perfect and all have leakages and operational improvements that need to be made. However, as a result of the UK water sector currently attracting political noise, we believe the three publicly listed companies are offering value.
As one of the most experienced infrastructure investment teams globally, we believe we have an in-depth understanding of regulated UK utilities. Our remit has always been to identify mispricing opportunities to exploit. While UK water assets have fallen out of favour, the fundamentals are strong and we see the potential for shareholder value over the longer term.
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