The global pandemic COVID-19 has disrupted businesses and lives worldwide. Many have been asking us about its impact on the water sector, and there are four areas where we are seeing the effects of this virus on our industry. These are incredibly uncertain times and the situation is changing rapidly, but here are our current thoughts on the implications for water & wastewater utilities, impact on companies providing water equipment and technologies, changes in industrial sector demand for water solutions, and opportunities arising for investors.
Providing clean water – and safely treating wastewater – is a critical but often thankless task which many people take for granted. For water and wastewater utilities around the world, we see resiliency as their critical challenge, specifically being able to keep enough people at work over the coming days, weeks and months to be able to treat and distribute the clean water which billions of people depend upon.
What gives us optimism is that utility leaders combine a lifetime of dedication to protecting human health with strong problem-solving capability, honed after years of juggling resources to address the multiple challenges that operating ageing infrastructure brings.
In terms of demand changes, while people will (hopefully) wash their hands much more frequently, the increase in demand for water is likely to be minimal and well-within the capacity of the system. All the cleansers and sanitisers being used will end up in wastewater treatment systems, where we expect biological treatment systems to continue to function well.
In some countries – like Bahrain – the government has stepped in to cover the cost of water bills, protecting their utility from any potential revenue shortfall. Some 90 US cities and states have also suspended water shutoffs for unpaid bills in response to the economic impact of the crisis.
Water utility stocks are proving to be relatively resilient in these turbulent times. For example, the share prices of Severn Trent and United Utilities – two listed water companies serving around 15 million people in the UK – are within 1-2% of where they were three months ago, yet in the same time period the FTSE 100 has fallen 33%.
So how might utility spending be affected by the COVID-19 crisis? Looking back to the recession of 2008-09, we saw utility operating costs relatively unaffected by the recession. On the other hand, while capital expenditure was affected, there was a delayed impact as many larger municipal projects have relatively long timeframes. Importantly the 2008-09 recession was primarily a financial crisis, and today, capital is both plentiful and cheap. The impact today is more likely to be delayed construction timetables as utilities and companies postpone projects and focus on keeping people safe.
In months ahead, as governments may choose to take advantage of cheap capital to stimulate their economy and invest into infrastructure, we may see increased spend on pumps, pipes, valves and water technologies.
For example, in the US, utility capital investment actually increased during the 2008-09 crisis. However, the impact of public procurement projects being halted during the crisis hit the water industry a couple of years later, with a subsequent drop of 12% and 11% in water and wastewater CAPEX respectively between 2009 and the 2011-12 period.
The supply chain in the water sector is very broad, from technology start-ups to global multi-nationals; from companies making individual components to those supplying or building complete solutions; from deep sector specialists to broad generalists.
For all of these companies we see two core challenges – first, keeping their own people safe and protecting manufacturing and supply chains, and second, dealing with a potentially significant pause or decline in demand.
What was initially viewed as a supply chain disruption in China has rapidly spread to become a global disruption. We know our clients are working very hard to protect their staff and, in doing so, to keep manufacturing and assembly sites open so that they can continue to produce their goods and supply services.
We look at industrial demand both in terms of what is being bought (i.e. products, solutions, services, etc.), and which industrial segment is buying.
Broadly speaking, we expect expenditure on services such as legionella testing or outsourced O&M) to be fairly resilient, as long as companies continue to operate.
Spend on consumables may fall roughly in line with the reduction in industrial output, as when you produce fewer goods you also treat less water or wastewater and hence need fewer replacement membranes for example.
Capital expenditure is more likely to see a significant pause or decline. Capital expenditure on water and wastewater systems is typically driven by one of two basic needs: firstly, expansion of treatment capacity to provide additional volumes of water and/or wastewater treatment; or secondly, replacing ageing assets and/or installing upgrades to provide better quality and consistency of water or wastewater treatment. In the latter case, a portion of wastewater investments may be required to meet regulatory requirements.
In uncertain times we expect industrial & commercial companies in general to look to conserve cash and defer capital expenditure where possible. The decision to defer replacing or upgrading water or wastewater assets is a relatively easy one to make, and we expect many companies – especially smaller businesses with lower cash reserves and shorter timeframes in mind than some of the larger multi-nationals – to pause capital projects.
During the 2008-09 crisis we saw overall investment in the US in industries such as Microelectronics and Pulp & Paper fall by 25%, and as ~10% of all capital expenditure in these industries is on water & wastewater, it will clearly have a direct reduction on the water equipment expenditure.
In addition, management time today will be occupied by planning to protect their own staff and to mitigate the impact of COVID-19, and companies may look to restrict access to their manufacturing sites as they look to decrease the likelihood of a full shut down on their own sites.
In the 2008-09 financial crisis we saw the market for ion exchange resins – commonly used in industrial water treatment – fall by more than 2-3x the change in GDP, before recovering much more strongly than GDP in 2010-11, as companies chose to defer purchasing new resins and instead chose to run their existing resin assets for longer, potentially at a higher operating cost.
In terms of specific industries:
– Power is typically fairly resilient, with expenditure on water only falling ~5% in the 2008-09 crisis, due to strong underlying demand for energy, however the long-term shift to renewables (with minimal need for water) will continue to depress demand for water treatment solutions
– Sectors such as Food & Beverage and Pulp & Paper may see a small short-term increase in demand as manufacturers look to compensate for panic buying, however the mid to longer-term demand is likely to be broadly stable, with lower cyclicality than GDP
– Oil & Gas has already seen significant declines in the oil price (also in the face of overproduction, independent of the pandemic) and this will likely affect decisions on large-scale capital programmes, and we would expect greater cyclicality than GDP
– Commercial and hospitality sectors are likely to be most affected by the COVID-19 crisis, with many pausing operations as people practice social distancing
The picture so far for equity investors is very mixed. As of March 19th, many water companies have seen falls in their share price which mirror the falls in standard indices, however as we noted above pure water utility stocks have been shown to be very resilient.
However, these troubled times will also present many opportunities for investors, and especially for investors with ready access to capital and a long-term view, including sovereign funds, family offices and private equity firms.
For larger corporates, this is an optimal time to look for the tuck-ins which help strengthen product portfolio, customer access or geographic reach.
As one example, the Residential & Commercial sector is highly fragmented, with many smaller dealers focused on their local geography. For companies like Waterlogic, Culligan or Cott Corporation there is an opportunity to offer the security of a larger balance sheet and to accelerate acquisition programmes.
During the financial recession of 2009-09 we saw valuations on water transactions fall by 30-50% on a EV/EBITDA basis, with the largest listed companies seeing a 35% decline in EV/EBITDA.
We think this should present opportunities for investors with a long-term perspective on water.
Amane Advisors is a global advisory firm dedicated to the water industry bringing services to its clients on all matters relating to their growth. Its clients range from multinationals, institutions and investors, to innovative start-ups and technology companies. Services include Strategy, Market Intelligence, Commercialization, M&A, PPP Advisory and Digital Transformation.