3 top picks in water and waste

-- | 26/06/2020

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Lex Hall: Hi, I'm Lex Hall for Morningstar, and welcome to another edition of "3 Top Picks." Today, I'm talking to Bertrand Lecourt. He is from Fidelity and he oversees the Sustainable Water & Waste Fund. And he's got a few interesting names up his sleeve today. We're going to talk about two American companies in particular and one French.

Bertrand Lecourt, thanks for joining here at Morningstar.

Bertrand Lecourt: Thank you for having me today.

Hall: It's a pleasure. Now, the first name on your list is a big company called American Water Works. Tell us about your interest in that company.

Lecourt: Yes, American Water Works, it's the biggest listed US water company. It looks boring at the first instance. But in fact, you have a lot of great dynamics happening. So, first, the US water market is very fragmented and only 15 per cent of the market is outsourced. And the state of the network in water is in very bad shape. Seventy to 75 per cent of the pipes are in bad condition and leaking, which means that you can keep on investing at the same pace just to try to deal with managing the network. So, you have the natural acceleration of investment in this field. And the beauty of these companies is that they are regulated, and regulation is good because they are regulated to what we say the cost of equity. If they do an investment of $1 million, they have 10 per cent return, let's say, on equity on this investment, which means that if you have wages going up, tax, or interest rates going up, it will be best to the water bill so that they keep their return. So, it's a kind of a protection to stimulate investments. So, you have a very long-term investment profile, acceleration, almost guaranteed return, very high visibility. And on top of that you have a new wave of acquisition.

Hall: So, we are talking about just a company that handles pipelines and basically transports water from one area to another. Is it as simple as that? Or is it more…?

Lecourt: Yes, it's very simple. You have typically the drinking water and the wastewater. So, if you think the value chain of water, you pump the water from the resource, you store it, you clean it, you transport it to your home or to your industries and then there's a waste water on the backend while you take the water and clean it before putting it back to the nature. And looking at the last six, seven years, I mean, some of this water, like this American Water Works, was doing as well as a tech fund. So, it's very…

Hall: Boring but safe.

Lecourt: …boring story, but safe—I don't know safe but visible and perpetual.

Hall: That was American Water Works. The second name on your list today is simply called Waste Management. Again, not a flashy name, but no doubt a very good company.

Lecourt: Exactly. Waste Management is the biggest waste company in the US. So, it's also very simple, but I like simple stories. Sometimes they compound beautifully. And I like to invest in companies I understand. So, Waste Management is a typical business. You collect the waste, you sort it, you dispatch it. You can put some in land fill, some in waste to energy, some in recycling activities. So, you have the whole capacity to help society and cities to deal with the other side of consumption which is waste.

And this company has been doing extremely well over the past few years. Why? Because I think there's firstly technology and optimisation of foods, the way you dispatch your trucks, the way you put technology in your trucks, the way you make sure you have a very optimum process. But because people are making more focus on waste now—we talk a lot about CO2, but Waste Management also think you don't want to pollute the environment in which you live. Some of the services that they provide now, they get price for it. And over the last 15 years, prices of the waste services keep always increasing. And this is a business which is more benefited from a price movement than volume movement. And if you believe typically a US bill of $20 per month, it's not much for a household. So, if you believe that you can recycle, do more and if the bill goes to $30, you will not even feel it. But this company is doing a huge, huge transformational value creation. So, I like that and it's also cheap on recovery consumption.

Hall: OK. And finally, the third name on the list today is Veolia.

Lecourt: So, Veolia, unlike American Water Works or Waste Management, they have both activities but it's mostly contracted activities. So, you have more maybe some volatility sometimes depending on the economic outlook. But Veolia, it's been—it's a legacy of the old Société Générale des Eaux and they've been managing water over the last 150 years. There's a very big know-how in the French, like Suez, in how to deal with water with great services and they are involved in all the value chain of water and all the value chain of waste to municipal, to industrials. And they have come up—they have done some restructuring since 2011. They have a much better balance sheet. They can address some new pockets of growth, especially to industrials, outsourcing and managing their water usage whether you are a tech company or an auto company or pharma. And also, there's a very big push with ESG where you see the world of packaging companies like Nestle selling products and the waste companies have to talk to each other, let's say, for the recycling plastic. You have to take your plastic and they need it in their new product of recycle material and they build new plants and can benefit from price increase, new profitability. So, I believe they have great flexibility. It can grow externally. They have all the services around it. You can have also some rebound post COVID crisis could be very interesting for these names.

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