Environmental, Social and Governance, or ESG, factors are an important input to our investment process and for utilities, these factors are increasingly relevant.
ESG analysis has led to a number of interesting investment insights across the utility sector. Some examples include the shift in power generation towards renewable energy, greater investment in safety for natural gas pipelines and addressing health and safety in drinking water infrastructure.
One of the utilities that I cover is American Water Works. This utility is a water utility that provides regulated water and wastewater services to customers and collects, treats, and transports recycled waste water.
The water utility sector in particular has been influenced by some particularly strong ESG considerations. As I’ve spent more time researching the water utility sector, I believe the US faces several long- term challenges due to a chronic underinvestment in water and wastewater infrastructure.
The American Society of Civil Engineers grades US waste water infrastructure a “D+” and drinking water a “D”, indicating an urgent need to invest in infrastructure. I liken it to a slow-moving trillion dollar problem. To put this rating in context, consider these facts:
- There are 1mm miles of water distribution pipes in the US and we experience a major main break every 2 minutes,
- Each year, the US loses over 20% or 2 trillion gallons of treated water through 240,000 main breaks at a cost of $2.6B annually,
- There are 800,000 miles of waste water collection pipes that are in dire need of replacement and leak 900 billion gallons of untreated sewage into rivers and streams,
- By 2020, 44% of all water and wastewater pipe will be classified as “poor, very poor or life elapsed” which is up from 10% since 1980 and
- There is a projected 67% funding gap in 2020 (~$126B industry-wide) and that could grow to nearly $200B by 2040.
Given the backdrop I’ve just described in the water sector, I believe there will be a durable investment opportunity in the water sector as well as continued privatization of municipal systems.
Water utilities also have a unique attribute as compared to other types of utilities – they actually deliver a product that is essential to life.
Environmental and public safety are critical ESG components. These take on a new dimension for water utilities versus gas/electric utilities since water is ingested. Many people have heard of the tragedy in Flint, MI where improper water treatment resulted in lead being leached from the old distribution mains.
Lead isn’t the only threat to drinking water quality – there are numerous potential contaminants that could pose threats to drinking water quality which utilities must manage. Overall, this factor has led to an insight that companies such as American Water Works aren’t just in the utility business but also in the health business. Including ESG factors in my analysis is all the more important as utility investors only do well when customers are properly served.
American Water Works has a low risk business model levered to this durable theme. They also have a strong management team with a disciplined strategy that focuses on customer satisfaction, technology, operational efficiency, and safety. Given these factors, I believe this company is well positioned to benefit from the potential investment in water infrastructure.
As an investment analyst, it’s my job to identify utilities that represent attractive prospects for our clients. ESG analysis plays an indispensable role in understanding important issues for water companies as they play a critical role in daily life.