COVID-19 Highlights Water and Sanitation Investment Opportunities

The COVID-19 pandemic has highlighted the shortcomings of key services and infrastructure in emerging markets, and exacerbated underlying vulnerabilities. A lack of access to adequate water and sanitation services has become a life- threatening problem in a context where health protocols require handwashing and proper sanitation facilities to combat the virus.

Given the diversity of emerging markets, challenges and opportunities in the water and sanitation sector differ from country to country. To this point, consider the following.

Water and Sanitation in China, the Philippines and Brazil

In China, according to the country’s National Bureau of Statistics, less than one-third of the population has access to drinkable tap water. About half of Chinese households are not connected to water pipelines and three-quarters are not equipped with bathing facilities or proper lavatories. Further, two-thirds of China’s 600 cities suffer from water shortages.

Elsewhere, in the Philippines, UNICEF reports that approximately 30 million Filipinos (out of a population of approximately 106 million) need improved sanitation facilities. Furthermore, the Philippine Statistics Authority’s (PSA) Annual Poverty Indicators   (APIs)   reveal   that only   70%   of   households    have    access    to    in- house handwashing   facilities,   such   as   sinks   and taps, and 30% of households rely on outdoor facilities, other means,   or   simply   have   no   access.   In   terms of drinking water, only about 20% of the population has piped drinkable water in their dwelling, with the remainder relying on water refilling stations and wells.

The government has prioritized the achievement of the United Nations’ Sustainable Development Goals (SDGs), but there remains room for improvement and investment, especially on SDG6, which targets clean water and sanitation to “ensure availability and sustainable management of water and sanitation for all.”

In Brazil, according to the National Sanitation Information System, 83% of Brazilians have access to water distribution services. With a population of about 211 million, this means roughly 36 million Brazilians are without water distribution services, a population nearly the size of Canada’s. In addition, only 50% of Brazilians have sewage collection and treatment services. In an effort to improve this situation, the country is prioritizing universal access to sanitation via a sanitation bill.

The aim of the sanitation bill is to expand water distribution services to 99% of the population and sewage collection and treatment services to 90% of the population by 2033. The bill also provides deadlines for the end of landfills for capital and metropolitan regions to cities with fewer than 100,000 inhabitants by 2024. Government estimates place the total pipeline of investments and projects at BRL 500 to 700 billion.

The Brazilian Association of Private Water and Sewage Operations (ABCON) estimates that private companies provide only 6% of water supply and sewage services in Brazil’s cities, while state-controlled companies serve more than 70%. For instance, São Paulo reportedly plans to provide a privatization model for Sabesp, one of the largest water and sewage service providers in the world, which may value the firm at BRL 50 to 60 billion. Copasa, a water and sewage services provider in Minais Gerais, is another company reportedly nearing a privatization plan.

Investing in Water and Sanitation in Emerging Markets: The Brazilian Example

The under-penetration of water and sanitation services, as outlined above, is a long-term story worth looking at in closer detail. The following two Brazilian companies are just some of the many opportunities in this area.

Sanepar is the third-largest sanitation company in Brazil. It is controlled by the State of Parana, which has a 60% ownership stake. Involved in water supply and sewage services, the company has operations in 346 cities, reaching approximately 10 million people (92% of Parana’s population). It provides water service to 3.2 million households and sewage service to 2.2 million households. Sanepar has superior performance and efficiency ratios relative to the industry average in Brazil. For example, the company has a 100% water coverage ratio compared to 83.5% nationally, 72.5% sewage coverage compared to 52% nationally and 100% sewage treatment compared to 46% nationally. The company is expected to grow its revenues by 8% and EBITDA at 9-10%. Expected earnings per share (EPS) should grow at 8% CAGR, with a 5% dividend yield. This could provide an investor with a 15% return with a minor multiple expansion. The stock trades at 7x P/E 2020.

Sabesp is one of the largest water and sewage service providers in the world, and is 50%-owned by the State of São Paulo. The company provides services to more than

20 million people under long-term service agreements. Sabesp operates in more than 379 municipalities, with the 10 largest concession areas representing almost 65% of its revenues. Sabesp has one of the highest likelihoods of privatization among the SOEs in our coverage. We expect that the privatization of Sabesp and the appointment of a new management team may lead to cost-cutting and a reduction in the cost of capital. In the long-term, under normalized conditions, revenues are projected to grow at 7-10% annually, while earnings will likely increase 12-13% CAGR, as with foreign exchange losses falling as the Brazilian real stabilizes.

The main drivers of revenue growth are customer growth (2-3%), volume growth per customer (1-2%), and a tariff increase (4-5%). We expect EPS to grow by 13% CAGR with a 3% dividend yield. This would provide an investor with a 16% return without any multiple expansion. The stock trades at 10x P/E 2021.

Conclusion: Opening the Taps

From both a bottom-up and top-down perspective, the emerging markets are home to many exciting investment opportunities in the water and sanitation sector. We see promising potential for value creation for investors willing to participate in this long-term growth story

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