Infrastructure assets' performance is typically stable throughout economic cycles, given the essential nature of the services they provide.
However, the past three years have seen a perfect storm for UK water utilities, as the mix of a challenging regulatory review by Ofwat and the threat of nationalisation by the Labour Party resulted in the sector de-rating from one of the highest valued utility sectors globally, to trading at below its regulated asset value.
Despite the criticism the sector has received of late, the three listed UK water companies (out of a total of 17 privatised water companies) have delivered significant quality and service improvements in the current regulatory period.
They were also the only companies to be fast-tracked and awarded an enhanced return by Ofwat for the new regulatory period beginning in 2020.
Water companies can optimise value for shareholders by looking at the overall strategy, growth options and capital allocation policy for the group.
One avenue water companies can benefit from is diversifying their business beyond the core activities of water supply and waste water.
For example, Pennon Group, the owner of South West Water, also owns Viridor, a leading recycling and waste management company. Viridor originally focused on collections, landfill and recycling.
But since 2010, it has built out a portfolio of 11 energy recovery facilities, which have become a key source of growth.
As well as adding new revenue streams, listed water utilities could also look to dispose of part of their asset base to the private market.
'Off-market' transactions have historically occurred at significant premiums to those within the listed market. Direct infrastructure funds continue to attract inflows, raising $98bn in 2019, according to Preqin, which increases competition for assets and elevates prices.
After the decisive result of the recent election, the threat of nationalisation has reduced and the improved sentiment on the sector is leading to more M&A speculation.
With stable demand underpinning their business models, water utility shares offer relatively attractive dividend yields in the region of 4%, and the strategic levers available to them through diversification or asset disposals offer upside.
Giuseppe Corona is manager of the AMP Capital Global Listed Infrastructure fund
• Strong outperformance within the regulatory regime could allow companies to earn higher returns on regulated equity
• A strategic review or M&A could lead to a sale of all or part of the group at a materially higher multiple than where the company is trading today
• Returns are highly regulated
• Renewed calls for nationalisation