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URBANISATION: THE WASTE CHALLENGE

A regulatory push towards higher environmental standards driven by the idea of the circular economy, with the potential upside from uptick in the construction cycle, as well as commodity price recovery, underpins a wealth of investment opportunities within the waste management and recycling industries.

According to the latest report by the United Nations, world population is projected to grow from about 7.1 billion people today to 8.5 billion by 2030, with 6 out of 10 people living in urban areas rather than rural ones. This rapid population growth is placing significant stress, not only on the supply of resources, but also on the way we manage waste and recover useful materials from our waste streams. Notably, waste volumes are growing faster than urbanisation rates and are set to double by 2025, and double again thereafter by 2050.

In its recent study, Global Waste Management Outlook, the UN estimates that 7 to 10 billion tonnes of urban waste is generated annually in cities around the world. In the UK alone, for example, Defra (Department for Environment, Food and Rural Affairs) reports that the UK generates around 28 million tonnes of household waste every year, with about 45% recycling rate. According to the Waste Framework Directive, the UK (and other EC Member States) must recycle 50% of household waste by 2020.

The global waste collection and disposal market is currently estimated at $1 trillion and could double in the next 10 years. Waste management is a significant global economic and environmental challenge, illustrated by the fact that currently about 3.5 billion people lack access to basic waste services and only about a quarter of the total tonnes collected annually are recycled or recovered, with more than 70% of global waste currently landfilled (Source: Bank of America Merrill Lynch).

THE EVOLVING TONNE AND THE CIRCULAR ECONOMY

Waste management is no longer what it used to be, consumption, technology and regulations have caught up with the sector and the winners are those companies with the track record and capabilities to manage not only the growing volumes, but also the increasing complexity of the waste stream.

We have seen a change of quantity and quality of recyclables driven by changes in legislation, consumer behaviour and innovation in packaging. Today, for example, the “evolving tonne” and its different waste streams may contain printing paper (newspaper, magazines and flyers), paper packaging (corrugated cardboard and boxboard), food, and beverage containers (glass, PET, milk jugs and aluminium cans). Interestingly, while plastics may account for less than 10% on average of all recyclables in the residential sector by weight, they may account for up to 25% of the total volume. On average the share of paper going to landfill is on the decline, while the share of plastics ending up in landfill is increasing. As such, increasing volumes relative to weight are impacting the economics and complexity of waste collection, as more volume equals more trucks and higher processing costs.

The evolving tonne is fundamental to the idea of the “circular economy”, as an alternative to a traditional linear economy, where we produce, use and dispose. In the circular economy, we keep resources in use for as long as possible, extract the maximum value

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URBANISATION: THE WASTE CHALLENGE

from them whilst in use, then recover and regenerate products and materials at the end of each life cycle. In a way, the circular economy not only reduces waste and increases productivity, but also ensures we address growing issues of resource security and scarcity and reduces the environmental impacts of growing production and consumption.

While the highest levels of consumption, and therefore disposal, are in the developed world, developing markets will present the highest opportunities for those businesses that understand how to manage the “evolving tonne” and use technology and innovation to develop the “circular economy”.

The waste management and recycling industry comprises several areas, including municipal solid waste (MSW), industrial waste, e-waste, medical waste, recycling packaging and waste-to-energy. Companies involved in the waste and recycling industries include Daiseki (Japan, industrial waste), DS Smith (United Kingdom, recycling paper and board), Stericycle (United States, medical waste), Sonoco Products (United States, recycling packaging), Sims Metals Management (Australia, metal recovery) and Covanta (United States, waste-to-energy).

MUNICIPAL SOLID WASTE

The MSW industry in the US is a fairly concentrated and specialist market, with the three largest players accounting for c.40% of the industry’s revenue. Waste Management, Republic Services and Waste Connections have a clear and differentiated approach to technology than the rest of smaller and local operators across the US. These three players in aggregate serve 35 million customers with 39 thousand collection trucks.

In the UK, most of the main waste management operators are part of utility companies, with significant scale and scope to secure large contracts, finance infrastructure and offer a broad set of services. Approximately 75% of the MSW market is controlled by the ‘Big 5’. French company Veolia Environnement is the largest operator with about 24% market share, followed by Biffa and Veridor, both with about 14% market share, Suez Environnement (formerly Sita UK) and FCC Environment with c.13% and c.10% market share, respectively (Source: Catalyst Corporate Finance).

• Veolia Environnement (listed in France) has a global footprint of nearly 14 thousand employees in the UK alone. The group has been vocal about its vision of a circular economy, claiming that using “resources in a closed loop system” has the potential to contribute £29bn (1.8%) of GDP and create 175 thousand new jobs in the UK (Source: Circular Revolution Report, commissioned by Veolia to Imperial College London, June 2015).

• Biffa is currently privately owned with hedge funds Angelo Gordon, Avenue Capital and Sankaty Advisors as the largest shareholders. Biffa handles about 6.6m tonnes of waste in the UK, with about a third being converted into energy and sold back to National Grid, to serve 250,000 homes. Biffa operates a fleet of about 2,500 waste collection trucks, some of which are powered by biofuel from waste cooking oil.

• Veridor is part of the listed UK water utility group Pennon. It has continued to reduce its landfill operations in line with the company’s strategy to transform waste into recyclables or energy, by investing £1.5bn in energy recovery technology.

• After a rebranding exercise, in March 2015, Sita UK became the Recycling and Waste Recovery UK division of Suez Environnement, a French listed multinational water and waste treatment specialist.

• FCC Environment, part of publicly listed Spanish conglomerate FCC, operates 87 household waste recycling centres to serve more than 60 local authorities in the UK.

RECYCLING AND EMISSION SAVINGS

Recycling MSW has significant net benefits in terms of energy conservation and reducing greenhouse gas emission (GHG). However, not all waste is created equal with regard to emissions savings potential. The recovery rate varies significantly among waste classes, for example, in the US over 60% of paper and corrugated board is recycled, while only c.10% of plastic waste is recycled. The GHG savings per tonne also varies among waste classes, with one tonne of paper recycled generating three times the GHG savings of a tonne of plastic, and 10 times that of a tonne of glass. As such, paper recycling remains the largest potential source of GHG savings.

Incremental GHG Savings Potential by Waste Stream

Source: www.wasteplan.co.za

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PORTFOLIO CONSTRUCTION

The waste and recycling sector is fundamentally a defensive industry, in our view, and has recently moved away from a logistics and low-technology business to adding value by commodity processing and fuel preparation, for example. While near-term challenges exist, we think that the longer term outlook for the industry is extremely positive, with ongoing industry consolidation to rationalise capacity and support industry profitability.

From an investment viewpoint, we have seen a transformation of recycling practices and business models across several markets, particularly in the US and the UK, where operators are focusing on extracting higher value from waste, like metal recycling and recycling packaging. Additionally, historical low betas, strong free cash flow generation and attractive dividends underpinned long term investment opportunities. In our view, the waste management and recycling sector is fundamental to gain defensiveness within an investment portfolio, while having the potential upside from uptick in the construction cycle as well as commodity price recovery.

The Climate Assets Fund, Quilter Cheviot’s sustainable investment strategy, invests in a diverse global range of waste stocks from defensive integrated waste operators to growth companies involved in material reuse and innovative packaging. This allows us to position the fund according to where we are in the economic cycle. The fund invests in five sustainability themes (energy, food, health, water and resource management) with companies involved in the waste management and recycling industry accounting at present for about 12% of the portfolio.

SUMMARY

Currently about 3.5 billion people lack access to basic waste services and only about a quarter of the total tonnes collected annually is recycled or recovered, with more than 70% of global waste currently landfilled. As such, waste management is a significant global economic and environmental challenge with a growing market estimated at $1 trillion that could double in the next 10 years.

The sector represents an attractive investment opportunity for investors seeking to understand the resources’ supply and demand imbalance problem and identify the array of companies involved in managing the evolving tonne and contributing to the so called circular economy. Investors can gain exposure to the investment opportunities across the waste management and recycling industry through the Quilter Cheviot Climate Assets Fund. The fund invests across the global resource management value chain alongside other four investment themes, namely low carbon energy, health, food and water.

May 2016

Claudia QuirozExecutive Directorclaudia.quiroz@quiltercheviot.comTel: 020 7150 4749

Claudia is the Lead Fund Manager of our award winning sustainable investment strategy, the Climate Assets Fund – recently shortlisted for a performance award at the Professional Adviser Awards 2015. She also manages segregated portfolios on behalf of private clients, pensions and charities with a focus on sustainable investment. Claudia holds an MBA from Cass Business School in London and joined Quilter Cheviot from Henderson Global Investors in 2009. She has 15 years’ experience in Sustainable & Responsible Investment and is a member of the Chartered Institute for Securities & Investment. At Quilter Cheviot, she sits on the International Equities Investment and Responsible Business Committees.

Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future returns. You may not recover what you invest. This document is not intended to constitute financial advice; investments referred to may not be suitable for all recipients.Quilter Cheviot Limited is registered in England with number 01923571, registered office at One Kingsway, London WC2B 6AN. Quilter Cheviot Limited has established a branch in Dublin, Ireland with number 904906, is a member of the London Stock Exchange, is authorised and regulated by the UK Financial Conduct Authority, is regulated by the Central Bank of Ireland for conduct of business rules, under the Financial Services (Jersey) Law 1998 by the Jersey Financial Services Commission for the conduct of investment business in Jersey and by the Guernsey Financial Services Commission under the Protection of Investors (Bailiwick of Guernsey) Law, 1987 to carry on investment business in the Bailiwick of Guernsey. Accordingly, in some respects the regulatory system that applies will be different from that of the United Kingdom.

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