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Building the Big Smoke

George Clapham, Managing Partner

The hustle and bustle of cities has always formed the cultural and economic centre of our society. Globally, urbanisation is on the rise; and, not just in developing countries but in many developed nations where cities are becoming more densely populated. Today, 54% of the world’s population live in cities compared to 30% in 1950. By 2025, 34 cities around the world will have populations greater than 10 million people. Growth and urbanisation in developing economies is driving the demand for infrastructure. According to the United Nations, by 2030, China’s urban population is expected to reach 1 billion, a 250 million increase from an estimated 780 million city dwellers today. India’s urban population is also growing and is expected to reach 580 million in 2030 – an increase of 170m from 2015.

Source: United Nations

With rising levels of urbanisation comes growing demand for infrastructure in sectors such as water treatment, communications, sewerage, energy, building and transport systems, schools and hospitals.
The essential infrastructure that require constant investment are;

1. Water Management Systems, including collection, treatment, distribution, waste removal, flood protection;
2. Grid Electricity Systems, including generation, transmission, distribution, back up supply;
3. Transportation Networks, including roads, railways, bridges, ports and moving parts (trains, buses, boats, bicycles, vehicles); and
4. Building Systems, including climate control, energy supply, data supply, fire & safety.

Source: Siemens AG

Importantly, these key infrastructure systems need to be resilient and capable of dealing with natural disasters including fire, flood, heat waves and cold snaps. For example, since Superstorm Sandy in 2012 (Sandy caused an estimated US$50bn of damage in Greater New York), it has now become critical that cities install Microgrids or small, independent electricity or heat grids that distribute locally generated energy to nearby customers.

Dealing with such demands and challenges requires smart planning and better use of data. To do this, governments and companies are looking to the Internet of Things (IoT). IoT Smart Cities’ technology enables the cutting-edge intelligence and flexibility necessary to help cities use resources more efficiently – to improve everything from quality of the air and water, to transportation, energy and communication systems. It is estimated that governments will invest approximately $41 trillion over the next 20 years to upgrade their infrastructure to benefit from the IoT. With these huge investments, the IoT will transform the quality of life for citizens in cities.

At Arnhem, we believe investors have a number of ways to access the opportunities growing cities present. The leading global capital goods enterprises are clear candidates for exposure to the accelerating urbanisation theme. Such companies are leading providers of capital equipment and services used in power, building, transport, water treatment, security and fire safety systems.
We have noticed a rising level of industry concentration in capital goods industries, as the lead players continue to strengthen their industry positions through targeted acquisitions or mergers. Such consolidations will typically enhance industry returns. Significant consolidations, which have either occurred or are in process, include the heating, ventilation, and air conditioning (HVAC) and safety equipment sector (Tyco, Johnson Controls), the wind turbine sector (Gamesa, Siemens) and the rail transport equipment sector (Alstom, Siemens).

Capital goods companies typically have cyclical earnings, relying on infrastructure spending and capital expenditure cycles. These demand drivers are presently buoyant and/or in recovery mode (particularly in Europe). The dominant global players in this space are Siemens (SIE DB), Honeywell (HON NYS), Schneider Electric (SU ENXTPA), ABB (ABBN SWX), General Electric (GE NYS) and Johnson Controls (JCI NYS). The companies with the most exposure to building and infrastructure capital goods are Johnson Controls, Siemens and Schneider. They derive about 70% of group revenues from these industries and also have sizeable exposures to developing economies (between 25-40% of revenues). Arnhem currently has a position in Johnson Controls (JCI NYS) in our Global Equity model portfolios.

George Clapham is a managing partner and Portfolio manager of the Long/Short Strategy. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.
This article has been prepared by Arnhem Investment Management Pty Limited ABN 17 129 606 775, AFSL 332484. It has no regard to the specific investment objectives, financial position or particular needs of any specific recipient. You should seek your own professional advice in relation to any financial product referred to. You should also obtain the product disclosure statement relating to any financial product referred to and consider the statement before making any decision about whether to acquire the financial product.

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© Arnhem Investment Management, 2017