Profit from fighting pollution

The environment is under assault, but those firms providing solutions tothe crisis will make great long-term bets, says Jonathan Compton.

After 140 million years of footling around doing little save eating and picking up the odd girlfriend, it seems that Dabry's sturgeon has ceased to exist. It follows the baiji, a 25 million-year-old species of fresh water dolphin, which was last seen in 2007. Both lived in China's 4,000 mile-long artery, the Yangtze River. While the causes for their demise include overfishing and pollution, the prime reason was the construction of the Three Gorges Dam, a monument to political egotism.

As is frequently the case once a government decides to make a grand gesture, the risks and consequences were well researched at the outset, but authors of critical reports were either fired or ignored. Without doubt, the entire project has been a monumental disaster. That's not just because of the destruction of many relatively unknown animal and plant species, or even the immense wider human and ecological impact (so large is the body of water behind the dam that it is causing major landslips and earthquakes over an area twice the size of France). Worse still, the dam has caused all this destruction and in the process it has failed to achieve its primary purpose of producing cheap electricity efficiently.

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In India, meanwhile, the capital,New Delhi, sits on the Yamuna River, which is a major tributary of the world's holiest river, the 1,700 mile-long Ganges. Tens of millions of people depend upon it for their existence. In the dry season, 100ml of water (about the same volume as a small glass of wine) contains1.1 billion fecal coliform bacteria (from excrement). This is 500,000 times greater than the safe limit, which is set by the government for bathing at 2,500. As a direct consequence, women in New Delhi suffer from the highest rate of gallbladder cancer in the world.

Such disasters are not confined to developing countries. The state of Pennsylvania has been a coal mining area for more than two centuries. On 27 May, 1962 an underground fire broke out in the Centralia mine, probably started by a miner burning a small pile of rubbish. More than 50 years later, it remains alight at up to 700 feet below the ground for an eight-mile stretch. According to a report by the University of Pennsylvania, the fire is hotter than the planet Mercury, with a temperature often exceeding 500C, and its atmosphere is more poisonous than the planet Saturn.

The town of Centralia has disappeared, with a population falling from 3,000 people to fewer than ten. At the current rate the fire is expected to burn for another 250 years. There are hundreds of underground mine fires globally; the median guess is that between them they account for 4% of the world's carbon dioxide emissions.

Why governments are apathetic

Everyone cares about their environment. This may range from annoyance about the trails of litter that adorn the verges of Britain's roads and railways, to concern for better sanitation or clean air. Yet most of us feel powerless to do anything about it, or are bludgeoned into submission by conflicting data.

Activists often appear hysterical and regularly abuse the facts. Environmental plans and companies frequently appear to be little more than get-rich-quick schemes for their promoters. Indeed, one of the largest so far appears to be unfolding right now: on 22 May, the share price of the Hong Kong-listed solar energy company Hanergy collapsed by 47% in an hour, before being suspended by the exchange pending investigation by various authorities. At its peak three months ago, the chairman's shareholding alone was worth $31bn on paper.

Governments and their departments tend to play down severe environmental problems, except when image building (remember the pictures of David Cameron cuddling his cute husky team in 2006?). One good reason is a fear of causing public alarm. Another is the stupendous sums of money required to rectify environmental problems, which requires taking the unpopular step of either diverting public funds, or creating new taxes.

The best example globally is the decommissioning of nuclear power stations: although no-one knows for sure the total cost required to do this, even the lowest estimates are huge. Hence, without exception, every government has fudged the long-term impact.

A third reason for government lethargy is often simple ignorance. The "science of the environment" is in its infancy. The causes and effects of many problems and potential side effects of remedial action remain little understood. Much scientific evidence appears compelling but it can also seem contradictory. Twenty years ago we were all being urged both morally (through campaigning) and financially (via taxation) to buy diesel cars to replace lead petrol with its toxic atmospheric damage. Yet diesel in turn has now been discovered to be more harmful to human health than improved unleaded petrol.

Management won't see it coming

For all the uncertainties and contradictions, however, environmental issues matter enormously and should be high on an investor's checklist asgetting it wrong can be financially damaging. It's easy to ignore this as a trendy concern of "ethical" investors, but the fact is that the amount of regulation is increasing alongside popular concernand awareness. These new rules will destroy many seemingly safe industries, while creating opportunities for investment elsewhere. You don't need to look far to find a great example of how regulation and awareness can fatally undermine an industry.

Until 2008, America's polluting coal industry seemed indestructible.It bankrolled politicians and, through well-funded lobbyists, swatted away opposition, even though there is rare universal agreement that coal is themost damaging of all fossil fuels.One of the industry giants wasPeabody Coal, which back thenwas trading at over $80 a share.Today the price is near $4. Yet whenI interviewed Peabody Coal duringthe glory days, the management team refused to accept that new regulationsor cheaper alternatives would affecttheir industry.

Further down the food chain is one of America's largest railway firms, Norfolk Southern Corp., whose management team I interviewed in 2013. Moving coal by rail was a major part of its business. Apart from a drop in coal demand due to a surge in cheap domestic gas supply, the company simply denied that the outlook for coal was poor, or that regulations would be tightened. To quote a senior spokesperson: "if necessary, we can always export to Europe". He was seemingly unaware that the European Union (EU) has harsher regulations and more environmentally aware politicians. Both firms were in denial about the major shifts in the dynamics of their businesses.

So you can't take it for granted that managements will see these sorts of threats coming. Many other businesses, including mining, construction, manufacturing even farming are in a similar position. Farmers in the EU are furious about a raft of new regulations, which by 2020 will severely restrict, and in some cases ban, the use of many pesticides and other chemicals.

This will make growing crops and husbandry more complex. Yet for all their attachment to the land, these rosy-cheeked entrepreneurs are major polluters. Half of all water pollution is caused not by rubbish or excrement (two million tonnes of human excrement enters the river systems every day), but by growing food: in the form of sprays such as nitrates and sulphates.

Concerns over the impact of a rapid rise in environmental decay, combined with a tighter regulatory framework, have the potential to wreak havoc in the corporate sector. But the greater effect will be economic, particularly affecting Asia's fast-growing countries. Many pollution indices are produced regularly unsurprisingly, poorer countries with large populations, such as Egypt, Bangladesh, China and India, fare badly, while advanced countries with small populations score best such as New Zealand or Sweden. Yet Asia, with 61% of the world's population and pell-mell growth, has been slow to realise the threats of growth at any cost.

One wake-up call was a report by the UN World Health Organisation (WHO). Half of China's population lives near its three main rivers. These are dumping grounds for toxic industrial waste. As a result, the level of heavy metals such as cadmium, lead, arsenic and mercury in the bloodstreams of up to a quarter of children under 16 living near them, are up to ten times the level considered safe by the WHO.

The serious impact of heavy metals on physical and mental health is well-known. (The phrase "Mad as a Hatter" was first recorded in 1829 when hat makers were using mercury compounds, which cause severe damage to the brain and nervous system.) Even if preventative action is taken now, nothing can stop a new generation of workers suffering from a record level of physical and mental impairment caused solely by ignoring the environment.

The rise of 'the Thames effect'

Apart from the obvious costs to the economy, such a casual approach is becoming socially unacceptable. And yet the political response remains contradictory. In March, a former TV anchor-woman produced a short video on air pollution, which within five days had over 150 million viewers on a single website. (China's air pollution is dire in its major cities. During the Beijing Olympics, private cars were banned to reduce air pollution; the Olympic Association considered it was too high for athletes.) Initially, the video received praise from some party leaders, but it proved so popular and controversial that within two weeks it was banned and its supporters were relocated or sacked.

Environmental issues tend not to make the headlines until the damage and the effects are so appalling that agreement for action can be made, whatever the cost.A good example was 19th-century London and "The Great Stink".The River Thames was an open sewer and the world's most polluted waterway.

In the summer of 1858 London came to a standstill. The sewage in the Thames began to solidify and cook, then ferment, during a heatwave. Within a record 18 days, Parliament passed one of its first pieces of environmental legislation. Today the levels of oxygen and marine life in the Thames are better than in many rural areas. The London example is encouraging, in that degradation can be reversed. Yet it's also depressing, in that the Thames was a sewer for two centuries before action was taken.

The scale of the problem now is so great that it is hard to comprehend the numbers. At a basic level, there are 1,700,000,000 people without access to clean water or sanitation. Yet there are signs that the world may be at a turning point and mankind might just have sufficient wit not to self-destruct within two generations. The environmental impact on health is acting as a powerful catalyst. So too is the "Thames effect", as in many countries the problems are both visible and affecting the ruling elites and ordinary citizens alike. Although the pace is often snail-like, better regulatory frameworks are appearing not just in the developed countries and, crucially, enforcement is slowly improving.

Moreover, there is one critical and encouraging long-term trend. The prime causes of pollution are people and then natural disasters. We can do little about the latter and radical population solutions, as, for example, in Exodus (God killing every firstborn child to punish the Pharaoh), have gone out of fashion. Yet population growth has reached a tipping point.

Between 1950 and 2015 the world's population grew from 2.5 billion to 7.0 billion. The 1960s saw the fastest rate of growth ever at 22% during the decade, falling to 7% in the ten years to 2020 and forecast to fall to as little as 0.5% by 2050. Thus we may yet avoid choking to death, which makes long-term investing during this period of significant demographic change particularly interesting.

The four environmental stocks to buy now

When searching for ideas of what to buy in this sector, I had two surprises. The first was that I could not find a fund to recommend that concentrated on clean water or the environment. Almost all of those with the highest performance rankings over the past five years have underperformed their benchmarks. The second was that I wanted to find at least two UK-listed companies in these sectors, but there are very few listed, so I have been forced to look for alternatives overseas.

My first commendation is the "Big Daddy" in water and waste treatment, Paris-listed Veolia Environnement SA (Paris: VIE), which, with a market capitalisation of €10.8bn, is the largest company in the sector and has broad international reach, especially in developing countries. As a bonus, it currently trades on a relatively high dividend yieldof 3.6%.

I do not particularly like solar or wind-energy companies. Although both sectors have recovered recently, there is considerable surplus capacity in the sector, which casts a doubt over profitability. One of the major problems with alternative energy is storage capacity. No company has yet developed large efficient batteries to store surplus power, but it will happen. Hence I shall fall back on a previous recommendation and another French company, SAFT Groupe (Paris: SAFT), which I have long held and which has performed well over the last six months.

It develops batteries for industrial and defence use and has just built an enormous new factory in America. Like all battery makers, it is trying to crack the storage problem, but in the meantime it has a robust and recovering business.

There was a British-listed environment group called Hyder Consulting, which was taken over by Dutch company Arcadis NV (Amsterdam: ARCAD). It provides design consulting expertise for construction, environment and water treatment internationally and although it is relatively expensive on aprice/earnings multiple of 20 times, it should see strongearnings growth.

My last suggestion is Tokyo-listed Kurita Water (JP: 6370), one of the top ten waste treatment companies in the world. While expensive relative to the Japanese market, this is justified as it is so well positioned to take advantage of the urgent needs across Asia for better sanitation and clean water.

Jonathan Compton spent 30 years in senior positions in fund managementand stockbroking.