Some of our recent commentaries (December 7, 2023 and February 8, 2024) cover the 2024 election landscape. One of the biggest surprises so far was the decision of UK Prime Minister Rishi Sunak to call a general election for July 4. In this commentary, we look at the UK economy and markets as we approach this election.

Sunak’s decision caught everyone off guard and, on the face of it, the timing seems strange. A summer election during peak holiday season usually entails poor turn outs. The general thinking behind the decision is that momentum would be strongest after a stronger-than-expected GDP print in Q1 and inflation almost back to normal. A slowdown in growth is expected, and while the drop in inflation was welcomed, it was due to a decline in home energy bills and the base effect. Consensus estimates expected a larger fall, and as such, expectations for the first interest rate cut from the Bank of England have been pushed back to September from June, keeping mortgage costs higher for longer.

Labour’s lead and Conservative struggles

At the time of writing, the Labour Party has a 21-point lead, and the incumbent Conservatives are falling into a battle with Reform UK to be the official opposition party. The election campaign is well under way and Labour seem set for an overwhelming majority. This means they should be able to implement their policies, so let’s look at their manifesto and see what is likely to impact the economy and capital markets.

Labour’s strategic plans: No EU return, but stronger ties

First and foremost, there is no return to the EU on the cards, but Labour will continue to work on EU trade and investment relationships. The main points concern economic stability, defence, housing, infrastructure and clean energy. With geopolitical tensions continuing to run high, Labour will kick off their first year in government with a Strategic Defense Review, setting out a plan to increase defence spending to 2.5% of GDP.

Push for affordable housing

As expected, housing is at the forefront. Labour would like to build 1.5 million new homes over their term with an emphasis on increasing social and affordable housing. Brownfield development is the priority and approval of sites will be fast-tracked. New developments will be obligated to ensure more affordable homes.

No tax increases, but closing loopholes

For personal taxes, Labour has pledged to freeze National Insurance, the basic, higher, or additional rates of Income Tax, and VAT. There are some changes around the fringes that will be a source of income – ending the use of offshore trusts and closing some other loopholes to tackle tax avoidance. Corporate tax will also be unchanged for the term, keeping it at 25%, which is the lowest rate of the G7, and a promise to act if tax changes elsewhere hinder UK competitiveness.

Building for the future

Infrastructure investment has been low, so public investment will be used to support and attract additional private investment, whether domestic or foreign. An overhaul of the planning system would help here. In parallel to the usual spending on roads, railways and other important national infrastructure, investments will go into upgrading ports and improving the supply chain, new gigafactories to help the automotive industry, rebuilding the steel industry, accelerating the deployment of carbon capture and supporting green hydrogen manufacturing.

Wind, solar and job creation

The UK has some natural advantages that should help the transition to clean energy – a long coastline, high winds, shallow waters and access to a skilled workforce with extensive offshore and engineering capabilities. The Green Prosperity Plan aims to double onshore wind, triple solar power and quadruple offshore wind by 2030 while creating jobs. Labour does not intend to issue new licenses to explore new oil and gas fields in the North Sea. The same applies to new coal licenses and fracking will also be banned. Labour remains committed to the EV transition by restoring the phase-out date of 2030 for new cars with internal combustion engines and will accelerate the roll out of charge points.

Financial services as a boost for innovation and investment

There was some positive language around financial services, an undoubted strength of the UK economy. Labour wants to support innovation and growth in the sector, talking about a pro-innovation regulatory framework. Also concerning financial services is the ambition to increase investment from pension funds in UK markets. Domestic pension funds are mature and have reduced equity allocations in general and even more so UK equity allocations. The UK Office for National Statistics shows that domestic pension funds own 1.6% of the UK equity market from over 30% in the 1990s, low compared to similar developed markets. Theoretically this number could go lower, but with some new incentives, arguably risk is skewed to the upside, especially if a minimum level of UK equity exposure within pension portfolios is mandated. Increased demand could see a re-rating for UK equities.

UK equities poised for growth

The party in charge is ultimately not the most important factor. The last Labour government coincided with the Great Financial Crisis in 2008, and the Labour government before that (Tony Blair) was impacted by the dot-com bubble bursting and the subsequent recovery. What has been consistent over the past 60 years has been an average 10% gain for the FTSE All-Share index in the first year of an election when a change of power occurs.

The UK market looks attractive. Valuations are depressed and the discount is broad, having seen a pickup in bids from overseas competitors and private equity acquirers opportunistically seeking assets and market positions. Losing listed companies to M&A, a slow environment for IPOs and UK-based companies choosing a primary listing overseas means UK equities are in short supply. Finding solutions for the structural challenges facing the UK economy is essential to kickstarting growth and attracting investors. If execution is successful, UK equities could gain favour the way Japanese stocks have lately.

When one thinks of high-return investments, the waste management sector rarely comes to mind. It’s not as exciting as tech or biotechnology companies. Yet, the waste services industry has captured the attention of some of the world’s most sophisticated investors. For instance, the Gates Foundation owns over 35 million shares of Waste Management, the largest waste service company in the United States, making it one of the foundation’s top holdings. Private equity funds also have a keen interest in this sector, with those specializing in environmental services amassing more than $1.3 trillion globally, according to PitchBook.

Global dry powder: private equity funds seeking investments in environmental services (in billions)
Source: PitchBook.

So, what makes the waste management business so attractive to some investors?

The sheer size and growth potential of the market. Globally, more than two billion tons of municipal solid waste are generated annually. To visualize this, if packed into standard shipping containers and placed end-to-end, this waste would circle the Earth 25 times, or to the moon and back. On top of municipal waste, human activity generates significant amounts of agricultural, construction, industrial and healthcare waste. The global waste management market was valued at $1.3 trillion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 5.4% until 2030, reaching $1.96 trillion.

Recession-resilient business model and high entry barrier. Waste management is a fundamental service in modern society. Every day, millions of tons of waste are generated, requiring efficient collection, treatment and disposal. This ongoing need makes waste management companies indispensable, ensuring a stable demand regardless of economic conditions. These companies typically generate strong cash flows, high margins and significant return on capital. Long-term contracts with municipalities and businesses provide predictable revenue streams. Moreover, high entry barriers associated with sizable upfront investment and stringent regulations deter newcomers, giving existing players pricing power and reducing competitive pressures. This stability translates into reliable revenue streams, making the sector attractive for long-term investors.

At Global Alpha, we have identified numerous promising investment opportunities within the waste services sector over the years. Here are some examples:

• Casella Waste Systems (CWST US) is a regional player providing integrated waste services, with a strong focus on the US Northeast and Mid-Atlantic regions. The company benefits from its strategic positioning in the capacity-constrained Northeast market, allowing it to capitalize on pricing power and opportunities for growth through M&A. The company also emphasizes operational optimization to enhance margins and efficiency.
• Befesa (BFSA GY) is the world’s leading recycler for steel dust and aluminum, with recycling facilities across Europe, Asia and North America. The company has over 50% market share in Europe and is a first mover in China for steel-dust recycling. With increasing regulatory mandates requiring decarbonizing steel production, Befesa is well-positioned to capture the volume growth with a well-defined capacity plan.
• Daiseki (9793 JP) is Japan’s largest liquid waste processor, including waste oil, wastewater and sludge. Its recycling technologies can treat waste oil to produce recycled lubricating oil, heavy oil and supplemental fuels. Demand for recycled oil is rising as Daiseki’s clients seek to reduce their carbon footprint.
• ARE Holdings (5857 JP) is the world’s largest precious metals refiner. The company collects, recycles and refines precious metals, including gold, silver, platinum and palladium from dental, electronics and jewelry materials. The carbon footprint of recycled silver is roughly one-third of mined silver. Recycling gold emits less than 1% of emissions than mining new gold. Many industry players, such as Prada, Tiffany, Cartier and Pandora, now use recycled metals.
• TRE Holdings (9427 JP) is one of the leading waste treatment and recycling companies in Japan, specializing in handling construction waste and waste metals from automobile, home appliances and industrial sectors. It has over 20% market share in the construction industry and recycling schemes with auto makers and home appliance manufacturers. The company also has renewable energy businesses that use recycled wood from its own operations as fuel for biomass power generation.

When it comes to waste management, Japan is known for its rigorous waste sorting and disposal practices. The country faces a challenge with limited landfill capacity. Existing landfill sites have remaining capacity of 96.66 million cubic meters, projected to reach full capacity in 23 years, so Japan tries to minimize garbage through efficient sorting and processing. That explains why Japan has such low landfill waste per capital compared to other economies.

Global landfill waste generated per capita 2022, by select countries (in kilograms)
Source: Statista.

Daiei Kankyo (9336 JP), a name added in our portfolios in a recent quarter, is a Kansai-based waste disposal company that offers one-stop services from collection, transport and intermediate processing, to final disposal. The company has top share in the final disposal market among private-sector players, accounting for approximately 11% of Japan’s total landfill capacity. The final disposal business is extremely difficult for new players to enter because of the strengthened regulatory processes and environmental concerns by local communities. Only companies with a strong track record and reputation can possibly get a permit and expand their capacity. Additionally, it takes six to seven years to open a new facility. This lengthy process further increases the barriers to entry, ensuring stable volume growth and strong pricing power for incumbents. That’s why Daiei Kankyo boasts the highest margin among its waste management peers in Japan. Over the years, the company has diversified into recycling, soil remediation and electricity generation businesses to provide a total solution to its clients.

In contrast to other markets, Japan’s waste management industry is more fragmented, with the four players accounting for only 4.2% of the market, compared to 40% to 50% of the US market, which allows ample M&A opportunities. Daiei Kankyo has acquired over 20 companies since its founding in 1979, typically at EV/EBITDA multiples of 3x to 5x. M&A will remain a growth driver in the coming years.

Another driver for the company is public-private partnerships (PPP). Many Japanese local municipalities struggle with handling household waste due to a declining population and labour shortages and have started working with private players. Daiei Kankyo pioneered PPP contracts where the plant will be built, owned and operated by Daiei Kankyo, and municipalities will pay waste treatment fees once operational. So far, the company has won three orders and expects to win 12 by 2030.

Turning waste into wealth

While only a small portion of waste is recycled, global innovators and industry leaders are finding new ways to turn waste into sustainable materials or fuels. The potential for these innovations to convert waste streams – currently incinerated or buried – into valuable resources is promising for the future.

Next time you experience an internet outage, don’t blame the weather. Blame the thieves who took a big bite out of your internet line instead. According to Bloomberg, telecom companies are sitting on 800,000 tonnes of copper worth $7 billion at today’s prices in the form of old copper wiring. A surge in copper thefts is usually correlated with two things: a rise in copper prices and a rise in unemployment. We have seen a clear upward trend with the former and copper thefts could be a leading indicator of the latter.

There is a good chance we will be hearing more on cable-cutting thievery in the future. Copper traded around $3.89 per pound at the beginning of the year and recently crossed $5 per pound. So, what is going on with the price of copper?

Net zero targets come at a cost

First, it’s important to understand why copper is so central to our lives. Apart from silver, it’s the most efficient conductor of electricity. Copper is everywhere, from small appliances like toasters, to cars, which have an average of 29 kilograms of copper built into them. Electric cars need at least double the copper.

To meet ambitious net zero targets, it’s not just about electrifying means of transport. It also means generating and sourcing clean energy from far-flung wind farms and solar parks that need millions more feet of copper wiring to connect greater distances. According to S&P Global, annual copper demand is expected to double to 50 million tonnes by 2035 to achieve net zero targets.

Power-hungry AI search

Your Google search consumes around 0.0003 kilowatt-hours of energy. Ask the same question on, say, ChatGPT4 and energy consumption jumps to 0.01 kilowatt-hours. That’s around 15 times more energy consumption. Extrapolate this to the exponential growth in AI searches we see on the horizon (ChatGPT had 100 million monthly active users at the end of 2023) and you get the scale of energy required to sustain this trend. According to Trafigura, copper demand related to AI and data centres could add up to a million tonnes by 2030. That’s on top of the expected four to five million tonne deficit gap expected for reasons other than AI.

Structural deficits

While demand could explode on the back of AI and ambitious net zero goals, supply is not expected to keep pace for two reasons. First, the 10 biggest copper mines are around 95 years old on average. With every passing year, it gets more expensive to go deeper into the ground to extract lower grades of ore. Most of the big mines are located in Chile and Peru, politically volatile jurisdictions with recurring water shortages. That leaves existing mines producing a dwindling supply of expensive copper.

When it comes to new mines, there is not much incentive to put dollars to work on known deposits. Copper prices would need to be much higher to incentivize mining companies to invest billions of dollars. With politics, red tape and tougher environmental regulations, it takes close to a decade to fully operationalize a mine. This explains the flurry of activity in recent months (Glencore & Teck, Newmont & NewCrest, BHP & Anglo) to buy and consolidate existing mining assets. However, without exploration for new assets, it’s unlikely this will make a dent in the current demand-supply equation. The last copper mega deposit was found in Southern Mongolia (Oyu Tolgoi mine) 20 years ago. After pouring $7 billion into it, it has yet to reach peak production.

One of our holdings is Capstone Copper (CS CN), a mid-tier copper producer with mines in Chile, Mexico and Arizona. Capstone’s growth is driven by its assets in Chile, which make up two thirds of its net asset value. As a mid-tier producer, Capstone is not blessed with scale or the most unique grade of ore. However, what we like about the company is its ability to find and manage high IRR assets stewarded by a CEO with over 30 years of experience in the mining space.

In 2023, the company produced 164 kilotonnes of copper; however, the ramp up of its two Chilean mines is projected to bring production to 350 kilotonnes by 2028. This production increase means cash costs could come down from $2.88 per pound today to $1.50 per pound in the future. Should copper prices remain elevated, this would make for a very profitable operation.

Twenty years ago, copper saw a five-time increase in price driven by underinvestment in the 90s and China’s rapid industrialization. Could the simultaneous confluence of AI, the green energy transition and supply shortages make history repeat itself?