The infrastructure sector is at an inflection point, with covid-19 being the catalyst of enormous dynamic change. The impact on certain sub-sectors, such as transport, has been particularly severe, with permanent destruction of demand. In others, such as utilities and grids, there is a growing trend of consumers putting pressure on regulators to reduce rates of return as economies become stretched and perceived value for money from regulated assets is called into question.
Conversely, several ‘new’ sub-sectors are arising from the pandemic. These are displaying high growth; are fully aligned with environmental, social and governance criteria; and are widely supported by the public at large. One sub-sector at the forefront of the ‘new’ infrastructure is indoor vertical farming, which has the potential to disrupt many aspects of the traditional, carbon-intensive, agriculture sector.
“The question is whether indoor vertical farming exhibits infrastructure-like characteristics. The answer is: it depends on both the business model and stage of the company”
Agriculture accounts for 26 percent of global greenhouse gas emissions. It also represents more than 70 percent of freshwater usage and contributes to an enormous amount of water pollution. Over recent years, climate change, which includes both high and non-linear temperatures as well as water scarcity, has had a negative impact on food production. The pandemic has also highlighted weaknesses in the food supply chain and distribution channels.
Indoor vertical farming provides economic and sustainable solutions to these challenges. It disintermediates several steps from ‘farm to fork’ and is rapidly proving to be smart city infrastructure. Reported production yields are represented to be upwards of 300 percent of those for open fields. Products are grown locally and can require 95 percent less water and use a similar amount of less land. Energy is a major component of the costs, and if cheap renewable energy is available, it provides a win-win scenario. The facilities for indoor vertical farming require significantly less fertiliser and minimise transportation, processing and cooling, which in turn significantly reduces the carbon footprint.
A couple of companies involved in indoor vertical farming use no pesticides or herbicides. Some are using automated processes, which minimises the number of touchpoints and reduces the probability of bacterial infections, such as E. coli. Indoor vertical farms are currently producing leafy greens, strawberries and tomatoes, most of which are labeled as organic or ‘beyond organic’. Other crops are being tested for future production. Innovative technologies also enable precision, which allows for the production of consistent and uniform crops, reducing food waste.
As with all ‘new’ infrastructure, the success of indoor vertical farming will be dependent on innovative technologies and processes. Whereas traditional agriculture is a fragmented industry, vertical farming has been able to aggregate the key processing steps – seeding, germination, propagation, harvesting, and logistics and sales – under one roof.
Success is based on mastering all of these while efficiently utilising space and energy. Much like the conductor of an orchestra, everything needs to be harmoniously synced, otherwise performance will be inferior. Companies such as &ever employ artificial intelligence, climate cells, robotics and other state-of-the-art processes to create indoor vertical farms at varying scales. These facilities will be designed to meet different customer segments, through large, small-scale or in-store units, and differing geographies, such as deserts or cities.
Given that technological innovation is a key factor in the success of these operations, investors need to be aware of what constitutes a competitive advantage in any investee company.
This emerging sub-sector includes companies at or nearing profitability, and which therefore display similar characteristics to those that have emerged in the cleantech era – some will be ‘first movers’, others will employ direct retail strategies or rely on non-proprietary technologies, while some will be engaged in ‘greenwashing’.
Accordingly, the key for investors is to fully understand a company’s sustainable competitive advantages, its business model (whether it is an owner, developer, operator or retailer) and its path to profitability.
Indoor vertical farms have the capability to disrupt portions of traditional crop production. Leafy greens produced through organic indoor vertical farming are already being competitively sold into organic food stores and brand grocers.
Recent analyst reports project a compound annual growth rate of around 20 percent for indoor vertical farming over a 20-year period. It is envisaged that the sub-sector will be able to scale up and economically produce a variety of crops while further selling to other large, medium and small grocers, distributors and restaurants under sustainable conditions. This method of farming should also provide security of supply amid the disruption caused by climate change and any further pandemic.
The question is whether indoor vertical farming exhibits infrastructure-like characteristics. This depends on both the business model and the stage of the company. More developed companies have business models analogous to those of the renewable industry or data centres. A couple of groups are entering into medium-term offtake agreements with high credit-rated companies. When the inputs and outputs of interior vertical farms are secured through agreements, the farms will generate long-term, stable cashflows. High asset intensity and stable cashflows are the typical characteristics of infrastructure investments. Demand for food can be predicted more reliably than demand for transport.
“As with all ‘new’ infrastructure, the success of indoor vertical farming will be dependent on innovative technologies and processes”
As such, several infrastructure investors are looking at various indoor vertical farming companies and projects, particularly as offtake agreements are expected to evolve into longer-term agreements as the sector matures to become more infrastructure-like. However, unlike most infrastructure-like assets, profit margins are expected to increase by more than 50 percent as innovation and scaling-up create further efficiencies. As such, venture capitalists, private equity funds, direct institutional investors (such as sovereign wealth funds, pensions and family offices) and real estate groups are either carefully examining or investing in this sub-sector.
One of the ‘green shoots’ to have emerged as a result of the pandemic is the development of new sustainable infrastructure sub-sectors. Indoor vertical farming is set to disrupt traditional agriculture and will ultimately become a part of infrastructure investors’ portfolio allocations. In today’s environment of uncertainty, it is at the vanguard of ‘new’ infrastructure that has wide public support in positively transforming the world we live in.
Jeffrey Altman is senior advisor at Switzerland-based consultancy Finadvice