Natural Capital: the invisible asset on which everything rests

Last week’s newspapers featured a slightly esoteric story describing the legal dispute emerging between Aviva (one of the UK’s largest insurers) and Butlins (venerable provider of UK seaside resorts). The specific dispute is over whether torrential rain causing £60m of physical and lost business damage to Butlins’ business in Somerset was a ‘storm’. Butlins argue that a ‘storm’ requires heavy winds, therefore this was a flood. Aviva argue that this was a ‘storm’ despite the lack of wind, therefore the insurance coverage is capped at £25m.

For an investor, the specifics of the dispute somewhat miss the point. Whether storm or flood, Butlins’ dependence upon natural capital (the availability of dry land and the climatic conditions overhead) was brutally exposed. Although recouping the contested £35m will be helpful to Butlins in the short run, it is inevitable that insurance cover will be adjusted and repriced to reflect the growing risks to the business. In short, Butlins’ deteriorating natural capital is going to reduce the profitability of the business, increase the volatility of the earnings of the business and increase its cost of capital.

Understanding and valuing the extent of this deterioration in natural capital value is challenging. Butlins is a private business and, having spent recent years badly disrupted by Covid and having been under private ownership, it is not entirely transparent to outside observers. However, recent property valuation uplifts are not especially consistent with the idea of deteriorating site conditions. The potentially uninsured losses being disputed almost certainly account for the majority of a ‘normal’ year’s operating profits. Going forward, should these losses recur, they will be unlikely to have insurance coverage: they will just be losses.

In summary (and wildly overly simplistically), should the deterioration in natural capital mean that one additional year in a decade the business makes no profits, then cashflows reduce by 10%; volatility increases, taking the cost of capital higher; insurance costs increase or coverage is reduced; and, most damagingly, there is a risk that future customers decide that a holiday ruined by floodwater is not worth the cost (or the higher travel insurance premiums they have to pay). In combination, it seems difficult to argue that this deterioration in natural capital has lowered the value of the business by less than 10%… and there is not a single penny anywhere in the financial statements of the business that mentions this critical asset.
Although this illustration has focused on recent events at just one business, the issues are universal and will apply to a greater or lesser extent to most businesses and most investors. The hidden value of natural capital needs urgent and serious attention from executives, boards and investors alike.

Natural Capital Associates are expert in helping businesses and investors identify these ‘invisible’ assets, value them appropriately and manage them more effectively.