Utility Sector Ideas

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Water Sector -- >>> 4 Water Plays for a Thirsty Portfolio



By Leo Sun

May 3, 2013

Tickers: AWK, PIO, PHO, XYL



http://beta.fool.com/leokornsun/2013/05/03/four-water-plays-for-a-thirsty-portfolio/33148/?source=eogyholnk0000001




When most people think about valuable commodities, they tend to think about gold or oil. Most people neglect the world’s most important commodity -- fresh water.

Although water covers 70% of the Earth’s surface, only 1% of the world’s water is available for drinking. 97.5% of the planet’s water is seawater, and 70% of our available fresh water is frozen in glaciers. Meanwhile, climate change, water pollution, and poor management of water resources has led to a rapid depletion of the world’s fresh water. Parts of the world (including the United States) have been hit with prolonged droughts, which have caused food prices to skyrocket.

Worst of all, the world’s population, currently at 7 billion, is projected to reach 9 billion by 2025. By that time, the UN estimates that 67% of the world’s population will be lacking continual access to fresh water. In addition, the UN has estimated that fresh water demand has risen threefold over the past five decades.

Let’s explore a few ways that investors can benefit from the upcoming fresh water crisis. Since water isn’t a tradeable, priced commodity that can be purchased on the futures market, there are three simple ways that investors can invest in water: infrastructure, utilities and ETFs.

Infrastructure

Water infrastructure companies will become increasingly important in the next decade, since many water pipes within the United States are more than 60 years old, with some exceeding 100 years old. This has led to water main breaks, sinkholes and leaking pipes across the country. The costs to repair the U.S. water infrastructure, which leaks around 1.7 trillion gallons of water daily, is estimated to be around $1 trillion. The rest of the world faces similar challenges.

Xylem (NYSE: XYL) is a solid pure water infrastructure play that has a presence in 150 countries worldwide. Xylem operates in two business segments - Water Infrastructure and Applied Water Systems. In the first quarter, Xylem earned $0.27 per share, down from $0.36 a year ago, and revenue declined $46 million to $879 million.

Xylem’s Water Infrastructure segment focuses on providing clean water delivery, wastewater transportation and treatment, and analytical instruments. During the first quarter, this segment's revenue declined 6% from the prior year quarter, which the company primarily attributed to U.S. industrial weakness and challenges in the European market. The segment reported lower volumes and higher expenses from acquisitions and investments.

Meanwhile, its Applied Water segment consists of water products and services for residential and commercial buildings, along with industrial and agricultural businesses. Revenue for this segment slid 3% for the same reasons as the Water Infrastructure business. However, U.S. residential buildings and agricultural end markets showed substantial strength that offset some losses.

To most investors, Xylem’s top and bottom figures look mediocre, but it’s important to remember that water stocks are long-term investments that should be held for one or two decades. Meanwhile, Xylem has been focusing on strengthening its brand portfolio. This quarter, it acquired U.K.-based wastewater service PIMS and Australian water and wastewater control company MultiTrode. It also introduced new dewatering solutions from its Godwin and Flygt brands, and new analytical instruments from its YSI and OI brands.

Xylem recently conducted a market survey, in which 88% of respondents stated that the U.S. government should be investing more heavily in improving water infrastructure, with 65% stating that they would accept higher monthly bills to cover the costs.

Utilities

Another simple way to invest in water is through investor-owned water and wastewater utilities. The biggest name in this field is American Water Works (NYSE: AWK). American Water Works operates primarily in the United States and Canada, covering 15 million people in 30 states and two Canadian provinces. The company, founded in 1886, has grown rapidly by buying up local utility companies. In 2012, it acquired 16 new water systems, which added 55,000 customers for the cost of $44.6 million.

In the fourth quarter of 2012, American Water Works’ net income came in at $0.31 per diluted share, down from $0.34 in the prior year quarter. However, revenue rose 7.9% to $2.9 billion. For the full year, the company’s earnings came in at $2.11, up from $1.73 in 2011.

Since the U.S. water infrastructure is aging quickly, American Water Works has invested a lot of capital into upgrading and maintaining its water systems. In 2012, the company invested $929 million in company-funded capital improvements, up from $925 million in the previous year. It completed two major projects in New Jersey and Pennsylvania, which cost a combined $176 million. The two projects will benefit over 625,000 people. The company noted that many of those upgrades were to its underground water systems, the importance of which was highlighted last year during Hurricane Sandy.

In 2012, the company’s subsidiary, American Water Resources, was chosen by the New York City Water Board as the office service line protection provider for the city’s five boroughs. This is the largest municipal-partnered water and sewer line protection contract in history, and will take effect in the first quarter of 2013.

Just like Xylem, investors in American Water Works shouldn’t expect big overnight profits. Rather, they should think of the investment like the water utility on a Monopoly board -- steady returns that pile up over time. In the meantime, the company pays a decent quarterly dividend of $0.25 per share.

ETFs

Last but not least, investors should consider two water ETFs for a more diverse slice of the market -- PowerShares Water Resources (NYSEMKT: PHO) and PowerShares Global Water (NYSEMKT: PIO).

PowerShares Water Resources is a domestic play that attempts to invest at least 90% of its total assets into the underlying components of the NASDAQ OMX US Water Index. The ETF is spread out over a wide range of water-related companies that specialize in water treatment, utilities, pipe and pump manufacturing. Considering the urgent necessity of upgrading America’s water infrastructure, this ETF is sure to rise in the long term.

Meanwhile, PowerShares Global Water is focused on international markets. This ETF attempts to invest 90% of its assets into tracking the underlying securities of the NASDAQ OMX Global Water Index. It mainly consists of international water infrastructure stocks that focus on conserving and purifying water for residential, commercial and industrial buildings. It consists of ADRs (American Depositary Receipts) and GDRs (Global Depositary Receipts) of companies based in 24 countries that span across the Americas, Europe, Africa and Asia.

You’ll notice that neither ETF has stayed ahead of the S&P 500 over the past three years, which means that these stocks should not comprise the core of your portfolio. Instead, they should be extended period satellite investments.

The Foolish Bottom Line

For now, water stocks are some of the most boring, slowest-growing stocks you can own. However, if you’re a young investor with time on your side, then I recommend picking up some shares of each of these long-term water plays, so you can capitalize on that day in the near future when the world realizes that fresh water, our most precious resource, is more valuable than oil.

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