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Investing in Water: How to Profit From the World's Most Precious Commodity

Commodities / Water Sector Feb 09, 2011 - 07:25 AM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleLarry D. Spears writes: 2010 was the year of the commodity. Gold prices soared, copper hit record highs, oil again marched towards $100 a barrel, and many agricultural products doubled in value.

Yet hardly a word was spoken about the world's most precious commodity - water.

Indeed, few people in the developed world think of water as a commodity. After all, they can usually get all they want out of the tap in their kitchen or bathroom. And even fewer think about water's price - unless, of course, they're buying a bottle at their local convenience store, where it typically cost twice as much as gasoline.

But for the rest of the world - and even some areas in the United States and other developed nations - water represents a significant problem because of supply shortages, poor quality, or inadequate distribution and disposal systems. And, thanks to a mushrooming global population, the water problem is rapidly approaching crisis proportions.

Consider the following data, compiled by the World Water Council (WWC) from a variety of sources, including the United Nations (U.N.), the World Health Organization (WHO), the Pacific Institute and others:

•The world population in the past 50 years more than doubled to an estimated 6.896 billion at the end of 2010, from just over 3 billion in 1960 - with annual growth rates ranging from 2.2% in 1963 to 1.1% in 2009. At those rates, the human population will rise to 9 billion by 2025.

•Annual water usage has grown almost twice as fast as the global population, averaging 2.5% to 3.0% per year - the basis for a recent estimate by The World Bank that annual water demand now doubles every 21 years. That pace is likely to increase in coming decades as development progresses in more countries, boosting water demand, and creating more pollution to threaten supplies.

•Roughly 17.5% of the world's existing population - 1.15 billion people - currently lacks access to ready sources of clean drinking water. More than 2.6 billion live in areas without adequate sanitation, a major factor in reducing clean-water availability.

•Although more than 70% of the world's surface is covered by water, 97.5% of that is undrinkable seawater. Most of the remaining 2.5% is inaccessible, leaving just 0.1% of global water readily available for human use and consumption.

•At least 80 countries are already experiencing water shortages; the U.N. estimates 67% of the world population will be "water stressed" by 2025.

Though the U.S. is in better shape than much of the world with respect to water, areas of the desert Southwest and West Coast are also experiencing increasing difficulties. The California Department of Water Resources in early 2010 reported that drought in the state's Central Valley was so severe that farmers had to bulldoze orchards and artichoke fields for lack of water.

Similarly, Tim Barnett of the Scripps Institution of Oceanography in a 2008 report estimated there was a 50% chance that climate change and excess usage could leave Lake Mead - the major source of water for Las Vegas - "effectively dry by 2021." At that time, the lake's level stood at 1,108 feet; today it's down to 1,081 feet.

Clearly, water offers a unique opportunity for investors. But be warned: finding so-called "water pure plays" is surprisingly difficult.

The Four Elements

Indeed, there are no water futures being traded on the New York Mercantile Exchange (NYMEX). So water investments are broken into four major divisions:

1.Water distribution and management - This includes both water-supply companies and firms involved in the construction of water plants, pipelines and other infrastructure. This division appears destined for substantial growth in the near future. While developing countries will need new and expanded water-distribution systems, many developed nations have badly deteriorating infrastructure that will need to be repaired or replaced.

Some estimates put total investment needs in this segment at more than $800 billion over the next decade alone. A big chunk of that will come from China, which two years ago pledged $200 billion to a 10-year program of water-infrastructure construction and upgrades.

The U.S. Environmental Protection Agency (EPA) predicts the United States will need to spend $277 billion on water infrastructure by 2020 to maintain present standards. That estimate is supported by the American Society of Civil Engineers (ASCE), which says the United States will require $14 billion a year to repair and upgrade drinking-water systems, with another $19 billion annually needed for sanitation systems. Overall, the ASCE said domestic infrastructure spending needs could reach $1 trillion over the next two decades.

2.Advanced water treatment - This industry segment focuses on water quality more than supply, and includes companies that manage water-treatment plants as well as those that manufacture systems and equipment used in the purifying, recycling and reclaiming of water. Given the changing climate and shifting weather patterns, reclaiming of wastewater is becoming increasingly important, already accounting for nearly 400 million gallons of recycled water annually, much of it for agricultural use.

The water treatment sector also has two subdivisions - reclaiming of raw materials, such as petroleum products, from polluted water, and desalination. Desalination, the conversion of seawater into fresh, drinkable water, is a rapidly growing field, particularly in arid areas such as the Middle East, where the bulk of the roughly 8,000 existing desalination plants are located. In the United States, both Las Vegas and cities in California and Arizona are either building or considering desalination plants. Globally, it's estimated that annual production of desalinated water could reach 14.2 trillion gallons by 2020.

3.Demand-side efficiency - This portion of the water industry focuses primarily on managing water resources, and includes companies that manufacture "smart meters" for measuring water usage, flow valves and other distribution-control devices.

4.Food production - This segment includes companies that manufacture irrigation and livestock-feeding equipment, develop more drought-resistant crops and work with farmers to help them reduce their water usage and better manage land and water resources.

Liquid Investments

Given the global scope of the water problem and the number of companies focusing on the individual industry segments, there are no dominant forces in the various fields. However, there are some leaders with promising prospects. They include:

•American Water Works Co., Inc.(NYSE: AWK), recent price $26.65 - AWK is a water and wastewater utility company that provides drinking water, sanitation and other water-related services to approximately 16 million people in 35 states and two Canadian provinces. About 90% of its operating revenue comes from regulated utility operations, which means its income stream is guaranteed; however, the company is limited in its ability to raise rates. It has 80 surface-water treatment plants drawing from 100 lakes, 600 groundwater treatment plants, 1,200 water wells, 50 wastewater treatment plants and about 49,000 miles of pipes and mains. It has grown substantially in recent years, mainly through acquisitions including seven in 2009 alone (six regulated utilities and one unregulated business). Earnings for 2010 won't be reported for another couple of weeks, but the estimate for the trailing 12 months is $1.50 per share. An 88-cent dividend provides a yield of 3.3%.

•Northwest Pipe Co. (Nasdaq: NWPX), recent price $23.95 - This is a top choice for those who'd prefer to focus on distribution and infrastructure. Based in Vancouver, WA, with plants in several other states, NWPX makes large-diameter steel pipeline systems for use primarily in high-pressure drinking water systems, hydroelectric power plants and wastewater treatment facilities, as well as a broad range of other structural steel and pipe products marketed throughout North America. The company lost 17 cents a share in fiscal 2009 due to a recession-related drop in new construction orders, but it's projecting a profit for both the fourth quarter and full-year 2010. That could give the stock a boost when the reports come out in mid-February.

•Danaher Corp. (NYSE: DHR), recent price $49.72 - DHR has four major business segments, but the focus for water investors is its Professional Instrumentation (PI) division. (The Medical Technologies, Industrial Technologies and Tools and Components sectors provide added diversification.). The PI segment supplies analytical instruments and consumable solutions that detect and measure chemical, physical and microbiological parameters in drinking water, wastewater, groundwater, oceans and ultrapure water. The company also makes ultraviolet disinfection systems and chemical-treatment solutions, as well as analytical services to address corrosion, scaling and biological growth problems in boilers, water-cooling systems and industrial wastewater facilities. It also provides environmental monitoring and leak-detection systems, vapor-recovery equipment, fuel dispensers, submersible turbine pumps and remote monitoring services. DHR's estimated earnings for 2010 are $2.35 a share and it's also fairly cash rich, with $1.64 billion ($2.50 per share) in the bank. The stock pays a modest 8-cent dividend.

•Veolia Environnement S.A. (NYSE ADR: VE), recent price $31.70 - Founded in 1853, Paris-based Veolia is one of the world's largest water infrastructure companies. It also has three other divisions, one of which - Environmental Services - focuses on wastewater collection, decontamination and recycling, as well as general sewage processing, waste management and pollution clean-up. The Energy Services and Transportation divisions provide added diversification, operating bus and suburban rail lines and providing management services for airports throughout Europe. With trailing earnings of $2.10 a share, and a Price/Earnings (P/E) ratio of 14.88, the stock seems reasonably priced, and the $1.23 dividend provides a yield of 4.57%.

•Energy Recovery Inc. (Nasdaq: ERII), recent price $3.63 - If desalination is the wave of the future in water production, then ERII will likely be riding the crest of that wave. The California company designs and manufactures energy-recovery devices and pumps for use in seawater and brackish water desalination projects. It markets primarily to original-equipment makers and builders of small to medium-sized desalination plants in the Middle East and elsewhere around the globe. The company lost 5 cents a share over the past 12 months, but analysts predict a break-even for 2010 and a 2011 profit of up to 10 cents a share. [Note: If you'd prefer a less-focused approach to investing in desalination, both The Dow Chemical Co. (NYSE: DOW) and General Electric Co. (NYSE: GE) have growing divisions manufacturing the required equipment and plant-operating systems.]

•Itron Inc. (Nasdaq: ITRI), recent price $62.35 - One of the clear leaders in the demand-side water efficiency sector, ITRI produces smart water and gas meters, electricity meters, automated watering systems, electronic water-usage and data-monitoring devices and ultrasonic water and heat meters, as well as a variety of other electrical and metering products, all of which it markets worldwide. Founded in 1977 and based in Washington state, Itron is expected to report earnings of $4.02 a share for 2010, up from $2.15 in 2009, with an increase to $4.33 in 2011. The company has a book value of $35.46 a share, but pays no dividend.

•Lindsay Corporation (NYSE: LNN), recent price $71.29 - Based in Omaha, Neb., Lindsay is a leader in the design and manufacture of automated central-pivot, lateral and hose-reel irrigation systems used to increase or stabilize agricultural crop production while conserving water, energy and labor. It markets products internationally, including to China. Lindsay also has an Infrastructure division that supplies transportation departments and road-construction contractors, making everything from crash barriers to reflective pavement safety tapes. The company earned $1.83 a share for the fiscal year ended in August 2010, with $2.19 forecast for FY 2011 and $2.72 for 2012. The 34-cent dividend provides a yield of 0.52%.

•Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE ADR: SBS), recent price $50.57 - If you'd like an international play as well as a water company, Brazil's Sabesp fits the bill. It provides water and sewage services in 365 of the 645 municipalities in the State of Sao Paulo (which is also a majority stockholder), serving 23.4 million people with water services through 7.2 million water connections. It also provides sewage services to 19.7 million people, with 5.6 million sewage connections, and offers other services including urban rainwater drainage and management, urban cleaning and solid waste management, power generation and conservation activities. The company earned $8.05 a share over the trailing 12 months, giving it a P/E of just 6.23, but the stock pays no dividend.

If picking one or two individual water-related investments out of the many available seems too daunting, there are several exchange-traded funds (ETFs) that can identify opportunities and provide diversification for you. Two of the top funds are:

•PowerShares Global Water Portfolio (ETF), (NYSE: PIO), recent price $20.30 - PIO is based on the Palisades Global Water Index, which tracks a group of international companies that provide drinkable water, water-treatment systems and technology and services directly related to water consumption. The fund's equal-weighted portfolio is rebalanced and reconstituted quarterly, with current assets of $316.2 million. PIO, founded in June 2007, has provided a three-year total return of -8.15%, reflecting the impact of the economic slowdown on new water projects, but has yielded 1.36% over the past 12 months, and the stock is up 28.9% from its 52-week low.

•Claymore S&P Global Water Index (NYSE: CGW), recent price $20.65 - CGW tracks the S&P Global Water Index, which consists of about 50 stocks traded on major world exchanges and selected based on the relative importance of the global water industry in the company's business plan. The index tries to balance representation from different segments of the water industry - 25 water utilities and infrastructure companies and 25 water equipment and materials companies. The fund normally invests at least 90% of its assets in common stock and American depositary receipts (ADRs) that comprise the Index. The fund, with $206.4 million in assets, reports a year-to-date return of 5.48% and a yield over the trailing 12 months of 1.03%.

Source :

Money Morning/The Money Map Report

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