How to Play the Water Shortage

by James Brumley | May 2, 2013 10:40 am

Contrary to popular belief, the market’s top investment opportunities aren’t the stocks being batted around on a daily basis by the media.

Indeed, those highly popular stocks are often dangerous trading ideas, if only because the attention they garner also means they’re subject to the market’s ever-changing mood.

No, the market’s best trades are often the obscure names most investors have barely, if ever, heard of.

Case in point: Water stocks. Over the past 12 months, the fairly diversified Powershares Water Resource Portfolio (NYSE:PHO[1]) exchange-traded fund has outpaced the broader market’s advance by more than a marginal difference. Some of the underlying water-centric names within that fund have more than doubled the market’s return during that time.

Interested? You should be.

The Opportunity

We’ve known for a while that water is becoming increasingly scarce. What might surprise some investors, however, is the still-growing degree of scarcity, and the amount of money that will be needed to solve just some of those issues.

Scary stuff. But for savvy investors, these alarming trends also point to opportunities.

One of those opportunities lies in the fact that water companies, for all intents and purposes, operate monopolies in their markets. While local utility boards must ultimately approve rate hikes, it’s a rarity for such a request to be denied.

It’s not just the suppliers that are sitting pretty, however. Companies that can build a water infrastructure like treatment plants (which are quite specialized) can also charge a premium for this kind of expertise.

You get the idea: Too few suppliers, too few service providers and too much demand mean a lot of money is up for grabs.

Ways to Play

Just to be clear, these problems and solutions aren’t the only investment-worthy themes stemming from the growing lack of water, but they are the most accessible to the average investor.

With that in mind, there are three basic ways to play the trend. Each offers its own risk/reward profile.

LOW RISK/LOW REWARD

The easy way to play the growing shortage of water — at least in the United States — is to own a piece of the middlemen. These are the utility companies, most of which are consistently profitable and pay a decent dividend. Aqua America (NYSE:WTR[2]), for instance, hasn’t booked a loss in at least 10 years. Neither has New Jersey’s Middlesex Water Company (NASDAQ:MSEX[3]). Both have ramped up their top and bottom lines in most of those years.

Top prospect: If you can handle a little more volatility, then Middlesex’s 3.9% dividend yield offers more of a cash payout than Aqua America’s 2.2%. However, Aqua America is a bigger, more diversified and more stable holding.

MODERATE RISK/MODERATE REWARD

Truthfully, the infrastructure segment of the water crisis might be the water industry’s best-kept secret. Whereas utility companies sell water, they can only sell what they can treat and deliver, and they’re running out of capacity. Meanwhile, the pipes and plants they have are falling apart. Just for perspective, an average of 850 water mains break every day in the United States. The cost to fix them all would reach $1 trillion.

Top prospect: To repair these systems and build more capacity, water companies call on companies like Mueller Industries (NYSE:MLI[4]) and Northwest Pipe (NASDAQ:NWPX[5]). Meuller makes fitting and valves, while Northwest makes steel pipes.

HIGH RISK/HIGH REWARD

While desalination of saltwater and/or the purification of dirty water has been met with mixed reviews (it’s expensive and can cause environmental problems), the technology has been proved and employed. By 2015, some experts think this market could be worth $65 billion per year, growing at an estimated 15% per year. It’s a big market with only a few players, but there’s reason — expensive water treatment plants are often the first projects to be scrapped, or never considered, at the first whiff of economic trouble.

Top prospects: Consolidated Water (NASDAQ:CWCO[6]) and Tetra Tech (NASDAQ:TTEK[7]) have both proved that the water purification business can be viable; each has turned a consistent profit for several years in a row.

Bottom Line

This megatrend isn’t likely to be “news” to any investor. Indeed, it’s an alarm bell that’s been rung repeatedly over the past several years. But water scarcity isn’t a problem that’s ever going to go away, and only money can solve it; mere conservation won’t do the trick given the global population’s growth rate.

For savvy investors, it’s a can’t-miss opportunity.

As of this writing, James Brumley was long WTR.

Endnotes:
  1. PHO: http://studio-5.financialcontent.com/investplace/quote?Symbol=PHO
  2. WTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=WTR
  3. MSEX: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSEX
  4. MLI: http://studio-5.financialcontent.com/investplace/quote?Symbol=MLI
  5. NWPX: http://studio-5.financialcontent.com/investplace/quote?Symbol=NWPX
  6. CWCO: http://studio-5.financialcontent.com/investplace/quote?Symbol=CWCO
  7. TTEK: http://studio-5.financialcontent.com/investplace/quote?Symbol=TTEK

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