The most recent edition of Real Assets Adviser, which helps the investment industry uncover investment opportunities in “real assets” such as commodities, real estate and other asset-heavy industries, highlighted the significant potential of the water industry.
It estimates that the global water industry reports $700 billion in annual sales, or as much as the pharmaceutical industry. The opportunity is mostly because of waste where, due to old pipes, valves, and transmission systems, as much as 70% to 80% of fresh water is lost each year.
An overall lack of investment in water infrastructure and the under-pricing of water are the primary culprits. Though, admittedly alarmist, the piece suggested that without proper investment the world could experience severe water shortages in the future.
Regardless of how severe water shortages might be some day, there is little to deny the vast need for investment to reduce wasted water and increase the efficiencies of utilities that bring water to customers.
Another investment merit is the industry isn’t subject to the whims of the business cycle — customers (business buildings, residential homeowners and farmers) need water regardless of what happens to the economy.
The industry is also highly fragmented. The article estimated in excess of 100,000 water utilities throughout the United States. This leaves room for consolidation and for more aggressive firms to buy market share.
Below are five of the largest water players out there that also happen to represent some of the only pure-plays for investors to focus on water exposure in their portfolios.
Water Stocks to Buy: American Water Works (AWK)
American Water Works Company Inc (NYSE:AWK) is one of the better known pure-play water companies. It bills itself as the largest publicly traded water utility in the United States. Its current market capitalization is $13.5 billion and the dividend yield is respectable at 2%, or right about at the market average.
American Water’s primary activities are what you would expect out of a water utility. It stores, pumps and delivers water and collects and treats wastewater. It owns many of the physical assets to do so across the 1,600 communities and 16 states it serves.
The company is dominant and qualifies as the industry’s bellwether, but its valuation currently leaves something to be desired. The forward P/E is rather lofty at 27 considering sales growth has averaged only 4% annually over the past decade.
Profit growth has been more respectable at 11% annually over the past five years to help justify the premium valuation. Combined with the fact that the water space is relatively immune to the business cycle, investors looking for exposure to the industry would be hard pressed to find a more stable company to add to their portfolio.
Water Stocks to Buy: American States Water (AWR)
American States Water Co (NYSE:AWR) has a market cap of $1.5 billion, roughly only 10% of larger rival American Water Works. Logically, a smaller firm should find it easier to grow faster from the smaller base of existing sales, and that appears to be the case here. American States Water’s sales growth has averaged nearly 7% per year over the past decade.
Average annual profit growth of 12.5% over the past five years is also running above its larger peer. The forward valuation is also slightly more reasonable at 23.5. The dividend yield is slightly more respectable at 2.2%.
American States operates primarily in California where it operates the Golden State Water Company in 10 counties. It also operates a small electric utility and contracted services where it works on water projects for the U.S. military on bases throughout the country.
The geographic concentration of the company’s California operations is a bit of a worry, but the stock offers some diversification from American Water Works and should continue to grow along with the California economy over the long haul.
Water Stocks to Buy: Aqua America (WTR)
Aqua America Inc (NYSE:WTR) sports a market capitalization of $5.5 billion. Just over half of its annual sales of $814 million (and 72% of 2015 profits) stem from its water and wastewater utility operations in Pennsylvania. It also operates in seven states in and around the Midwest and Eastern portion of the United States.
The market metrics resemble the above two players — a forward P/E of 23.2 and dividend yield of 2.3%. Growth is also respectable; the 10-year average annual sales growth has been 5% and profits are up about 10% annually over the past five years.
Aqua America’s faster-growing markets include Texas and North Carolina and the company is actively looking to buy its way to growth. Over the past five years it has acquired 75 local water utility assets, companies and ventures it considers to be growth avenues. Investors are hoping this helps boost growth trends going forward.
Water Stocks to Buy: Mueller Water Products (MWA)
Mueller Water Products, Inc. (NYSE:MWA) has a market capitalization of $2 billion. The firm serves water and wastewater utilities by manufacturing valves for water (and gas) systems. It estimates that around 70% of sales relate to infrastructure upgrade, repair and replacement — common themes in the investment-starved water industry.
Mueller’s dividend yield is only 0.98% and its forward P/E of 25, though in line with industry peers, is high considering that sales and profits have been stagnant in recent years. However, cash flow generation has been much steadier and free cash flow has exceeded reported net income by a fairly wide margin in recent years.
The cash flow stability adds another layer of visibility in an industry that is relatively recession-resistant (people need to shower and use water regardless of economic climate).
Combined with the opportunity to serve any water utility, which helps reduce reliance on a certain geographic area, Mueller Water Products has arguably untapped potential.
Water Stocks to Buy: Badger Meter (BMI)
Badger Meter, Inc. (NYSE:BMI) is also a supplier to the municipal water and wastewater industries. It provides flow measurement, control and communication solutions, or namely water meters that utilities need to monitor and charge their underlying customers.
The firm has a market capitalization just below $1 billion. This makes it the smallest of the bunch. However, its forward P/E of 28.6 is the largest of the group covered, which looks excessive given sales over the past decade have averaged less than 6% annually and profit growth has been negligible over the past five years.
The dividend yield is also relatively puny at 1.4%. What the company does have going for it is it announced back in May that it is exploring strategic options to sell itself. Any buyout would likely be at a premium to the current share price of $66 per share.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.