Water Utilities: $450B Industry with 100% Penetration

Includes: CTWS, PHO, WTR, YORW
by: Guy Bennett

Bill Gates can’t live without his.  Factory workers in Xiamen need it.  Nomads on the Sahara desert fought wars over it.

It’s more important than oil.

It’s a $450 billion industry growing globally at a double-digit clip.

Investor attention in this sector is heating up, and it’s a good time to get in.

Yes, I’m talking about water.

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I know what you’re thinking. Water is boring. It hasn’t gone anywhere for a long time. How can you make money from something that comes gushing out of your tap for free?

But as it happens, a lot of people are making money in the water industry.  And the profit taking is just heating up.  You may not get a bill for your water, but you are paying for it through state and municipal taxes.  Investor-owned companies who provide free drinkable water are thriving.  No doubt about it: in the current market, water is a smart safe haven for your portfolio.

Andrew Mickey, Chief Investment Strategist of Q1 Publishing and contributing editor to the Prosperity Dispatch, said, “Gold and silver have their place, but water is an equally safe place to invest. After the NASDAQ took a turn for the worse in 2001, I put almost everything I had into water. I made a killing while everyone else was wondering where the ‘New Economy’ went to.”

The water sector is pretty diverse. Businesses that make pumps, valves, desalinators (which turn salt water into fresh), bottlers, filtration systems, membranes, and water utilities can all be classified as water stocks. There will be quite a few winners and losers within the group.

For instance, the United States has 650,000 miles of aging water pipes and sub stations which need replacing.  Thirty percent of the underground pipes in New York City were installed during the Lincoln Administration.

On top of that, rapidly expanding urban populations in Asia and India require billions of dollars of new infrastructure.  China is expected to spend $280 billion on water systems in the next five years.  US consumers spend $8 billion a year on bottled water, undaunted by the fact that bottled water costs more than gasoline.

For investors, the beauty of water is that it is impervious to “demand destruction”.  It never goes out of fashion. You need about a pint a day to maintain your health. The average human body contains 40 litres of water.  If you squeezed all the water out of the 6.7 billion people currently living on the planet, you could fill a swimming pool the size of football field, 250 miles deep.  We are water.  Consume it or die.

In the last two years, the water sector has outperformed the DJIA by a margin of 30%. PowerShares Water Resources (NASDAQ:PHO) is an ETF which invests in technologies directly related to water consumption.  PowerShares has managed to buck the downward trend in the stock market by positioning itself in a solid industry with an inelastic demand.

Later, I’m going to write about opportunities to invest in the water infrastructure boom in Asia but now I’d like to highlight investment opportunities in US utilities. Approximately 15% of the water utilities in the US are investor-owned. The sector is consolidating fast, with a flurry of acquisitions.

Investors often shy away from water utilities on the assumption that government regulation will curtail profits.  While it’s true water utiliities probably won’t turn into 5 baggers, they enjoy one rare advantage.  They are monopolies in the areas they serve!  Everyone consumes their product.  And everyone must buy from them. Unlike electricity which can be shunted around the grid, water is too cheap and heavy to transport, so consumers must buy from the utility in their area.

This provides a massive cushion against sales and revenue set-backs that plague other industries...especially during an economic downturn we currently are facing. That’s why water utilities make some of the safest bets right now. In most cases, their profitability is actually enacted by law. Here’s a few of the better ones.

Aqua America (NYSE:WTR) is a water utility in the United States. It provides residential, commercial, fire protection, industrial, and other water and wastewater services to 3 million customers in 12 different states. Aqua America has a forward P/E of 21 (a bit high, but in line with its long-run average). In August 2007 it was trading at a high of $25, and it is now trading at $18.  As investors seek safety and run from financials, I expect a good bit of the “safe” money to flow into water.

Connecticut Water Service (NASDAQ:CTWS) supplies public drinking water, sewer operations and other water-related services. The Services and Rentals segment provides contracted services to water and wastewater utilities, and other clients, as well as bulk delivery of emergency drinking water to businesses and residences through tanker trucks.

What I like most about this $230 million company is the growth in its operating margins (the horse power in the engine of the company). The 2007 revenues were up 20% from 2006, while the operating margin surged 86%. This means that the company is expanding its customer base (or charging customers more) while becoming much more efficient. The stock price has risen 18% to $27 in the last two months. Based on these numbers, I predict there will be more investors piling in.

The York Water Company (NASDAQ:YORW) is almost 200 years old. It distributes water in York and Adams Counties in Pennsylvania. York owns two reservoirs, Lake Williams and Lake Redman, which together holds approximately 2.2 billion gallons of water.

York Water has recently completed a supply security project a 15-mile pipeline from the Susquehanna River to Lake Redman that provides access to an additional supply of 12.0 million gallons of water.

This is a small utility and it has about 60,000 residential customers and generates about $500 per customer in revenue. This $160 million company has an operating margin of 43% with a forward P/E of 21. York Water Company’s claim to fame is that it hasn’t missed a single dividend payment in more than 100 years.

As you can see, water utilities are very safe businesses. Not wildly exciting, but you know they will still be there when you wake up in the morning (which cannot be said for all the big banks). However, they still get treated like ugly ducklings. But lately the beauty queens have been hit hard [Starbucks (NASDAQ:SBUX) is 60% off its highs; Google (NASDAQ:GOOG) has plummeted 35% in the last 10 months].

Suddenly the water utilities with their captive customer base and 100% market penetration are looking much better.

When the times get tough, smart investors stay nimble and find safety in stocks like water utilities.  Food prices are soaring, internet advertising revenues are leveling off, and a $4 cup of coffee seems like a ridiculous luxury, but you’re not going to stop drinking water.

At Q1 Publishing we believe that investing in non-discretionary items is a good way of riding out an economic downturn.

Disclosure: No position in stocks mentioned.