Current & Long-term Trends Favor Water Stocks

By BA McKenna - July 12, 2012 | Tickers: AWR, WTR, CTWS, YORW | 0 Comments

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If you live on the East Coast or in the Midwest, you've likely just lived through a record-breaking heat wave. Now imagine a heat wave, but with no water. Tap is dry. No bottled water. No other fluids as they’re mostly made of water. Resourceful thought, but, no, nobody else has any water either, so looting is out! Your only hope would be for rain, so you could run outside and catch the drops – or hopefully, downpour – in your mouth.

Typing that paragraph made me thirsty — and appreciate what many of us take for granted: water. It’s essential to life, yet we undervalue it because it has been readily and cheaply available.

The majority of people living on this planet don’t have easy access to clean, drinkable water. And the issue is now spreading to the “developed” world -- including the U.S.

U.S. Warming Trend 

• The first six months in 2012 have been the hottest since modern record-keeping began in 1895.
• The last 12 months also have been the warmest since modern record-keeping began.
• These recent periods are not isolated; they are part of a long-term trend.

U.S. Drought & Water Shortage 

• Drought conditions spread to 56% of the contiguous U.S. states in June, making it the largest drought footprint of the 21st century. 
• The USDA said that crops were in their worst condition since the drought of 1988.
• Florida doesn’t have nearly enough water for its expected population boom.
• The Great Lakes are shrinking.
• The coastal states face a water crisis not only from increased demand, but also from rising temperatures. Higher temperatures result in more water lost to evaporation.

Worldwide Water Supply

• 97% of the world’s water is in the oceans, so only 3% is fresh.
• Of the 3% freshwater, 2/3rds is locked in glaciers and polar ice caps.
• Of the remaining 1%, about 1/2 is located beneath the earth’s surface.
• Rivers and lakes contain only about 1/50th of 1% of the earth’s water.
• Of the 3% freshwater, a significant portion is severely contaminated.

U.S. Water Use By Category

(Source: USGS, 2005. Data compiled every 5 yrs, but 2010 survey delayed.)  

• Thermoelectric #1 User -- 41% of freshwater was used to cool electricity-generating equipment.
• Irrigation #2 User, but #1 Most Critical User -- 37% of freshwater was used for crop irrigation. This is the most critical use as only about half this water is returned to the water supply, whereas most of the water used by the thermoelectric industry is returned. Given the trends toward both increasing temperatures and less rain, irrigation's water use is likely to increase. 
• Public Supply #3 User -- This figure is bound to increase as the population increases. Immigrants moving here will no doubt greatly increase their water use as they become more "Americanized." (See below.) 

Americans are Addicted to Water  

(Source: CBS News)

Understandably, we use a lot more water than they do in poorer countries. But we also use almost 4 times as much water per person as they do in the UK. Granted, the UK's weather is typically rainier, but weather factors alone aren't enough to explain increased use of this magnitude.

Addictions are hard to break. So it's likely our collective addiction to generous (and wasteful) water use will continue, even if water prices increase. You might be able to cut back a bit, but good luck finding a cheaper liquid that will adequately clean you, your dishes, your clothes or Rover.

Bottom Line: Investing Opportunity

It's Economics 101: DWINDLING SUPPLY + INCREASING DEMAND = RISING PRICES.

In addition to the supply-demand dynamics, other characteristics of water stocks that make them attractive investments:

• Huge barriers to entry -- protected monopolies
• Huge competitive advantage -- no substitutes
• Significant dividends
• Low betas (a measure of stock price volatility)

U.S. Water Utility Stocks with Market Caps over $200 Million 

(Source: Morningstar. All numbers are percentages, except Betas. Data to 7-9-12.)

The last three stocks have significantly underperformed their industry peers on two key metrics: 1-year total return and 1-year EPS growth. They're also at the low end of the ROE range. So I'm flushing them away before looking at additional metrics.

5 Water Stocks Left 

3 Top Water Stocks

• American Water Works (AWK)
• American States Water (AWR)
• Aqua America (WTR)

Overall, American States Water and Aqua America look the most attractive. American States Water owns several public utilities. More than 90% of its assets are in the Golden State Water Co., a water utility operating in three regions in California. Aqua America supplies provides water, wastewater, and other services to customers in Pennsylvania, Texas, North Carolina, Ohio, Illinois, New Jersey, New York, Florida, Indiana, Virginia, Maine, and Georgia These two companies not only have the best ROEs, they also have the best 1- and 3-year EPS growth rates.

Additionally, AWR has the best 3-year revenue growth rate. Companies can increase earnings only so much by increasing rates (with approval) and cutting costs; over the long-term, revenue growth is needed to fuel future earnings increases. And WTR has a significantly higher-than-average net profit margin.

I'm adding American Water Works, the largest investor-owned water utility in the U.S., as the third top stock. The company provides about 15 million people with drinking water, wastewater, and other water-related services in approximately 30 states and 2 Canadian provinces.

A key strength is its size -- its $6.2 billion market cap dwarfs the others (WTR's market cap is $3.6 billion; AWR, CTWS, and YORW are much smaller at $800 million, $300 million, and $200 million, respectively.) Size can add economies of scale, acquisition ability, and muscle when dealing with regulatory agencies. 

Additionally, its stock has proven it can perform. It has the highest 1-year, 3-year (27.3% vs. 17.7% for S&P), and history of company (2008) total returns. While past performance is not indicative of future performance, it is meaningful as it shows a company can successfully execute its business plans.  

Let's drink (water, of course) to a successful stock investment!

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