Using Water for Defense and Offense

By Alvin Gonzales - June 29, 2012 | Tickers: AWK, WTR | 0 Comments

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When it comes to investing, ignorance is not bliss. Currently, the European Union is facing a debt crisis and investors would be wise to take the necessary precautions to protect themselves from a potential collapse of the Euro. The European Union has the largest GDP in the world and a collapse would be globally catastrophic.

For protection, investors only need to turn to the water coming out of their faucet. Water is the most precious liquid on the planet. It is also the ultimate defense against a potential global economic downturn. Since water is a need not a want, the demand for water is price inelastic. Essentially, this means that water utility companies are immune to economic slowdowns.

Two dividend paying water utility stocks are Aqua America (NYSE: WTR) and American Water Works (NYSE: AWK) (note: thinly traded stocks or stocks with a market cap of less than $200 million were ignored). American Water Works serves 15 million people and operates in two Canadian provinces and over 30 states. Aqua America serves 3 million people in 12 states. The following table gives a summary of the two companies’ earnings power.

Water utility stocks are not just defensive plays, but are also growth stocks. The water utility market is highly fragmented. According to the 2011 annual report by Aqua America, there are “approximately 53,000 community water systems in the U.S., 83% of which serve less than 3,300 customers.” To put it simply, water utility companies have lots of opportunities to grow through acquisitions.

This is beneficial to Aqua America and American Water Works, who have been using their size to gobble up other smaller systems. In 2011, Aqua America acquired 5 wastewater and 51 water systems in Texas. This represented an increase of 5,300 customers. In American Water Works’ 2011 annual report, the company stated, “We intend to continue to expand our regulated footprint geographically by acquiring water and wastewater systems in our existing markets and, if appropriate, certain markets in the United States where we do not currently operate our Regulated Businesses.”

Moving on to the balance sheet, the following table summarizes the two companies’ current situation.

Both Aqua America and American Water Works have a current ratio of 0.8. This means both companies are relying on earnings from their businesses to fund their debts. Furthermore, both companies have low cash to debt ratios. However, water utility stocks face low competition in their current markets. In the 2011 annual report by American Water Works, the company said, “In our Regulated Businesses, we generally do not face direct competition in providing services in our existing markets...” Thus, the earnings of Aqua America and American Water Works are very reliable and their current debt situations are sustainable.

In conclusion, water utility stocks are the perfect defense against economic downturns. Currently, Europe is facing problems that investors should not ignore. Spain, the fifth largest GDP in Europe, is now finding it difficult to finance its debts through the bond market. Thus, investors should protect their portfolios. Two dividend paying water utility stocks investors should look at are Aqua America and American Water Works. Both companies are profitable and have numerous growth opportunities. In summary, the combination of defense and offense provided by water utility stocks gives investors a great way to protect themselves from the Euro debt crisis.

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