How Should Investors Capitalize on the American Energy Boom?

Ryan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Let’s take a journey back to just after World War II. Nearly all major countries in the world are in shambles, and the country which is perceived to be the strongest, the United States, produces nearly 40% of the world’s goods. Present day, this measure has shrunk to roughly 18%.

However, not all news is gloomy for the red, white, and blue. Right now as you read this article the United States is undergoing a monumental energy boom as a result of innovative technologies such as fracking, a process in which pressurized fluids are pumped through rock formations, usually a mile or more underground, to extract oil and gas. While this process has evoked substantial controversy about the harm it causes to the environment, it has sparked the energy boom currently underway in the US.

North America currently produces considerably more natural gas than any other continent. Unlike the far more famous oil, natural gas is rather difficult to transport, as the transportation of the liquid requires substantial capital and a process to condense the natural gas to make it ready for shipment. Thus, natural gas currently is priced at roughly $3.56 per million BTUs (British thermal units) in the US. Skip across the pond and the same amount of natural gas will set you back $12 in Europe, $16 in Japan.

By 2025, Exxon Mobil predicts that North America will be a net energy exporter, representing breathtaking growth from levels of current production. Over just the past six years, United States production of petroleum jumped from 15 million barrels of oil-equivalents to 20.1 million, and analysts’ projections show production do nothing but rise as massive reserves are confirmed to be spotting the United States like lights on a Christmas tree. Thus, the question is, how should investors capitalize on the American energy boom?

<img alt="" src="http://g.fool.com/editorial/images/54216/1212_large.png" />

So What?

The controversial process depicted earlier, fracking, is widely anticipated to be a trailblazer in this revolution, as the process allows more natural gas to be extracted in greater amounts than ever before. One major component is essential for the process to occur at every step, water.

About 70-140 billion gallons of water are used in over 50,000 US wells every year. This water must go through cycles during the fracking process, being transported, treated, recycled, and finally disposed of. With environmentalists already protesting fracking in its infancy, the industry will be forced to adhere to strict environmental regulations. The companies that provide these services are set to cash in as the industry’s deep-pocketed leaders begin searching for the vital resources and services fundamental to their operation. Simon Gottelier of Impax Asset Management remarked, “We could be about to witness a modern-day equivalent of selling shovels during the gold rush.”

Now What?

Investors can take advantage by looking to companies such as Xylem (NYSE: XYL), Aqua America (NYSE: WTR), Veolia Environment (NYSE: VE), and American Water Works (NYSE: AWK).

Xylem

Recently spun off from ITT, Xylem is a provider of equipment and service for water and wastewater applications. The company possesses a portfolio of products and services addressing the full cycle of water. In 2012, the company produced $3.79 billion in revenue, and projections place revenue at $4.66 billion by 2017.

The profit margin of the Xylem currently sits at around 8%, and expectations are that the company expands this metric to 11.5% by 2017. The company pays out quarterly dividends of $0.12, which places the dividend yield at 1.75%.

Overall, Xylem appears to be a nice mix of growth and stability, and with a price to earnings ratio of 18.00, investors should not have to worry about a massive re-pricing of the stock to lower levels.

Aqua America

Aqua America is a holding company for regulated utilities providing water and wastewater services in states from Maine to Georgia, 23 in total.

The company has a long history of strategic acquisitions that have extended the company geographical reach and allowed the company to produce $758 million in revenue in 2012. Projections place revenue growing to $904 million by 2017.

Profitability is one of this company's strong suits, as currently Aqua America possesses a profit margin of 25.90%. Analysts see this margin decreasing to 24.7% by 2017. Quarterly dividends of $0.19 put the yield of the company’s dividend at 2.44%; and with a price to earnings ratio of 22.02, the company does not appear to be vastly overpriced.

Veolia Environment

This French company operates in the 3 segments: water, waste, and energy management; and is much less a direct play on the water aspect than the other three companies.

In 2012, the company pumped out $38.31 billion in revenue, however projections place revenue only topping $32.42 billion by 2016. The profitability factor of the company is weak, as currently the profit margin of the company only sits at 1.3%, however expectations are that this metric will rise to 2.3% by 2016.

The company pays out annual dividends, $0.93 most recently, which places the yield at 8.15%. As a result of weakness in the profit margin, the company presently possesses a price to earnings ratio of 614.72.

American Water Works

American Water Works provides drinking water, wastewater, and other water related services to roughly 15 million people in more than 30 states and in two Canadian provinces.

In 2012, the company generated $2.87 billion in revenue, and projections expect revenue topping $3.48 billion by 2017. Profitability metrics of the company are strong, with a 12.4% profit margin currently being sustained, and projections display the profit margin strengthening to 14.7% by 2017. Quarterly dividends of $0.28 place the dividend yield at 2.77%.

Additionally, a reasonable valuation is pinned to the company, with a price to earnings ratio of 18.82.

The Foolish Bottom Line

The American energy boom has begun, and is here to stay. Fracking will lead this revolution, as its economic benefits simply outweigh its disadvantages. Talk to 10 different analysts, and they may tell you 10 different ways to play this boom.

However I believe the water service companies such as the four outlined in this article are a rather compelling method in which to play the trend. Which one fits your portfolio depends.

If you are you looking for growth go with Xylem, for dividends consider Veolia. All in all, this particular industry stands to cash in majorly on the upcoming American energy boom as a result of the necessity of water during the fracking process, and investors should capitalize on this fundamental trend by positioning themselves in water service companies. 


Ryan Guenette has no position in any stocks mentioned. The Motley Fool recommends Aqua America and Veolia Environnement (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus