Staying Liquid For The Future: Playing The Water Shortage

By Aaron Levitt | November 10, 2008 AAA

The world is facing a growing natural resource problem. And no, I'm not talking about oil and natural gas, but instead the shortage of clean, fresh, potable water. More than 1 billion people do not even have access to the wet stuff, according to the World Water Council. The Environmental Protection Agency estimates that improving America's aging water infrastructure will cost $277 billion over the next 15 years. As emerging markets grow and economic powerhouses increase the need for clean water, water treatment becomes vital. This all makes for a very bullish case for investing. (For more, read Water: The Ultimate Commodity.)

Taking The Index Approach
In terms of water investing, the exchange traded fund (ETF) market offers a few choices. PowerShares sponsors two funds in the sector. The PowerShares Water Resources ETF (AMEX:PHO) is the oldest and largest of the funds. The ETF follows the Palisades Water Index, which singles out companies that focus on the treatment, movement and technologies associated with clean, potable water. The United States-based fund is down about 14% for the year and includes a healthy mix of utilities, industrial manufacturers and materials companies.

The PowerShares Global Water Portfolio (AMEX:PIO) is similar in style to its U.S. counterpart, but with an international tilt. Only 29% of its current holdings are U.S.-listed companies. I prefer the global portfolio as it gives retail investors the opportunity to invest in a wide range of stocks to which most of us do not have access. For domestic water plays, I think investors should look at individual stocks in the sector. Most of them fall under the value heading and are established firms.

A Few Individual Picks
When a municipality or watershed needs to build or manage a new wastewater treatment plant, it calls on Tetra Tech (Nasdaq:TTEK). The global engineering and consulting powerhouse is the No.1 supplier of these services to water companies. The company, which was founded in 1966, has constantly raised guidance. It expects to earn an estimated $2 billion in revenue for full-year 2008, which equates to about 96 cents diluted earnings per share. Currently the company faces an order backlog of about $1.5 billion in contracts. In addition, it is involved heavily in wind power with projects totaling 15,000 megawatts. Major Clients include FPL Energy and T. Boone Pickens Mesa Power. Tetra counts 44 percent of its revenue from the federal government and 18 percent from local and state authorities, but it does have numerous consulting projects around the globe.

Benefactors of increased water infrastructure spending will include companies that directly manufacture the pipes, values and other equipment used in making a water system work. Northwest Pipe (Nasdaq:NWPX) is the leading supplier of high-pressure steel pipe used in water-related activities including wastewater, hydro-electric power and potable drinking water. Water authorities in dryer climates, such as Arizona, prefer Northwest's steel pipes over those made of concrete. The company reported record results October 22. Northwest earned $1.09 per share versus analyst estimates of 75 cents per share, according to Thomson Reuters. The company currently has a $235 million backlog and has a strong energy division that can offset lows in its water-based business.

Originally part of Walter Industries, Mueller Water Products (NYSE:MWA, MWA.B) was spun off in November 2006. The company is another of the water-backbone stocks producing products such as valves, fittings, fire hydrants and ductile iron pipe. It recently reported earnings and saw an increase in net sales, net income and earnings per share over last year. Management has also put forth a proposal to merge the two share classes, a remnant from the spin-off, into one to simplify its capital structure. Mueller shares currently pay a 7 cent dividend and trade at a price-earnings ratio of about 18. (Interested in mutual funds devoted to keeping roads, structures and communities safe? Check out Build Your Portfolio With Infrastructure Investments.)

Energy Recovery (Nasdaq:ERII) performs an important but often overlooked role in water treatment and conservation. Desalination plants use a massive amount of energy in their processes of converting salt water to fresh water. Energy Recovery manufactures products that help recapture this lost power, often with up to 98% efficiency. This makes desalination a more affordable option for many smaller water authorities. The company's PX Pressure Exchange uses all ceramic and PVC components and has a long life expectancy. Energy Recovery was founded in 1992 but recently had its initial public offering in July. The stock is down about 45% since then. At $5.68 (November 7 close), the stock trades for a P/E ratio of 30. A new earnings release is scheduled for November 11 after market close.

Bottom Line
We often take water for granted, choosing to set our media attention on the direction of a barrel of oil and the price of corn. There is, however, the growing concern about our aging water infrastructure and booming global population without access to potable clean water. Long-term investors would be wise to shift some attention in their portfolios to such endeavors either through an index purchase or through individual stocks. (For more on investments into water, see Clean Or Green Technology Investing.)

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