Promising Water Infrastructure Plays

By Aaron Levitt | July 27, 2009 AAA

The flood gates have been opened as the U.S. government finally embraced the importance of improving our aging water infrastructure. While nearly $96 billion in stimulus cash is earmarked for U.S. water improvement, a drop in the bucket compared to the estimated $600 billion needed, the real potential for the sector comes from a bipartisan bill created by Representative Earl Blumenauer (D-Ore.). The Water Protection & Reinvestment Act (H.R. 3202) would create $10 billion in annual funds to repair decaying pipes and water treatment systems.

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A second bipartisan bill floating through the Senate (S. 1005), would reauthorize the Clean Water State Revolving and Drinking Water State Revolving Funds. This would provide nearly $39 billion for the Environmental Protection Agency's various water infrastructure programs over the next five years. These two funds have sat dormant for 22 and 12 years, respectively. In March, the house passed a similar bill allowing for a $13.8 billion for the Clean Water State Revolving.

The $400 Billion Market
General Electric (NYSE: GE), a leader in desalination, estimates that the total global water market, including water infrastructure construction, pollution control and water management/treatment could be worth nearly $400 billion. Analysts predict that over the next 20 years, various stateside water utilities will need to spend nearly $1 trillion on improving their systems. While most of this capital flooding the water sector will go to behemoths such as GE or water treatment specialist Veolia Environment (NYSE: VE), there are plenty of smaller companies that will benefit from the increased spending.

Technology Edge
Replacing aging pipes within urban and suburban areas will be on of the biggest challenges. Heavy construction firm Insituform Technologies (NASDAQ: INSU) has developed proprietary technologies that allow for trenchless installation, repair and management of various underground pipes. Local and State governments have been taking notice as Insituform's second-quarter profit nearly doubled from additional funding. Chief executive Joe Burgess seemed bullish on the company's prospects. In a statement about Insituform's North American sewer rehabilitation segment, he said "we also anticipate bidding opportunities to increase in this market as the impact of the stimulus dollars flow into the system." The company expects to receive nearly $200 million in federal stimulus funds over the next two years.

Economically viable and safe groundwater supplies are becoming increasingly difficult to locate and develop. Layne Christensen (NASDAQ: LAYN) provides hydro-geological seismic and drilling services to water authorities and utilities. The company also provides a suite of other water-related businesses including waste treatment and pipeline installation. The company recently reported second-quarter earnings in June. Layne reported lower earnings due to the overall commodities market, as the company has recently entered into natural gas drilling through its 581 producing wells. Overall, the water business is healthy long term and should reward patient investors as spending the area increases.

Recovering Energy
Energy efficiency is playing a larger role in how businesses and states operate. In combining that with water investment, we do have a winner. Desalination plants use a massive amount of energy in their processes of converting salt water to fresh. Energy Recovery (NASDAQ: ERII) designs and manufactures products that allow plants to capture lost power, often with up to 98% efficiency. This can help reduce energy costs up to 60%. This puts desalination as an affordable option for smaller water authorities and utilities. Worldwide demand for its products is growing. Energy Recovery recently inked a deal with Inima (Grupo OHL) and Aqualia (Grupo FCC), to provide its pressure exchangers for a large desalination plant in Algeria. The company estimates that it will save 9 MW of power per hour at the plant and improve the carbon footprint by 26,000 tons of CO2 per year.

Bottom Line
The U.S. government seems to have finally woken up when it comes to water infrastructure. The recent proposed bills, while nearly just a precursor to what needs to be spent, are a good start. Investors looking for growth in the sector, may want to bypass some of the larger firms and take a look at a few of the small caps in the area. (To learn more, read Water: The Ultimate Commodity.)

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