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Water, water (stocks) everywhere–and here are 10

posted on September 4, 2012 at 8:30 am
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water

Water.

It’s the global commodity that most deserves a place in your portfolio—ahead, I’d argue of gold, iron ore, copper, or oil.

And it’s also the toughest to invest in. Water isn’t traded—in fact, in many countries it’s not even metered. Pure play water companies are hard to find—especially if you rule out the obvious but slowly growing water utilities. The leading companies in big swathes of the market are industrial conglomerates where water has, historically, made up a relatively small share of revenues.

For example, of the top 10 companies in the Guggenheim S&P Global Water ETF (CGW), which is designed to track the Standard & Poor’s Global Water Index, I’d call five water utilities and two diversified industrial companies with a presence in water. That leaves only 3 or about 30% of the ETF and Index anywhere near the sweet spot in water. (More about what that sweet spot—or spots—later in this post.)

But that’s changing.

As the individual parts of the water market get bigger, investors are seeing a wider array of pure plays. For example, orders for desalination equipment to make drinking and industrial processing water from sea water hit $5 billion in 2011, according to Global Water Intelligence, and are forecast to hit a record $17 billion in 2016.

And it doesn’t hurt that both companies and investors see that water is bucking the trend of other environmental sectors. As of August 29, the Guggenheim S&P Global Water ETF is up 8.85% over the last year versus a brutal -38.53% drop for the PowerShares WilderHill Clean Energy ETF (PBW).

You can put together the investment case for water from the headlines.

Supply is falling. Drought in—depending on the year—the United States, Australia, India, China, or Argentina. Evidence that the global climate is becoming more volatile, putting historic water-carrying weather patterns such as India’s Monsoon at risk. Shrinking supplies of clean water as underground aquifers are mined for limited supplies of water accumulated over hundreds of millions of years. Shrinking supplies of clean water as existing sources are polluted by farm chemicals, inadequately treated industrial discharges, and untreated urban sewage.

And demand is rising. According to data from the United Nations withdrawals of freshwater have tripled over the last 50 years with demand for freshwater increasing by 64 billion cubic meters (or 64 trillion liters) a year. Some of that is from global population growth of about 80 million people a year at current rates. Some is from changes in lifestyles and eating habits that increase water consumption per capita. Add in soaring demand for clean water from farmers, industry, and city dwellers. And some is from increases in energy production (with sources such as oil sands and biofuels requiring more water than traditional sources of oil and natural gas).

The math is pretty simple—falling supply and rising demand will drive the price of the commodity higher.

Want to know where to invest in water? Follow the flow. Today in this post it has taken me to 10 water stocks.

Rising prices for water will produce gains for global water utilities, even if the returns of those utilities are capped at a specific return on invested capital by regulators. The best bet here is on water utilities that are building out infrastructure in places where water demand is rising most rapidly and the new investment represents a large percentage increase over existing investment.

If that sounds like a prescription for investing in water utilities in developing economies, it is.

For example, Manila Water (MWC.PM) supplies water for half of Manila and has also recently bought a 47% stake of Vietnamese water distributor Kenh Dong Water Supply and 49% of Thu Duc Water. The stock is up 43.86% in the last year.

Or Guangdong Investment (GGDVY in New York or 270.HK in Hong Kong), which supplies Hong Kong’s Water (and is up 33.97% in the last year). Or Cia de Saneamento Basico do Estado de Sao Paulo (SBS in New York or SBSP3.BZ in Sao Paulo), which collects, treats, and supplies water in Brazil’s Sao Paulo state (and is up 60.62% in the last year.)

That math is also a prescription for investing in companies that handle and treat wastewater. More water consumed means more water as waste. More water demand means more demand for treatment services that turn dirty water back into clean water.

For example, Xylem (XYL) an October 2011 spin-off from ITT (ITT), focuses on moving water from distant sources and through increasingly complex supply systems, and then treating and testing it. The company’s water infrastructure unit—about half of revenue—gets its revenues from transportation equipment/pumps (73%), treatment (18%), and testing (9%). In 2011 64% of the company’s revenues came from outside the U.S., which exposed the company to the recession in European economies (37% of revenue). As a result the stock is down 5.36% in 2012 as of August 29. Since most of the company’s European business is in the water infrastructure unit, where customers are water utilities that derive their revenue from customer’s water bills, I think the pullback to date is understandable but creates a buying opportunity for patient investors. I’ll be adding shares of Xylem to my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ today.

But the biggest opportunity suggested by that math is investing in companies that create more clean water. God may not be making any more water but human beings—with enough money and energy—are turning part of the current supply of seawater (and other brackish waters) into water fit for drinking or for industrials uses.

Current technologies for desalination use huge amounts of energy and therefore produce water at a high cost. But when the alternative is moving San Diego to a wetter climate or giving up on the Saudi royal family’s dream of an economy that can feed itself and that can turn its raw commodities into higher margin chemicals, then the high cost of water from this source is relatively unimportant. And that cost is falling. Reverse osmosis, the current desalination technology of choice, produces clean water for about $1 per cubic meter. That’s about 10 times the cost of water from traditional sources (which aren’t available, of course), but about half the price of water from desalination 20 years ago, according to the International Desalination Association.

If you’d like to get your desalination (and general water) exposure as part of an industrial equipment company with its fingers in a lot of infrastructure pies, I’d recommend General Electric (GE). The stock has been a member of my Jubak Dividend Income portfolio February 2012 http://jubakpicks.com/jubak-dividend-income-portfolio/ .

If you’re looking for more concentrated exposure to desalination, I’d suggest turning to Singapore, which has become a world leader in the technology out of the challenge of being a tiny city-national with very limited sources of natural water.

Keppel (KPELY in New York and KEP.SP in Singapore) combines three very timely businesses: construction of deepwater drilling rigs, waste disposal and waste to energy in Asia, and water desalination and waste water treatment in Singapore, the Middle East, and China. (The stock is up 2.7% in the last year.)

A more concentrated Singapore water play is Hyflux (HYF.SP in Singapore and HYFXY in New York.) The company has just completed a water desalination plant in Algeria and has begun work on a joint desalination plant in India. Profit in the second quarter climbed 21% year over year. China currently accounts for 20% of the company’s revenue and Hyflux is looking to grow that share to 33% within the next two years. (The shares are down 20.14% in the last year.)

And in building your water portfolio I wouldn’t forget about some long time favorites such as pump-maker FlowServe (FLS), and water meter makers Badger Meter (BMI) and Itron (ITRI).

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares Guangdong Investment, Keppel, and Manila Water as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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7 comments

  • alovasz on 4 September 2012

    Would you buy FB at this price? S&P has upgraded its status to a “buy”.

  • cjxland on 4 September 2012

    Jim- you seem to be studiously ignoring two world-water biggies: Veolia and Suez. Care to comment?

    India has a particular need for clean water in its interior… do you know anything of specifically India-based or -concentrated water companies?

    Thanks for another fine article.

  • chapmame on 4 September 2012

    Even though it is a Chinese micro cap (gasp), look into Tritech Holding (trit). Has American subsidiary and licensed forward osmosis technology.

  • mwp2634 on 4 September 2012

    Remember

    Jim is a HORRIBLE stock picker and DOES NOT own any of these companies in his personal portfolio.

  • scottsws on 4 September 2012

    Jim sold his personal portfolio and placed all his personal investment money into his mutual fund.

  • Jim Jubak on 5 September 2012

    mwp2634, I suppose if you say something often enough someone will believe it. I don’t own any of these stocks in my personal portfolio because at scottsws notes, I’ve put all my personal money into my fund.

    Do you have anything useful to add that might help readers of this site? Some picks of your own that readers might evaluate? Some reasons that specific picks of mine are terrible–and I don’t mean “reasons” based on after the fact price movements.

    Manila Water is a bad pick because?
    Xylem is a bad pick because?

    It’s by putting some factually based argument on the table that we can all learn something.

  • GRANDY on 5 September 2012

    Jim — I’ve owned SBS for a long time, but recently saw an idea that perhaps Brazil may consider nationalizing SBS claiming water is a ‘stratigic natural resource’ – thus leave the stock holders with nothing. I’m concerned and sold most, but with it’s strange but healthy ‘dividend’ I hated to give it up. Your ideas and I might buy it back.

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