This article summarizes “Investing in Water”, a special report released by our sustainable investing newsletter, Progressive Investor.
Water is a huge, complex subject. Through this report, you’ll gain an understanding of the grave issues associated with this precious resource, insight into the solutions that await us, and a succinct overview of the water industry and where it stands for investors. You’ll become familiar with the major players, where the action is on the private equity side, and future trends for the industry.
As usual, it includes an extended conversation between a group of analysts to give you insight into their investment strategies, help you understand the companies and the differences between them, and to help you make informed investment decisions.
The Big Problems
We drain the world’s precious freshwater to supply uncontrolled population growth, industry and agriculture, and add insult to injury by contaminating it with thousands of chemicals – whether they be from industrial processes, fertilizers and pesticides from farms, or from human excretions of birth control pills, antibiotics or the remnants of chemotherapy. Add climate change to the mix, which is changing water and weather patterns around the world, and we have the makings of a real disaster.
Contributors to the big problems are: population growth, climate change, waste, pollution, agriculture, and industrial use.
A third of the world’s population live in water stressed areas (expected to increase six times in 20 years) and over a billion people lack access to water supplies (expected to double in 20 years). one billion people drink unsanitary water; three to four million people die each year from waterborne disease – the single largest cause of illness and death worldwide.
In the U.S. and other industrialized countries, 15-20% of the water is lost to leaks in the pipe network. In developing countries, the figure rises to 20-40%, due to illegal withdrawals as well as leaks.
Agriculture is the world’s largest water consumer, using 70% of the world’s water supply, extremely inefficiently. Industry is the biggest consumer in developed countries, but is more and more moving to the developing world, which is already water stressed.
Big Solutions
The technology is available to fix many of the problems, but there isn’t the money – or more accurately, the priority – to pay for it.
Water is currently managed – through subsidies and absurdly low prices – as if it were worthless instead of the life-sustaining, valuable, and increasingly scarce resource that it is. The root of the problem is that water is ridiculously cheap.
Water utilities can’t afford to upgrade, the infrastructure continues to decay, and individuals, businesses and farms have little incentive to conserve and change practices toward greater efficiency.
Why is it so cheap? Because people view access to clean water as a basic right and because they believe the supply of water is unlimited.
The greatest opportunities for solutions lie in using water more efficiently. It’s much cheaper to conserve and re-use water and to fix the infrastructure than it is to build dams, reservoirs or desalination plants or to replace infrastructure.
Particularly in the developing world, low-cost, low-tech solutions can play substantial roles in alleviating the water crisis. High tech solutions are also important, particularly in industrialized nations. Major technologies include monitoring and measuring water use, advanced treatment membranes, pipe repair technologies and desalination.
Only 10% of new water plants filter contaminants using membranes today – that’s expected to jump to 70% in ten years. Chlorine will be replaced by technologies such as ultraviolet radiation, ion exchange and ozonation; microbiological wastewater treatment techniques will be used in tandem with novel membranes and alternative chemicals. Constructed wetlands will become more commonly used to naturally treat water.
Systemic Solutions are also needed. How should water be fairly priced? What kinds of financial mechanisms should be used to promote conservation and investment? For example, do we need to treat water to drinking water standards when only 1% of all water used is for drinking? Should society pay to provide drinking quality water for car washes, soda manufacturers or even for people to water their lawns?
The Water Investment Landscape
Trends in the water industry, all of which have investment implications, are:
1. Tighter regulations: zero discharge policies, water re-use policies, and regulations that require desalination plants to treat byproducts rather than dump them into the ocean.
2. Advanced filtration techniques: replacing chemicals for water treatment, especially in industry; filtering more complex contaminants, such as growth hormones from farm runoff.
3. Measuring water consumption: increasing water use efficiency, companies reporting on their “water footprint.”
4. Water pricing mechanisms: higher prices, trading water rights and water pollution rights.
5. Continued consolidation and privatization: While only 10% of customers worldwide are served by investor-owned utilities today, that’s expected to rise by as much as 500% over the next decade. Small water utilities are being rolled up by large ones.
6. Dominance of a few conglomerates: General Electric, Danaher, Siemens, 3M, and Suez are widely expected to dominate the water industry in the next 5-10 years, none of which derives a significant percentage of revenue from water.
Investment sectors:
The water industry can be broken down into the following major segments: utilities, treatment technologies, infrastructure, efficiency, and monitoring.
A few niche segments are growing faster than the industry as a whole, which tends to grow by a steady, but not “growthy,” 4-6% annually. Ultraviolet radiation and membrane filtration are growing 15% a year, while chemical treatments are declining. Infrastructure spending is likely to experience accelerated growth in the future, as more capital is invested in maintaining and upgrading infrastructure. Metering and monitoring are strong growth areas.
At the moment, the industry is the subject of intense investment interest from all kinds of investors – individuals, private equity and corporate. Stocks are trading at very high valuations for the most part – investors have to pick the right companies and consider how long they plan to hold the stock. Valuations for U.S. companies are higher, but overall returns are lower than those in the rest of the world.
Although water utilities have long been core investments because of their stability and high dividend yields, that’s changing. Dividends are lower and volatility is higher. Aqua America is a key utility stock. This superbly managed company is also an environmental leader, having designed the first wastewater re-use systems for an apartment complex.
Key core stock: Veolia (a bit pricey)
Treatment:
Companies with advanced treatment systems – which ha
ve higher margins and recurring revenue from membrane replacement – should experience 10-20% growth in the coming years. UV disinfection, for example, is a cost-effective alternative to chlorine, which has a $500 million world market, growing 15-20% a year.
Desal technology, a huge growth area, is shifting from less efficient, energy intensive thermal (distillation) technology (74% market share) to reverse osmosis (22% market share). All desal technologies produce toxic waste and are environmnentally problematic because they enable over-population in water scare areas.
Key stocks (“buy”): ITT, Hyflux, Bio-Treat
Infrastructure
Utilities are ramping up investments to maintain and upgrade infrastructure – the pipes, pumps, valves and tanks that aren’t sexy but they make the system work. The segment is growing 10% a year in industrialized countries and 10-15% a year in developing countries. New, important technologies detect damage before a pipe leaks and repair pipes, rather than replace them.
Key stocks (“buy”) : Insituform, Layne Christensen, Gorman Rupp
Water Efficiency:
In industry, the market for decentralized wastewater treatment systems that re-use water is growing 20% a year. Domestic meters can save an estimated 15% of water by giving users feedback on how much water they’re using and when. They can also help locate leaks.
Key stocks (“buy”): Itron, Badger Meter
Modern irrigation technologies, such as micro and drip irrigation use 30-70% less water, minimize soil salination, and boost crop yields by 20-90%.
Key stock (“buy”): Lindsay Corp.
Monitoring:
The ability to pinpoint abnormalities in the system, chemicals that need to be removed from discrete locations, or finding a leak before it implodes, enables targeted cost-effective solutions.
Investment Vehicles for Water
For U.S. investors, besides, developing a stock portfolio for water, there are few investment options: PowerShares Water Resources Portfolio (Amex: PHO), an international water ETF which will launch soon, and the Global Water Equities Portfolio (CGWEFX).
The Pictet Water Fund, The SAM Sustainable Water Fund and KBC Eco Water Fund are open to investors outside the U.S.
Private Equity
From an investment perspective, the water industry has never been hotter. Investors of all stripes have been rushing in – corporate and strategic investors like the General Electrics and Siemens of the world, hundreds of private equity groups like the Carlyle Group, venture capital firms, and literally millions of private individual investors.
Yet, while there are lots of dollars looking to be invested, there are huge infrastructure and capacity needs that are crying out for new dollars.
There’s a consensus that the water industry won’t be characterized by silver bullets or huge technological breakthroughs, but rather dozens of known technologies in which we see consistent, incremental improvements. Pumps use less energy, membranes are far more efficient.
The water business needs to consolidate to some degree. It’s not a matter of finding breakthrough technologies; it’s a matter of making what exists efficient.
Rather than looking for gee wiz” technology, look for technologies or processes that improve water quality and allows for re-use.
Frustrations in Water Investing
Sustainable investors look for companies that enable conservation, but many of the innovations don’t make it to market because water is just too inexpensive. Strapped utilities can’t pay for it and government regulations don’t require it. There won’t be demand for technologies that can detect very low levels of toxics, for example, until people are willing to pay for that.
Desalination isn’t a “sustainable” investment – it provides water for millions of people to live where they shouldn’t live in the first place. Utilities like Southwest Water are pumping acquifers dry.
Conclusion
The biggest thing that must change is an idea. The idea is that endless, unlimited growth is our right as humans and that growth is necessary for a high quality of life. As we know, if we continue on the path we’ve traveled for the last 200 years, our penchant for growth will make the Earth unlivable for any creature, including humans.
There’s lots of bad news about the state of the world’s water, but there’s also good news. Although a billion people don’t have access to adequate quantities of clean water, the other 5.2 billion do (83% of population). Tanzania and some other African countries are making progress – while only 38% of the population had access to safe drinking water in 1990, 80% did in 2002.
Industry and agriculture are becoming more efficient. Awareness of water issues is increasing. And in the end, if we draw less and stop polluting, nature will provide free freshwater for all of eternity.
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To purchase the report ($79), click here.
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