Do Your Investments Need Water to Grow?

Unknown-14Dear Mr. Market:

One of the most fundamental concepts of economics is Supply and Demand.  Demand refers to how much quantity of a product or service is wanted from buyers and supply tells how much is available. We can often apply the law of supply and demand to investments to find the next lucrative opportunity. In general if there is low supply but high demand the price will rise. Conversely, heavy supply with weaker demand should lower prices. What happens if you had a resource in abundant supply but it was also scarce?  Water actually fits this paradox of sorts.

Most people have heard at one point or another that water covers about 71% of the earth’s surface.  Even the human body’s composition is somewhere in the range of 60% to 70% water. Again, although water is abundant it’s also scarce. Over 97% of the earth’s water is seawater and of the remaining 3% that is fresh water, only 1% is available for human use. Saltwater can’t be used for drinking, crop irrigation, or for most industrial applications. Not only is there a global shortage of water but also the demand for it is estimated to double every 20 years!

Investors need to understand where the next great opportunity is before it happens. Hockey legend Wayne Gretzky said it best, “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.”  This can be applied to investing in oil over the last century as it has driven the headlines and proven to be investment worthy. While that may not change overnight there are other developments and trends to watch for and the price and supply of water is such an example.

When you think of what the world’s greatest health crisis is most people don’t typically put water at the top of the list…but it is. Water related diseases kill one child every eight seconds and over 5,000 daily child deaths are diarrhea related. Sweltering population growth is not only stressing water usage but it’s causing pollution issues that compound other economic challenges. Another issue aside from water shortage is how to actually get it to people and the infrastructure needed to deliver water.

Most of the water pipes in the U.S. are anywhere from 60 to 100 years old and are in dire need of replacement. It’s estimated that we lose about 1.7 trillion gallons of water every year from leakage alone. Clearly, water infrastructure and delivery systems need improvement in the United States but the issue is even greater overseas.

The World Water Council estimates that annual spending on water infrastructure is currently at $80 billion and it will double in the next few years. Aside from obvious population strain and infrastructure deterioration, consider what happened in the 2010 Haiti earthquake. Lack of clean drinking water is nothing new in Haiti but this natural disaster wiped out most of their existing infrastructure. Even though there are reconstruction plans, at the time of this writing Haiti still does not have a single pipe built to transport water from a treatment center to a residence. Some companies are obviously flourishing in countries like this by providing drinking water but larger scale investment opportunities will be born here and elsewhere.

The trick is to find companies that clean and transport water and have solid management. Some water stocks have already completely outperformed the broader stock market but we believe we’re still early in the game and that there are still several with considerable value. Here’s a brief list of some companies that are worth a look:

Hyflux Ltd. (HYF)- This is an investment holding company based in Singapore that provides integrated water management and environmental solutions. Hyflux is involved in purification of raw water, cleaning of wastewater, desalination of seawater, production of ultra pure water for industrial and municipal clients, and provides home consumer filtration products among several other lines of business. Normally we’re not one to play with too many penny stocks but this is a company that has considerable upside over the long-term.

Xylem Inc. (XYL)- Xylem is a leading global water technology company that’s made up of four business units – Water Solutions, Flow Control, Analytics and Residential and Commercial Water. Xylem is number one or two globally in all of these spaces but with that comes a bit of a premium. The stock has not done as well as some might expect recently; partly due to high exposure to Europe (almost 40% of revenues). Investors in Xylem should be looking at a company like this as not just an emerging markets play but rather a huge opportunity to capitalize on massive infrastructure upgrades that face the globe. Much of the water infrastructure in Europe was put in the ground after World War II and its shelf life should only be 50- 70 years…so do the math!

Tetra Tech Inc. (TTEK)- There’s always a “diamond in the rough” and that even applies within a stock market that has hit all-time records over the past year. Tetra Tech is such a company and it’s simply overly punished this year but is extremely well positioned to take advantage of not only water as a scarce commodity, but also with the other pieces of their business mix via alternative energy, natural resources, and infrastructure. The recent pullback offers investors a potentially nice entry point to a company that has solid earnings quality, strong sales, and smart management. It currently trades around $23 per share but don’t be surprised to see it back over $30 in the next 12 to 18 months.

If stock picking isn’t your cup of tea and you simply want exposure to water investments, consider a number of Exchange Traded Funds (ETF’s). PowerShares offers the largest water related ETF with the PowerShares Water Resources Portfolio (PHO).  If you’re a fan of indexing the S&P 1500 Water Utilities Index is an option. Most indexes are obviously diversified but oddly enough this one is comprised of only two companies with Aqua America (WTR) and American States Water (AWR). A more diversified way to capture exposure is through the Guggenheim S&P Water Index (CGW), which tracks the Standard & Poor’s Global Water Index. Lastly, the First Trust ISE Water Index Fund (FIW) is an ETF that is made up of 36 stocks in the potable and wastewater industries.

Remember the simple but powerful economic law of supply and demand that we first opened this article with. With regard to our abundant yet scare commodity of water, demand is outstripping supply and creating a massive opportunity for investors.

We welcome your comments or questions. Feel free to use the response option below or contact us directly.

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