From Standard & Poor's investing newsletter The Outlook.
While most people take water for granted as a routine part of daily existence, it is actually a commodity of limited supply and unlimited demand—thereby making companies involved in its provision, treatment, and delivery an attractive investment opportunity.
"Water is the one commodity where demand is not subject to the pressures of macroeconomics," says William Brennan, president of Aqua Terra Asset Management, a specialist in the water infrastructure sector. "Water cannot be duplicated and has no substitute. Water is virtually inelastic—as prices rise, consumption does not decrease." Aqua Terra, a subsidiary of investment and brokerage firm Boenning & Scattergood Holdings, is the sub-adviser of the Kinetics WaterInfrastructure Fund, a mutual fund that became available to investors on July 2, 2007.
Som Seif, chief executive officer of Claymore Investments, which recently launched the Claymore S&P Global Water ETF (exchange-traded fund) (CGW), believes that fundamentals surrounding the water and water-treatment industry are extremely bullish.
Toward Private Management
"Demand for clean water supply and improved water infrastructure is growing around the globe—driven by a rising population, increased industrial demand, and the need to upgrade or replace the aging pipes carrying our water," he says.
Moreover, Seif notes, there has been a gradual transition in the management of water resources away from municipalities and toward larger private corporations. Consequently, infrastructure spending on water delivery systems is expected to rise sharply, and much of that is anticipated to come from private investment.
The numbers surrounding water and its supply-demand characteristics are staggering and sobering.
Water available for human consumption represents less than 1% of all water on the planet, while the renewable supply has fallen by almost 60%, Brennan notes. "Only 20% of the global population has access to running water and 40% has no access to clean water or sanitation," he adds. "Within 50 years, more than half of the entire earth's population of more than 9 billion will be living with water shortages affecting 80 countries, including the U.S. And more demand for water means that the already under-supplied resource will become scarcer in the years to come."
M&A Activity in Water Industry
The annual cost of maintaining the infrastructure of global water systems, says Brennan, falls somewhere between $425 billion and $700 billion (including $110 billion in the U.S. alone). Brennan expects spending on U.S. water infrastructure to accelerate, noting the Environmental Protection Agency declared that at least 25% of the nation's pipes are in poor shape; by 2020, that number is expected to rise to 45%. Indeed, according to the American Society of Civil Engineers, the U.S. water infrastructure will require more than $1 trillion in repairs by 2025.
Stewart Scharf, an equity analyst at Standard & Poor's, notes that since more than 80% of the U.S. population gets water from government entities, he thinks municipalities are eager to find cost-effective, private-sector solutions, such as long-term management contracts or outright asset sales. This should result in increased mergers-and-acquisitions activity in the water industry.
"We believe municipalities will continue to turn to private entities to help repair decaying water systems," he adds.
Brennan expects private investments and M&A to continue in the U.S. water industry, noting that the massive and costly upgrades and repairs required are "beyond the ability of local municipalities to finance." About 15% of water customers in the U.S. receive their water from private sources, Brennan estimates, while water privatization is far more developed in Western Europe, particularly France.
China's Water Pollution Problem
The water situation in emerging markets, where infrastructure needs are enormous, is particularly dire. For example, Brennan cites China, which has more than a fifth of the world's population, but only 7% of its fresh water supply. China's water is so polluted that less than 15% of the nation's population has access to safe drinking water. The Chinese government has committed more than $128 billion to water infrastructure spending over the next five years, but that may not be nearly enough.
As far as investors are concerned, water-related stocks are typically companies that are engaged in either the provision or treatment of potable water, or those companies involved in technology and services related to water consumption. The sector is somewhat loosely defined, but encompasses far more than just the water utilities that investors are already familiar with.
The Claymore water ETF tracks the S&P Global Water index, which is invested equally between two separate types of water-related businesses: water utilities and infrastructure, and water equipment and materials. The ETF has high geographic diversity—as of Apr. 30, it had 28% of its assets invested in U.S. stocks, 19.6% in France, 16.4% in Japan, and 14.2% in Britain.
An International Issue
PowerShares Capital Management recently introduced the PowerShares Global Water Portfolio (PIO), which complements its existing PowerShares Water Resources Portfolio (PHO). PHO, which has amassed more than $1.8 billion in assets since its December, 2005, launch, is based on the Palisades Water index. Almost 85% of its holdings are U.S.-based companies. As of June 15, PHO's top holdings included such names as Valmont Industries (VMI), which makes metal products used in irrigation; Tetra Tech (TTEK), an engineering consultant; and Veolia Environnement (VE), the French energy and water conglomerate.
PIO serves as an international variant of the PHO product—it has 35.9% exposure in the U.S., 10.6% in Japan, and 7.9% in Britain. "Water supply/scarcity is a much greater issue in other parts of the world," says Bruce Bond, president of PowerShares. "So we decided to broaden our exposure by entering international water companies."
Srikant Dash, S&P index strategist, expects to see more interest from investors for vehicles such as water ETFs. "As we look beyond traditional sector and regional boundaries to global investment themes, we see a lot of interest in such products," he says. "We recently launched the S&P Global Thematic Index Series based on such themes as clean energy, water, infrastructure, nuclear energy, etc. The S&P Global Water index is part of the series."