Dipping into Water Stocks

There aren't a lot of names trading in this strong-performing sector, but here are five worth looking at

Water stocks are sparkling. Companies focused on collecting, distributing, and purifying the mundane and precious liquid have risen handsomely over the last year, and water management appears poised to become an increasingly vital industry in the future. However, the situation poses a dilemma to investors: With many water stocks at or near the top of their 52-week range -- including all of the ones we're featuring below -- is now still the time to jump on board? Or would it be prudent to hold off on the sector?

The answer isn't immediately clear. Debra Coy, a water-industry analyst with the Stanford Washington Research Group, says that for a sector in which there's so much interest, there are a "relatively scarce number of stocks," compared with, say, oil. This paucity may be one of the factors behind the sector's strong advance.


  Clearly, some shrewd investors dove in a few years ago. (See BW, 4/18/05, "Now That's A Liquid Investment".) The research group Security Stock Watch tracks a 20-stock water index that has more than doubled since the end of 2002, substantially outpacing the Dow Jones industrial average, the Nasdaq composite, and the Standard & Poor's 500-stock index. In an e-mail, company President Deborah Gilbert cited several reasons for the boom, including increasing privatization of government utilities and an enormous need to replace deteriorating water infrastructure.

Water, water everywhere, but so few worthy aquatic stocks to play. The best investors can often find opportunity in scarcity, but is now the right time? With those difficulties in mind, Five for the Money presents water-related stocks that might be worth a look.

1.United Utilities

United Utilities (UU) is a water and electricity distributor operating in the Northwest of Britain. While its services resemble those of many utilities, there are several reasons to be enthusiastic about the company. As a British group, United operates under a performance-based rates system through which regulators periodically reset rates based on a utilities' price reductions and organizational cost efficiency.

Mark Sadeghian, a utilities analyst at Morningstar, says that most U.S. companies take in a target return on equity, and so have fewer incentives to keep their prices down. Generally speaking, "I think there are better capitalizations in Europe," Sadeghian says. He gives the stock three stars, out of a possible five.

The company offers utility investors an unusual extra. United runs a business in outsourcing utility services such as billing, information technology, and call centers. "It's a way to capture growth on the side," Sadeghian says, though "you wouldn't want it to get too big."

2. Tetra Tech

Like many water-related stocks, Tetra Tech (TTEK) has performed well over the past year, climbing about 72% from its early May low of $10.29 per share. But Stanford Washington's Coy says she sees untapped potential in the engineering and consulting group's share price. (She owns the stock and Stanford makes a market for the company.)

One reason is that after a long disentanglement process, the company has managed to largely separate itself from a foray into the telecom business, a departure from its core focus on water that Coy characterized as unsuccessful. Tetra Tech has also cleared up confusion over who would succeed retiring Chairman and CEO Li-San Hwang.

Though the company is now primarily devoted to water contracts, Coy suggests that the lingering associations of the company with telecom may have left a sour taste for investors. Tetra Tech's specialties include groundwater cleanup and environmental restoration. Coy says its contracts include projects in the Everglades, the Los Angeles River basin, and the sewers of Detroit. It's the "premier company in a space that's going to have great long-term fundamentals," Coy says.

3. Aqua America

It's the biggest water utility in the U.S., and is poised to grow rapidly. But some observers are wary of Aqua America's (WTR) stock, saying the giant's share price has climbed too high, too fast. On Mar. 20, it traded at $27.61, up from a split-adjusted $17.49 last March.

Aqua America provides water and waste services in parts of the Northeast, South, and Midwest, and it maintains a ravenous appetite for acquisitions. Stewart Scharf, an S&P analyst who rates the stock a hold, says, "They've been generally successful in getting their rate cases approved by state commissions." He projects revenue growth for the company of 7% in 2006.

As a whole, S&P's outlook for the sector is mixed. It recently downgraded water utilities to neutral from positive. Through last week, the S&P's water utilities index has risen 2.7% thus far in 2006, underperforming the S&P 1500 index.

4. Sabesp (SBS)

Here's another global play. Sabesp (SBS), a utility based in São Paolo, Brazil, provides water and sanitation to 25.6 million clients across the state of São Paolo, including the gargantuan city of the same name. John Dickerson, the CEO of Summit Global Management who manages about $125 million in water-focused portfolios that hold a position in SBS, says the utility's appeal is based on "just a simple financial metric."

Sabesp has a price-to-earnings ratio of 5.69. By comparison, the much larger Aqua America's number is 39.29 at the end of trading on Mar. 20. Dickerson points out that the company has opportunities to expand as it takes over jurisdictions where water services are still provided by small municipal entities.

5. ITT Industries

One tricky aspect of divining water plays is that many of them are hidden in larger conglomerates. Among these, Morningstar analyst Matthew Warren likes the looks of water-equipment and defense group ITT Industries (ITT), another of Morningstar's three-star stocks. ITT is the industry leader in highly engineered pumps that can be used to take out the waste resulting from wastewater. The business is attractive for sales and then follow-up work like repairs and retro-fitting, Warren says.

Beyond the pump, ITT is one of several developers of advanced water-filtration systems employing methods like ozone and sophisticated membranes. They're making headway into water-purification systems now dominated by the use of chlorine, which may have associated health problems.

In water purification, there's no shortage of competition with other global businesses like General Electric (GE) and Siemens (SI). But Warren says that hasn't affected White Plains (N.Y.)-based ITT. "So far, all three companies have been taking advantage of a growing market." And with growing concerns on the safety and adequacy of the world's water supply, investors may do well to take a careful look.

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