Stock Market: 3 Ways to Invest in the Water Industry

Top Four - Money - GPape

Water-based investing can offer slow but steady growth potential and respectable cash flow. Photo: Andrew Nguyen / EyeEm / GettyImages

Water management is not a very exciting subject. Unless a toxic wastewater pond overflows or a city’s drinking water is contaminated, we don’t hear much about the business of getting potable water into our homes or taking it away.

In fact, it’s a huge business and growing at a steady rate of 6.5 per cent annually, according to a report published last year by London-based Meticulous Research. In it, the British firm estimates that the global market for water and wastewater treatment could be worth US$211.3 billion by 2025.

“Growing global demand for clean water, more stringent regulatory issues, and increasing environmental concerns make water and wastewater treatment systems more relevant than ever,” the report says. “Rapid population growth and urbanization, growing demand for new water resources, rising focus on water quality and public health, increasing prevalence of water borne diseases, increase in industrial demand, and stringent governmental regulations on treating wastewater also aids in the growth of this market. Moreover, growing focus on sewage treatment in countries like the U.S., China, and India; and potable water for small communities provide significant opportunities in this market.”

The report goes on to note that the “high cost of equipment, operations, and disposal obstructs the growth of this market to some extent. In addition, aging water infrastructure, excess energy consumption, and rising expenditure due to excess sludge production are some of the major challenges in the overall water and wastewater treatment market.”

Despite the obstacles, a few investors have discovered that water-based investing can offer slow but steady growth potential and respectable cash flow. But most ignore the sector or only have exposure to it through an infrastructure fund.

Here are three ways you can invest in the water industry.

Xylem Inc. (NYSE: XYL). Xylem is based in Rye Brook, New York. It is a leading global water technology provider, enabling customers to transport, treat, test, and efficiently use water in public utility, residential, and commercial building services, and in industrial and agricultural settings. It makes pumps and control systems used in management of wastewater and the collection and distribution of drinking water. It also offers smart metering, network technologies, and advanced data analytics for water, gas, and electric utilities. Xylem does business in more than 150 countries.

The stock has been a strong performer over the past year, almost doubling from its 52-week low of $56.63 (figures in U.S. dollars) to close on Friday at $108.64. The stock was first recommended in my Internet Wealth Builder newsletter in May 2015 at $37.14.

The company’s fourth-quarter and fiscal 2020 financial results beat expectations, despite the economic impact of the pandemic. Revenue in the final quarter was $1.37 billion, slightly higher than the same period in 2019. Net income was $148 million ($0.82 a share) compared to $118 million ($0.65 per share) in the same quarter pf 2019.

For the full year, Xylem reported revenue of almost $4.9 billion, down from $5.2 billion in 2019. Net income was $254 million ($1.40 per share), down from $401 million ($2.21 per share) in the prior year.

The company announced an 8 per cent increase in the quarterly dividend, the 10th year in a row it has hiked its payout. The new rate is $0.28 per share ($1.12 per year) for a yield of 1 per cent.

Xylem is forecasting a strong year in 2021, with revenue up 6-8 per cent to between $5.16 and $5.26 billion. It is forecasting adjusted earnings per share of between $2.35 and $2.60.

American Water Works Company (NYSE: AWK). This company, which traces its history back to 1886, is the largest and most geographically diverse U.S. publicly traded water and wastewater utility. It employs more than 7,000 people who provide regulated and market-based drinking water, wastewater and other related services to more than 15 million consumers in 46 states.

The business involves the ownership of water and wastewater utilities that provide services to residential, commercial, and industrial customers, treating and delivering more than 1 billion gallons of water per day.

The stock has had a choppy year, but the overall trend has been up. The shares did not drop below $100, even during the market plunge of March 2020. They closed Friday at $160.12.

Fourth-quarter and year-end results for 2020 were impressive. Operating revenue for the final quarter was $923 million, up from $902 million in the prior year. Net income attributable to common shareholders was $145 million ($0.80 per share, fully diluted), a healthy increase from $98 million ($0.54 per share).

For the full year, AWK reported revenue of almost $3.8 billion, up from about $3.6 billion the year before. Net income was $709 billion ($3.91 per share) compared to $621 million ($3.43 per share) in 2019.

The company is projecting 2021 earnings per share of $4.18 to $4.28 and a five-year annual compound growth rate of 7-10 per cent.

The stock pays a quarterly dividend of $0.55 a share ($2.20 annually) to yield 1.4 per cent.

iShares S&P Global Water Index Fund (TSX: CWW). If you’d prefer to put your money into a diversified fund rather than individual stocks, this is a good choice. It was recommended in my Income Investor newsletter in July 2013 at $19.65. The units closed Friday at $48.70. (Figures here are in Canadian currency.)

This ETF provides exposure to 50 companies from developed markets on the basis of their relative importance to the global water industry. These include water utilities, infrastructure companies, and those involved in the manufacture and distribution of equipment. About half the portfolio is invested in U.S. companies. The U.K. accounts for 13.2 per cent, France 9 per cent, and Switzerland 7.4 per cent. Canada represents 3.6 per cent of total investments.

The top two companies in the portfolio are those mentioned above: Xylem (9.3 per cent) and American Water Works (8.4 per cent). Rounding out the top five are France’s Veolia (5.4 per cent), Pentair (5 per cent), and U.K.-based Halma PLC (4.7 per cent).

The fund has been a strong performer. One-year return to March 31 was 31.8 per cent and the 10-year average annual compound rate of return was 13.4 per cent. Since our original recommendation in 2013, we have a capital gain of 148 per cent, plus distributions.

Those distributions are paid quarterly, and the amount varies considerably. The trailing 12-month payout to the end of March was $0.594 for a yield of 1.2 per cent at the current price.

The fund was launched in June 2007 and has about $277 million in assets under management. The management expense ratio is on the high side at 0.66 per cent but the high return makes the expense worthwhile.

I view these as relatively low-risk securities, suitable for conservative portfolios.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.

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