Evaluating the Water Utility Sector

As we mentioned in my last column (“Demand Begins to Outstrip Supply,” September/October 2005), the water industry has been - and is currently - enjoying a great burst of investment interest and activity.

Th 201341

As we mentioned in my last column (“Demand Begins to Outstrip Supply,” September/October 2005), the water industry has been - and is currently - enjoying a great burst of investment interest and activity. And although the water industry definitely represents a strong and very sustainable long-term market, two great misnomers about it seem to be emerging.

First, the availability of individual investment opportunities in the public marketplace continues to dwindle as more independent companies are snapped up by larger consolidators. There just aren’t many significant water-related companies trading on U.S. public markets - Table 1 shows almost all the reasonably sized public companies, and even some of these are only partially water-related. Click here to view Table 1.

Second, profitability levels of most water companies aren’t much higher than a typical industrial equipment or services company. Yes, there are certain niches within the water industry - such as emerging technology areas like UV irradiation treatment and membrane filtration - where growth and profitability rates are higher, but there are few significant “pure-play” public investment opportunities in those sectors.

The one sector where there are significant opportunities to invest in substantially more profitable companies is the water utility sector. Although most water utilities in this country are municipally owned and operated, there are about 10 publicly traded water utilities, ranging in size from about $25 million up to $500 million in annual revenue. Like other parts of the water industry, this sector has seen considerable consolidation over recent years, and the number of public companies is down from about 20 just a few years ago.

These private water utility companies are focused exclusively in the northeast and in California, and - as regulated monopolies - tend to show much higher operating margins and profitability than other water companies. They also typically pay much higher and more predictable dividends to investors. Amongst these companies, it isn’t unusual to see operating margins in the 25% plus range - well above the level obtainable by most other water companies. Historically, water utilities have been viewed as sound value-based investments, but with relatively limited growth prospects. That, however, is beginning to change as new growth opportunities emerge.

The basic driver behind likely future growth (and profitability) of these water utilities is pretty clear. Demand for clean water will continue to rise with growing population and economic activity, but supply is basically fixed - and as we all know, there really is no substitute for water. And, further consolidation within the sector also seems likely - providing new growth opportunities, particularly for larger players like Aqua America, American States, and Cal Water. Large economies of scale are the key attribute of regulated monopolies like the water business - larger and more integrated companies will better handle increasingly complex regulatory controls and requirements, and make needed capital expenditures to upgrade aging treatment and distribution infrastructure.

In addition, many municipal utilities are finding it increasingly difficult to simultaneously deal with the increasingly complex regulatory and costly nature of this business, in times of fiscal constraints and cutbacks. Hence, some are turning to private companies, like those mentioned above, to operate their facilities on a contract basis. This represents another key growth opportunity for the private water utilities - one already being addressed by firms like Aqua America and Southwest Water.

With the recent (and apparently complete) reversal of German conglomerate RWE’s strategic diversification into the U.S. water business, it also appears possible the country’s largest private water utility - American Water Works - may again be floated onto public markets. This could represent an other large, attractive investment vehicle in the sector.

Conclusion

For investors seeking stable, dependable performers in the water industry - but where new growth opportunities are also emerging - the water utility sector deserves a close inspection.

Click here to enlarge image

About the Author: Steve Maxwell heads TechKNOWLEDGEy Strategic Group, a Boulder, CO-based management consultancy specializing in merger and acquisition support services, strategic planning, and market research for water and broader environmental industries. He’s also editor and founder of The Environmental Benchmarker. Contact: 303-442-4800 or maxwell@tech-strategy.com.

More in Home
Stormwater Management Guide
Sponsored
Stormwater Management Guide