Parched

by Eric J. Fry

The average New Yorker buys a new toothbrush every three months, but he brushes his teeth with water that flows through 100-year old tunnels and pipes.

The water infrastructure in most of the rest of the nation isn’t much newer than Manhattan’s. It should be no surprise, therefore, that water pipes are rusting and crumbling all across this great land of ours. The nation’s alarmingly decrepit water infrastructure will require a $1 trillion overhaul over the next twenty years, according to the American Society of Civil Engineers (ASCE). This massive infrastructure spending will mean big business for many water infrastructure companies.

“America’s crumbling infrastructure is eroding our quality of life,” the Midwest Contractor warns. “In its 2005 Report Card for America’s Infrastructure, the American Society of Civil Engineers ASCE assigned a cumulative D grade to the nation’s infrastructure, saying that the condition of roads, bridges, drinking water systems, and other public works have shown little to no improvement since ASCE graded them a D-plus in 2001. Grades in all the categories range from a high of C-plus for solid waste to a low of D-minus for drinking water, navigable waterways and wastewater.”

America’s “D-” water systems would probably receive a passing grade in most parts of the world, but they are still very far from an “A.” According to the EPA, the nation’s 55,000 community drinking water systems and 16,000 wastewater treatment systems face “staggering public investment needs” over the next 20 years.

Repairing the nation’s water-supply infrastructure will cost hundreds of billions of dollars over the next two decades. That’s bad news for the municipalities, tax-payers and rate-payers that will have to foot the bill, but very good news for the companies that will be sending the bills.

Enter companies like Aqua America (NYSE: WTR), Northwest Pipe (Nasdaq: NWPX), Mueller Water Products (NYSE: MWA) and PW Eagle Inc. (Nasdaq: PWEI).

Aqua America, for its part, is busily buying up municipal water systems in 13 different states, and spending millions to bring them into compliance with stringent new EPA guidelines. Even if some municipalities would be content to tolerate an excess of arsenic in the local water supply, the EPA is not.

The EPA’s new dispensations would require many municipalities to make improvements that they cannot afford. Thanks to this assist from the EPA, therefore, Aqua America is finding itself in a buyer’s market for municipal water systems.

Meanwhile, companies like Mueller Water Products are capitalizing upon a much more rudimentary problem: many water pipes and valves are simply too old to do the job effectively.

According to the EPA, nearly 25% of the nation’s water pipes are “poor, very poor or elapsed.” Even worse, the EPA expects that percentage to increase to 45% by 2020…unless something is done about it.

“Many systems have reached the end of their useful design lives,” the ASCE reports. “Older systems are plagued by chronic overflows during major rain storms and heavy snowmelt and, intentionally or not, are bringing about the discharge of raw sewage into U.S. surface waters. The U.S. Environmental Protection Agency (EPA) estimated in August 2004 that the volume of combined sewer overflows (CSOs) discharged nationwide is 850 billion gallons per year…If the nation fails to meet the investment needs of the next 20 years, it risks reversing the public health, environmental, and economic gains of the past three decades.”

Mueller hopes its pipes and valves will provide a major part of the solution. Mueller only started trading as a public company on May 26th. But most of us – and most of our dogs – have known this company from birth. It manufactures about half of all the fire hydrants in the country. Mueller’s stock, which sells for about 27 times earnings, is hardly cheap. But all major U.S. water stocks command a premium valuation. The portfolio of the PowerShares Global Water Fund (NYSE: PHO), for example, carries an average PE of 28.

We have no idea if these water stocks are worth their premium pricing. But we have some idea that business will be booming for a very long time in the U.S. water infrastructure industry.