Water is Too Cheap, Part II

Water is too cheap in the US…and it is also too cheap in the global stock markets. These are the main thoughts I took away from the Gabelli Water Investment Summit in New York earlier this year.

The most eye-opening presentation was by Nick DeBenedictis, the CEO of Aqua America, which is the second largest investor-owned water utility in the country. (It trades on the NYSE under the ticker WTR.) DeBenedictis told us about a city that “wondered why it couldn’t put fires out anymore.” The reason was the pipes were so old and clogged that there was only two inches for water flow. You’re never going to get enough water flow out of a pipe that size to put out a fire. “That’s not even enough to take a shower,” DeBenedictis said.

Speaking of showers, DeBenedictis told us about another water system where people wondered why they couldn’t take a shower and wash the dishes at the same time. Again, an old dilapidated water system was the culprit. “This is Middle America,” he said. “It can’t afford the pension for the police, much less new pipes.”

When a water system gets bad enough and the public finances strained enough, then a city will look to sell it. Sometimes, it is so bad and has so many problems that the municipality will sell it at any price. “We’ve picked up some for $1,” DeBenedictis said. “They just wanted to give it away.”

Or as Don Correll, CEO of American Water Works (the largest investor-owned utility in the US) put it, “We’re seeing financial distress in municipalities today that we’ve never seen in our lifetime… The more we keep printing money and running deficits, the more we’ll turn toward private investment.” That means more opportunities for the investor-owned water utilities.

Water is still too cheap in America. We subsidize water and hold it to an artificially low price. Most people pay a fraction for water compared with what they pay to an electric or telephone utility. But based on what I see and hear about the quality of our water systems, we’re going to have to pay up soon. As the Dennis Doll, CEO of Middlesex Water Co. said, “Many of these systems are disasters waiting to happen.”

It’s also going to affect us in ways you may not think of. It’s more than just the health and safety of our drinking water and the care of our wastewater – though that ought to be reason enough for concern. Our water supply will also dictate our choice of energy sources. (It takes water to make energy and energy to make water. This area of overlap is known as the energy-water nexus. It will be much more important in the 21st century than ever before.)

For instance, the renewable biofuels targets put out by the US Department of Energy are “completely dependent upon water supplies that simply do not exist at this point,” according to Summit. California’s goal of producing 1 billion gallons of ethanol per year, for example, will consume 2.5 trillion gallons of water. That’s more than “all the water from the Sacramento River Delta that currently goes to Southern California and Central Valley farmers combined.”

So what does all this mean for an investor? The water utilities look interesting again. Some are starting to enjoy rate increases. I like SJW Corp., a stock I recommended a few years ago. It’s now back below the price where I originally recommended it. SJW owns excess land and trades below its takeover value. Another good one is Aqua America, as the stock has not rallied much from the bottom and it has many opportunities to grow. Both stocks pay decent dividends.

The other stocks I’m following in this space are the many industrials that make the pipes, pumps, valves and other goods that support water. This has been a good place to fish for stocks. As Summit’s research over the last 30 years shows, “These businesses have tended to outperform other industrial sectors.”

Chris Mayer
for The Daily Reckoning

The Daily Reckoning