Water: Good as Gold for Investors

08/31/2012 4:11 pm EST

Focus: COMMODITIES

Jim Jubak

Founder and Editor, JubakPicks.com

The world's most critical commodity is getting harder to find, which makes it an attractive investment. Here are ten ways to play it, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

Water. It’s the global commodity that most deserves a place in your portfolio—ahead of gold, iron ore, copper, or oil, I’d argue.

And it’s also the toughest to invest in. Water isn’t traded—in fact, in many countries it’s not even metered.

Pure-play water companies are hard to find, especially if you rule out the obvious but slow-growing water utilities. The leading companies in big swaths of the market are industrial conglomerates in which water has historically made up a relatively small share of revenues.

For example, among the top ten companies in the Guggenheim S&P Global Water (CGW) exchange traded fund, which is designed to track the Standard & Poor’s Global Water Index, I’d call five of them water utilities and two diversified industrial companies with a presence in water.

That leaves only three, or about 30% of the ETF and index, anywhere near the sweet spot in water. (More about what the sweet spots are later in this column.)

But this is changing. As the individual parts of the water market get bigger, investors are seeing a wider array of pure plays.

For example, orders for desalination equipment to convert seawater into water for drinking and industrial processing hit $5 billion in 2011, according to Global Water Intelligence. Those orders are forecast to hit a record $17 billion in 2016.

And it doesn’t hurt that both companies and investors see water bucking the trend of other environmental sectors. As of August 29, the Guggenheim S&P Global Water ETF was up 8.85% from last year, versus a brutal 38.53% drop for PowerShares WilderHill Clean Energy (PBW).

A Resource You Can't Live Without
You can put together the investment case for water from the headlines.

Supply is falling. Droughts devastate—depending on the year—the United States, Australia, India, China, and Argentina. Evidence mounts that the global climate is becoming more volatile, putting historic water-carrying weather patterns such as India’s monsoon season at risk.

Supplies of clean water shrink as underground aquifers are mined for limited supplies of water accumulated over millions of years. Clean water supplies also dwindle as existing sources are polluted by farm chemicals, inadequately treated industrial discharge, and untreated urban sewage.

Amid all this, demand is rising. According to data from the United Nations, withdrawals of fresh water have tripled in the last 50 years, with demand for fresh water increasing by 64 billion cubic meters (64 trillion liters, or 16.9 trillion gallons) a year.

Some of that is from global population growth of about 80 million people a year, at current rates. Some is from changes in lifestyles and eating habits that increase per-capita water consumption. And some is from soaring demand for clean water from farmers, industry and city dwellers.

Add in increases in energy production (because tapping sources such as oil sands and biofuels requires more water than extracting from traditional sources of oil and natural gas) and the math is pretty simple: Falling supply and rising demand will drive the price of the commodity higher.

Want to know where to invest in water? Follow the flow. In this column, it takes me to ten water stocks in three categories.

NEXT: Jim’s Recommendations

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1. Global Water Utilities
Rising prices for water will produce gains for global water utilities, even if those returns are capped by regulators at a specific return on invested capital.

The best bet here is on water utilities that are building out infrastructure in places where water demand is rising most rapidly, and new investment represents a large percentage increase over existing investment. If that sounds like a prescription for investing in water utilities in developing economies, it is.

For example, Manila Water (trading in Manila as MWC.PM), which already supplies water for half the Philippine capital, has recently bought a 47% stake of Vietnamese water distributor Kenh Dong Water Supply and 49% of treatment-plant operator Thu Duc Water. The stock is up 43.86% in the last year.

Or Guangdong Investment (GGDVY), which supplies Hong Kong’s water (and is up 33.97% in the last year). Or Companhia de Saneamento Basico do Estado de São Paulo (SBS), which collects, treats, and supplies water in Brazil’s Sao Paulo state (and is up 60.62% in the last year).

2. Wastewater Companies
That math also adds up for investing in companies that handle and treat wastewater. More water consumed means more water as waste. More water demand means more demand for treatment services that turn dirty water back into clean water.

For example, Xylem (XYL), an October 2011 spinoff from ITT (ITT), focuses on moving water from distant sources and through increasingly complex supply systems, then treating and testing it. The company’s water infrastructure unit—which accounts for about half of its revenue—gets its income from transportation equipment/pumps (73%), treatment (18%), and testing (9%).

In 2011, 64% of the company’s revenues came from outside the United States, which exposed the company to the recession in European economies (37% of revenue). As a result, the stock was down 5.36% in 2012 as of August 29.

Since most of the company’s European business is in the water-infrastructure unit, where customers are water utilities that derive revenue from their customers’ water bills, I think the pullback to date is understandable. And it creates a buying opportunity for patient investors. I’ll be adding shares of Xylem to my Jubak’s Picks Portfolio.

3. Companies Making More Water
The biggest opportunity suggested by that math is investing in companies that create more clean water. God may not be making any more water, but human beings—with enough money and energy—are turning part of the current supply of seawater (and other brackish water) into water fit for drinking or industrial uses.

Current technologies for desalination use huge amounts of energy, so they produce water at a high cost. But when the alternative is moving San Diego to a wetter climate or giving up on the Saudi royal family’s dream of an economy that can feed itself and turn its raw commodities into higher-margin chemicals, the high cost of desalinated water is relatively unimportant.

The cost is falling, though. Reverse osmosis, the current desalination technology of choice, produces clean water for about $1 per cubic meter. That’s about ten times the cost of water from traditional sources (which are limited, of course), but about half the price of water from desalination 20 years ago, according to the International Desalination Association.

If you’d like to get your desalination (and general water) exposure as part of an industrial equipment company with its fingers in a lot of infrastructure pies, I’d recommend General Electric (GE). The stock has been a member of my Jubak Dividend Income Portfolio since February.

If you’re looking for more-concentrated exposure to desalination, I’d suggest turning to Singapore, which has become a world leader in the technology, thanks to the challenge of being a tiny city-nation with very limited sources of natural water.

Keppel (KPELY) combines three very timely businesses: construction of deepwater drilling rigs; waste disposal and waste-to-energy in Asia; and water desalination and wastewater treatment in Singapore, the Middle East, and China. (The stock is up 2.7% in the last year.)

A more concentrated Singapore water play is Hyflux (HYFXY). The company has just completed a water desalination plant in Algeria and has begun work on a desalination plant in India. Profit in the second quarter climbed 21% year over year.

China currently accounts for 20% of the company’s revenue, and Hyflux is looking to grow that share to 33% within the next two years. (The shares are down 20.14% in the last year.)

And in building your water portfolio, I wouldn’t forget about some longtime favorites, such as pump maker Flowserve (FLS), and water-meter makers Badger Meter (BMI) and Itron (ITRI).

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Guangdong Investment, Keppel and Manila Water as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.

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