Investing in Water

Water & Wastes Digest recently spoke with Ryan Connors, senior water analyst at Boenning & Scattergood (B&S)—an investment firm that provides institutional sales and trading, research, public finance and corporate finance services.

Investing is the key to renewing the nation’s water infrastructure, so WWD asked Connors why people should invest in different water/wastewater treatment companies, his advice for industry shareholders and a 2008 industry outlook.

WWD: B&S indicated in a recent research report that the drinking water industry attracts more investors than the wastewater industry. Why do you think this is, and is this changing at all?

Ryan Connors: People generally like to invest in things they know and understand, and when it comes to the water industry, that means the water they get at the tap. This is reinforced by the fact that the potable water side gets more attention in the press.

Still, if you look at the EPA’s estimates of the spending that will be required to shore up infrastructure here in the U.S., it becomes clear that the opportunity in wastewater is at least as large as that in potable water.

WWD: What are the key differences between the water equipment and technology sector and the water utility sector from an investment perspective?

Connors: Water utilities and water equipment and technology companies are two entirely different types of investments, and their differences bring to mind the old story of the tortoise and the hare. Water utility stocks are tortoises. They may not grow very fast, but they are remarkably consistent—delivering solid but not spectacular returns every year. This enables these stocks to deliver impressive compounded returns over time.

Water equipment and technology stocks are the hares. Some key technologies—especially in areas like metering, desalination and conveyance—have the potential for very strong growth, and if you invest wisely, you can earn outsized returns. On the other hand, if a company’s technology does not pan out, its stock can fall dramatically, making these stocks higher risk/reward investments.

WWD: What is the current state of water equipment stocks in today’s economy? Do you have any advice for people that own stocks in this industry?

Connors: For investors holding water utility shares, patience is the name of the game, and the key to success is a “buy and hold” strategy that minimizes trading costs. Water utilities will probably never lead the market in any given year. That said, they will probably never be the market’s worst-performing sector either. Over time, that type of consistency adds up to very competitive total returns.

For those investors looking at water equipment and technology stocks, we advise a “top-down” approach. First, identify the subsectors of the market that you believe will see the strongest growth in product demand, then invest in quality companies that should benefit from that demand tailwind.

WWD: Water scarcity in the Southwest, coupled with increasing population growth in that area, is a common topic covered by the media. What technologies and types of companies are likely to benefit from this situation?

Connors: Two areas that are positioned to benefit are advanced water metering solutions and water conveyance. On the metering side, these communities have a pronounced incentive to minimize wasteful water usage patterns on the part of businesses and households. Clearly, the best way to do that is to ensure that those wasting water feel it where it counts—in the wallet. Therefore, what we’ve seen is accelerated adoption of cutting-edge metering methods in the Southwest, and this benefits water meter manufacturers.

Another area that will see increased demand from continued growth in the Southwest is water conveyance, or pipelines. Obviously, desert communities are often located far away from the nearest water source, and pipelines are typically the best solution for getting water to where it needs to be.

WWD: Finally, B&S completed a 2007 outlook for the water industry’s economic growth. Do you have any idea what the 2008 outlook will look like?

Connors: Relative to other, less mature areas of the economy, change occurs fairly slowly in the water industry. Therefore, the same key trends that have driven growth in 2007 will likely continue into 2008. Still, one sector that we see priming for a cyclical upturn is the large-diameter water pipeline market, especially in the key Southwestern region.

A key set of data that we keep an eye on in this market is municipal bond issuance for water infrastructure projects. This has been on the rise over the last several quarters. Coupled with a few major projects already on the docket and a generally upbeat tone among industry participants, this leads us to believe that this area will see a rebound in 2008 after a lull in project activity in 2006 and 2007.