water stocks

Water Stocks: Three Non-Utility Pure Plays

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Ever since the epilogue of the movie The Big Short mentioned that one of its key protagonists, Michael Burry, was “focusing all of his investing around one commodity: water,” curious investors have wanted to know how they too can invest in water. In fact, if you visit Reddit’s main Investing subreddit, you’ll still occasionally see questions about Michael Burry’s water plays and interest in what other water investments are out there.

The truth is there are quite a lot of different ways to invest in water plays. Here are four categories of water investments that Robinhood investors can access:

  • Water utility stocks – These are companies such as American Water Works (AWK), that serve municipal customers in a certain local region and are regulated in how they operate. AWK has been a winner of an investment, returning more than 21% annualized over the past ten years while also paying a dividend of about 1.3%. However, water utility stocks were not necessarily what Burry had in mind at the end of The Big Short and therefore will not be the focus of this article.
  • Diversified companies – There are many large manufacturing conglomerates that have gobbled up water-oriented companies but do not necessarily trade as “pure play” water stocks and because these companies are so large, the water companies which they own may not impact the overall trajectory of its performance. Two examples of companies that are diversified but offer water services include Gorman Rupp (GRC), a pump manufacturer that services municipal water and wastewater customers, but also operates in oil & gas, sewage, industrial and construction markets. The second is Danaher (DHR), a large industrial conglomerate that owns the Hach Company, the latter of which creates analytical instruments and reagents to test water quality. While these types of companies can be interesting, they require more research to understand the full package one is investing in.
  • Water ETFs – For broad based and global exposure that includes a range of stocks involved in water services you can always try an ETF. There are three currently available on Robinhood: PowerShares Global Water Portfolio (PIO) (managed by Invesco), Guggenheim S&P Global Water ETF (CGW) and Global X Funds Global X Clean Water ETF (AQWA). If you review their respective portfolios you will see a range of diverse names including the already mentioned Danaher and American Water Works. If you’re looking for diversification within the water space and want to leave the research to professionals, an ETF can be a good way to get your feet wet.
  • Non-utility water stocks – What most interested in Burry and where we will spend the duration of this article is on water stocks not tied to regulated utilities. These are privately run companies that can potentially be more nimble and strategic than a regulated utility. As water becomes a more scarce resource, these non-utility water stocks that can provide valuable services should be seen as potentially attractive to the market. However, it’s important to understand that all of the stocks below focus on different market segments and have different strategies. You should do your own research including carefully reviewing the company’s annual reports, quarterly investment call transcripts and reviewing third party research before investing your own money.

None of the stocks listed below are meant as recommendations, but only as an educational jumping off point for you to do more research. We tried to profile stocks of different sizes and serving different parts of the market to give you an idea of what is out there—this is not a comprehensive list of all non-utility water stocks.

Xylem Inc. (XYL)

Xylem is a large American water technology provider serving customers in public utility, residential, commercial, agricultural and industrial settings. It operates in more than 150 countries and according to Deane Dray, an analyst with RBC Capital Markets, it is the “premier water-sector pure play, with a first-mover advantage in investing in disruptive digital solutions for water utilities.”

Xylem has been a refreshing investment for shareholders, returning more than 22% annualized over the past five years, outperforming both the S&P 500 and almost doubling the return of XLI, an ETF that tracks the industrial sector during that period. It also pays a modest dividend of 0.81%.

Xylem has performed really well for investors in the short-term as well, returning more than 36% YTD and more than 67% over the past 12 months, putting it at or near all-time high levels. As a result, some classic valuation tools such as consensus forward P/E ratio indicate the stock is in expensive territory. Xylem’s management will need to continue to execute at a high level to drive the stock forward.

According to Xylem’s recent earnings call transcript, there are a lot of relevant solutions the company is pursuing including:

  • Growth in emerging markets, such as India, China and Eastern Europe.
  • Flood management solutions including an “automated wastewater network optimization is amongst our most advanced digital solutions. Its job is to manage overflows and prevent flooding.”
  • Developing drought resiliency technologies like “leak detection, smart metering and especially water reuse.” One trillion gallons of water are being recycled using Xylem technology, according to the company’s CEO, Patrick Decker.

Like many companies, Xylem also faces challenges, including fulfilling a huge amount of backorders, made more complicated by the worldwide shortage in key materials and components. Decker also cited employee attrition as a current “headache.” The ongoing pandemic can be an obstacle to fulfilling short-term goals in under-vaccinated emerging markets and analysts on the latest earnings call seem to be pushing management to acquire more companies, which presents more risks particularly in a richly valued market as this one.

Evoqua Water Technologies Corp. (AQUA)

Evoqua Water Technologies describes itself as a leading provider of water and wastewater treatment solutions, offering a broad portfolio of products, services and expertise to support industrial, municipal and recreational customers. In contrast to Xylem, which primarily focuses on valves and pumps, Evoqua is focused on water and wastewater treatment solutions.

With an IPO in late 2017, AQUA’s performance track record is less than four full years. But investors who have held it for almost any amount of time have had reason to be pleased: according to Morningstar data, the stock has returned more than 26% annualized over the past three years, more than 81% over the past twelve months and more than 45% YTD, at the time of writing. The stock is considered a small-cap growth stock so despite its strong performance some investors may be willing to swallow its relatively expensive valuation in the hopes of further gains over the long-term. The flip side is that smaller companies are inherently more risky than larger ones and AQUA’s track record is still relatively short.

Evoqua’s recent earnings call transcript also indicates that their business is at the center of many relevant issues to the US government and everyday citizens including:

  • Newly unveiled clean water provisions in the proposed Biden infrastructure bill.
  • A major and bipartisan focus on mitigating PFAAs and other similar contaminants in drinking water, an issue that would put Evoqua in a strong position to potentially win government contracts in the future as the EPA codifies new standards.
  • Like Xylem, Evoqua’s business puts it in a strong ESG position for both its own sustainability and also helping customers improve their own sustainable practices through (for example) helping industrial plans better reuse wastewater.

In terms of challenges, Evoqua’s CEO, Ron Keating, sums up what we read from most CEOs operating in the industrial space: “Economies are reopening at varying rates due to the pandemic, and challenges exist fulfilling demand. The search for skilled talent, rising commodity prices, and labor inflation is prevalent.”

Pure Cycle Corp. (PCYO)

Pure Cycle Corporation may be one of the better examples of what Michael Burry was thinking about when he was evaluating water investments back in the early 2010s. That’s because Pure Cycle is more than just a diversified water resource company, it also manages land with water rights in the resource-challenged American West and Colorado to be more specific. According to the company, “in addition to being a water and wastewater provider, we possess a lucrative portfolio of land and water rights in the fastest growing sector of the Denver metropolitan area.”

Pure Cycle, despite being a small-cap growth company, has the longest track record of any of the three companies we have looked at in-depth. Its 15 year returns have been meagre, returning just over 4% annualized, far below the industry and benchmark for that time period, according to Morningstar. However, recent times have been better, with a more than 57% gain over the past 12 months and more than 34% gain YTD, placing it well above industry peers and its benchmark during those times. It’s clear PureCycle is a more volatile stock and investors should carefully evaluate if they can handle the sequence of returns and potential drawdown that comes with a very small (360 million market cap) company.

Reviewing Pure Cycle Corp’s recent earnings transcript it becomes clear just how localized the company is, with both unique risks and potential rewards from focusing solely on the Denver metro market. The company is involved in real estate development, managing “cradle to grave” water rights within their Colorado land holdings and more recently, managing single-family home rentals as an offshoot of their experience as master land developers. It seems the future success of the company will rely on it continuing to acquire land (and water rights) at a good value, so that more housing and business real estate can be placed on it.

Above are three distinct non-utility water stocks to give you a head start on further research and potentially capitalize on the increasing value of water.