Water stocks can be a choice for those seeking to diversify.
Investors seeking investments to diversify their portfolios may be drawn to water stocks since the companies produce high earnings growth and pay dividends. In the current market environment, some investors are on the hunt for nontraditional investments to decrease risk with water stocks, says Mike Loewengart, managing director of investment strategy for E-Trade. Water utilities trade at a premium compared with other utilities such as electricity and natural gas “thanks to their steady and accelerating capital expenditure programs, favorable dividend policies and the potential for takeovers by larger utilities,” says Heike Doerr, principal analyst at S&P Global Market Intelligence who covers water stocks. Here are seven ways to invest in this natural resource.
American Water Works Co. (ticker: AWK)
A public utility company that provides drinking water and wastewater services to 15 million people in 46 states, American Water Works completed 21 acquisitions in eight states and added 67,000 customers in 2019. Water utilities currently trade at 26.7 times the average projected 2021 price-earnings multiple, compared with 18.2, 18.9 and 20.4 for electric, multiutility and natural gas utilities, respectively, across S&P Global Market Intelligence’s 56-company utility universe, Doerr says. Water utilities are considered more recession resistant than other utilities, since a higher percentage of their demand comes from residential usage. They’re also an excellent environmental, social and governance, or ESG, play, she says. “They are stewards of a natural resource,” Doerr says. “If you’re looking at regulated utilities, water companies are a very attractive opportunity.”
Essential Utilities (WTRG)
Essential Utilities is a Pennsylvania-based water and wastewater utility company, formerly called Aqua America. The company changed its name after it acquired Peoples, a natural gas distribution utility, and 30% of its rate base is now from natural gas. The company is waiting for regulatory approval of its $276.5 million wastewater acquisition of the Delaware County Regional Water Quality Control Authority, which was announced in September 2019 and is expected to close in late 2020. Essential Utilities reported net income for the first quarter of $51.8 million on revenue of $255.6 million, an increase of 27% year over year.
Evoqua Water Technologies Corp. (AQUA)
Evoqua Water Technologies reported strong second-quarter results and has a positive outlook for the remainder of the year, says Michael Underhill, chief investment officer of Capital Innovations. “AQUA noted that it is prioritizing capital deployment in 2020 in end markets and that it expects will grow and operate without material project delays and cancellations in order to preserve liquidity and noted an outlook for neutral to positive growth in six of its 10 key end markets in the second half of 2020.” Capital Innovations has a “buy” rating for AQUA with its 12-month price target increasing to $18 a share.
Xylem is a smart water infrastructure player expected to benefit from the accelerated adoption of technology in the water sector, says Scott Ellspermann, director of exchange-traded products at Tortoise, a Leawood, Kansas-based investment company. The company has a strong position in the developed markets and growing exposure to Southeast Asia, where smart water infrastructure spending is increasing significantly, he says. “The utility end market exposure is expected to be relatively resilient in the near term, providing cash flow stability relative to other water players,” Ellspermann says. Water companies have the potential for attractive long-term total returns — in the low double digits, he says — since there is an estimated $5 trillion to $23 trillion in infrastructure and technology investment backlog, he says.
Pentair, a water treatment company, demonstrates earnings potential because of residential tailwinds that position the company to “outgrow peers given high leverage to this end market,” says Underhill, who has a 12-month price target of $54. The company has a U.S. office in Minneapolis and provides energy-efficient water treatment, filtration products, pumps and water systems for residential use worldwide. Pentair reported first-quarter sales of $710 million, which rose by 3% year over year. The company ended the quarter with $169 million in cash, $1.45 billion of total debt and $326 million available under its revolving credit facility. The company’s valuation looks the least expensive from a free cash flow yield perspective and is trading near the low end of the peer group from a P/E perspective, Underhill says.
First Trust Water ETF (FIW)
First Trust Water ETF holds 36 stocks and is based on the ISE Clean Edge Water Index, a modified market capitalization-weighted index comprised of companies that derive a substantial portion of revenue from the potable and wastewater industry. The exchange-traded fund was founded in 2007, and its top holdings include Danaher Corp. (DHR), Agilent Technologies (A), IDEXX Laboratories (IDXX) and Ecolab (ECL). FIW manages more than $500 million in assets, and its exposure includes 47% in the industrials sector, 25% in the utilities sector and 12% in the health care sector.
Invesco Water Resources ETF (PHO)
The Invesco Water Resources ETF is based on the Nasdaq OMX US Water Index and focuses on U.S.-based companies that create products designed to conserve and purify water for homes, businesses and industries. This ETF gives investors exposure to the clean water sector and invests in 35 companies. Investors who are seeking income might find the higher dividend yields to be attractive, says Jodie Gunzberg, chief investment strategist at Graystone Consulting, a Morgan Stanley business. The current dividend yields of the Dow Jones U.S. Water Index, S&P Global Water Index, NASDAQ OMX Global Water Index and S-Network Global Water Indexes are 1.73%, 2.41%, 1.83% and 2.33%, respectively. “Water can also be a good portfolio diversifier since it does not have a liquid enough futures market to be included in the major commodity indexes,” Gunzberg says, “so it is not perfectly correlated with commodities or other assets.”
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