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American Water Works Co., Inc. (AWK), Aqua America Inc (WTR): Accessing the Water Investment Theme

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It is not too controversial to say that water is a necessity for life. The United Nations’ Water for Life campaign says that almost one-fifth of the world’s population lives with actual water shortages and that the problem is getting worse even in the most developed of countries. Should water industry investments also be a necessity for your portfolio?

The first stop has to be the listed water utilities.  15% of water provision in the US comes from private regulated operators.  What is the simple reason why this is a growth area? There are big deficits at all levels of government.  With a report suggesting that there is a need to invest $335 billionn into America’s water infrastructure in the period 2007-2027 there is an obvious problem…and a need to find a solution.

Utilities are often thought of as lower growth, steady dividend investments.  The opportunity in the water utility area offers a growth angle.  Two of the larger stock market listed providers are American Water Works Co., Inc. (NYSE:AWKand Aqua America Inc (NYSE:WTR).

American Water Works Co., Inc. (NYSE:AWK) is the larger of the two with a $7.6 billion market cap and currently services around 14 million individuals in 30 states.  By contrast Aqua America Inc (NYSE:WTR) provides water and wastewater services to around 3 million customers in 10 states.

American Water Works Co., Inc.The core business model for both of these companies is to identify a need to upgrade the level of water services and then approach the local and/or state government with a business plan to make the investment.  In exchange for the initial build and ongoing maintenance and running costs, the company is compensated via an allowed rate increase on individual and business customers using the service.  Despite the still uncertain financial environment, attractive allowable returns are going through as these infrastructure upgrades are needed and desired.

The strength of this business model is its predictability assuming continued operational discipline and focus.  Both companies talk about the importance of maintaining a strong balance sheet and this has provided the backdrop for earnings and dividend growth.  American Water Works Co., Inc. (NYSE:AWK), in their latest presentation, talk about targeting a 7-10% longer-term growth rate, while Aqua America Inc (NYSE:WTR) talked about a 7%+ historic annual dividend increase.  Given the extent of the investment needed, experienced operators like these two companies continue to have good capital and dividend growth opportunities.

Extending the search beyond water utilities, I came across Xylem Inc (NYSE:XYL) a $4.6 billion market capitalization business which listed in 2011 following a spin-off by its previous parent company ITT.    

Looking at their operations, the company is split between a Water Infrastructure and an Applied Water division. In Water Infrastructure they are the world’s leading water pump provider and have strong positions in filtration and disinfection technologies. While in Applied Water they are the world’s leading supplier of efficient water use solutions across many sectors.  Two of the companies Xylem Inc (NYSE:XYL) would supply are the aforementioned American Water Works Co., Inc. (NYSE:AWK) and Aqua America Inc (NYSE:WTR).

The business is very international reflecting the global reach of water and related issues. The company sells products or operates in over 150 countries. Only a third of sales are in the United States.

Xylem Inc (NYSE:XYL)’s international exposures though was the cause of some challenges. During the recently reported Q2 2013 corporate numbers, the delays by governments and municipal authorities, especially in Europe, in buying Water Infrastructure equipment or Applied Water services, impacted the company’s earnings. Hopes for organic growth for this year have been cut to a range of 0-1%. The shares fell over 10% to a level not seen since October 2012.

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