Flowing profits? S&P eyes water stocks and ETFs

Privatization is a growing trend in the water sector; here's how to play this theme.

By TheStockAdvisors Nov 30, 2011 5:20PM
By Stewart Scharf, S&P's The Outlook

As budget-strapped municipalities seek funding to clean up their decaying water and wastewater systems, privatization is a word that keeps popping up.

With the EPA estimating that it will cost more than $1 trillion over the next 20 years to maintain the current water infrastructure system, privatizing the systems may be an attractive solution.

This recurring theme was evident at the recent American Water Summit in Atlanta, where various water industry executives, consultants, professors and public officials offered their views on the industry.

With municipalities owning roughly 85% of the nearly 55,000 water supply and wastewater systems in the U.S., private entities believe the opportunities are favorable as local and state tax revenues decline, and environmental regulations tighten.

We expect Pentair (PNR), which makes water pumps, treatment and storage equipment, to benefit from sales of engineered flow pumps and other filtration products, as it strengthens its position in emerging markets.

Margins should widen in 2012 on volume leverage and supply chain cost savings, in our view.

Water utility Aqua America (WTR) is focusing on niche acquisitions to expand its customer base in areas such as Texas, Ohio, and Pennsylvania.

Meanwhile, with the cost of water on the rise, water reuse is growing in popularity for irrigation. More local governments are seeking reuse and desalination projects as technology lowers costs.

We believe long-term prospects are very favorable for flow control and filtration-related water treatment companies.

Investors seeking broad exposure to water-related businesses may want to consider exchange traded funds. There are currently four ETFs that target water utility and equipment stocks.

Two of them, the Power Shares Water Resources Portfolio (PHO) and the First Trust ISE Water Index Fund (FIW), focus on U.S. domestic stocks.

The other two, the Power Shares Global Water Portfolio (PIO) and the Guggenheim S&P Global Water Index ETF (CGW), have significant foreign holdings.

All these ETFs have experienced losses in 2011, with PIO down 20.6% for the year to date through November 17, PHI down 11.8%, CGW down 8.1%, and FIW falling 7.3%.

PowerShares Water Resources Portfolio is the oldest and largest of the four, listing in 2005 and holding about $837 million in assets. It owns mostly industrial companies, with water utilities making up just 12.7% of asset as of November 17.

Its three largest holdings were URS, a construction and engineering firm that builds water-related infrastructure, AECOM Technology which also builds water supply systems, filter maker Pall.

The First Trust ISE Water Index Fund also owns mostly industrial companies, with about 20% of assets in utilities.

Its top three holdings are Nalco (NLC), which sells wastewater treatment equipment, Watts Water Technology (WTS), which makes flow control equipment like valves, and American Water Works (AWK).

The Guggenheim S&P Global Water Index ETF has about 40% of its assets in U.S. companies, with slightly less than half of that in water utilities.

It’s top three holdings are Geberit, a Swiss maker of toilets and water related building products, and British water utility United Utilities.

The PowerShares Global Water Portfolio has 25% of its assets in U.S. companies. Industrials comprise more than half the fund’s holdings, with water utilities accounting for slightly more than one quarter of assets.

The largest of the fund’s 31 holdings is Finnish chemicals maker Kemira Oyj, Pentair, and Nalco.

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Tags: etfPNRWTR
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