Water Investing Long-Term Stock Picks Out to 2012 & Beyond (GE, MMM, AWK, WTS, INSU, TTEK, CCC, VE, SBS, DGW, PHO, PIO, ERII, CGW, FIW, CFWAX)

Water may be the source of life, but it is also perhaps one of the most misunderstood and most “under-invested” themes for those investors who want income and growth year after year throughout the various business and market cycles. Apple Fanboys might think that they’ll die if their iPad, iPhone, and iPod are all taken away, but watch what happens if you take away their water few days.  It is also sad to report that investing in water is no simple task today.  Either the water utilities are too narrowly focused, or there is too much dependence upon government contracts, or there is too much of a tie into broader segments like housing or construction for these to be pure “water” investments.

Water is a sector we consider as a “Must-Have” in most long-term investment portfolios.  We have even gone as far as saying that H2O is one of the key and critical investment sectors for futurists, who often look out a decade or more when evaluating trends.

Investing in water used to be much easier, but now companies like General Electric Co. (NYSE: GE) and 3M Co. (NYSE: MMM) have helped to consolidate the filtration segment of the water-trade.  Both of those are attractive investments from time to time, but both are far too broad to invest in just because they have water exposure that will drive growth in the future.  The top water stock for 2011 from 24/7 Wall St. was American Water Works Company, Inc. (NYSE: AWK) and that remains a favorite today.  Shares were trading around $25.30 when that award was issued versus about $29.00 now.  We continue to love this company and we admire its recent dividend hike.

Our goal is not just to update our own price target in American Water Works Company, Inc. (NYSE: AWK).  We believe that can continue on higher and we now think that $35.00 is feasible.  It just raised its dividend and we expect another dividend hike in a year and then again after that.  Still, the goal is to now identify those water investments which offer both growth and safety ahead as the stock market and economy are facing mixed outlooks.

Since we started covering the sector broadly, a lot has changed. Conversely, much remains the same as well and that is a good thing.  The 2012 election cycle is not far away, the economy is in a soft-patch, Greece is a real threat that could to topple Europe, Japan is trying to get out of the red in its GDP again, and both China and India are trying to slow their economies to fight inflation.  We want to review our “investable water universe” and single out some of our own single ‘best idea’ water investing strategies based on today’s valuations and trends of today that can have a significant upside ahead.

Some reports have been out about actual water scarcity here in America.  Securing potable water reserves in the future will be a challenge for many nations and this is where the term “The International Water Wars” comes from.  The water sector has given large rewards in some cases, and been very painful in other cases.

We are reviewing the following today: American Water Works Company, Inc. (NYSE: AWK); Watts Water Technologies, Inc. (NYSE: WTS); Instituform Technologies Inc.  (NYSE: INSU); Tetra Tech Inc. (NASDAQ: TTEK); and Calgon Carbon Corporation (NYSE: CCC).  On the international scene, there is Veolia Environmental S. A. (NYSE: VE) as well as Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS) as the international emerging wild cards.  To show just how risky this can be in foreign lands, there is Duoyuan Global Water Inc. (NYSE: DGW) that has been crushed with the batch of reverse-merger companies out of China and which has been halted for some time.  For more diversified picks via ETFs, there are also the PowerShares Water Resources (NYSE: PHO) and the PowerShares Global Water (NYSE: PIO) to consider.

U.S.-BASED WATER PICKS OF TODAY

Many water stocks grew in the early part of the last decade because they were building new large infrastructure projects for all of those new housing communities from the 1990’s to 2007.  That business is gone for now and it may be a generation before building comes back strong.  Water is actually not all that immune to the economy, even if you die after a few days without water.  Austerity measures are another group of risks as local, state, and even national governments have to be able to pay for water investments via taxes.  Another risk is protection and seizure, where local government may declare that water is a public asset and we have already seen many local and regional instances where the exporting or transporting of water away has been blocked. There are even documentaries where local groups are forcing change about companies taking water for a fee and selling it elsewhere.  Bottled water has even become the new evil in many aspects even if local tap water is often contaminated, tastes bad, and is believed to contain trace elements of pharmaceutical products.

American Water Works Company, Inc. (NYSE: AWK) remains on top and it remains what we called one of our ten stocks to own for the next decade.  It is the largest public water and waste water utility in many states that serves millions of diverse customers. This may not be a home run stock, but it is also one that doesn’t strike investors out.  Try to go find instances where it has pulled back more than 10%.  Not an easy task and you earn more than 3% in the dividend yield.

This water utility giant is said to have a 1.24:1 price to book value, placing it in the top-tier of the six companies.  The company’s P/E multiple is a slightly higher than average 15.8.  Its 6.8% return on equity (ROE) ranks it in the bottom tier of these water industry players.  American Water Works’ consensus target price of $31.60 implies a mere 8% upside.  Again, we think this can go to $35.00 and any time the stock sells off it should be considered as being “on sale in the investing super-market.”  It recently closed at $29.17 and the 52-week price range is $19.39 to $30.70.

Tetra Tech Inc. (NASDAQ: TTEK) is a diversified consulting and management company with operations in water resources, groundwater services, watershed management, mining, wetland restoration, remedial planning, and even in environmental management.  The company is involved in many large-scale projects tied to state and federal governments.  That used to be great for predictability of earnings, but austerity measures and put-offs in spending pose real and serious risks now.  Tetra Tech also has a history of “good hits and bad misses” on earnings reports and on its guidance.

Tetra Tech Inc. (NASDAQ: TTEK) trades with an implied 1.7 to 1 price to book ratio and its P/E of just over 14 is close to peers among those water companies we favor. Tetra Tech’s $27.88 consensus target price from Thomson Reuters implies about 23% upside from the recent $22.60 close and the 52-week trading range is $18.00 to $27.16.  Our take is that at least some additional weak government business is getting priced into the stock.  As there is no dividend, it may not be suited for widows and orphans.

Watts Water Technologies,  Inc. (NYSE: WTS) is interesting because it has a diversified family of products around valves and other aspects of water conservation, safety, and control in commercial, residential, industrial and municipal applications with operations in North America, Europe, Asia and Africa. If the water infrastructure has to be built out for the next century, Watts Water may find itself as an ongoing winner or it could find itself gobbled up by a larger infrastructure player.

Unfortunately, Watts Water is rarely considered cheap, it has a low dividend yield, and it is not one which can just blindly be bought at any time.  We expect it to remain under peak revenues from 2008.  Still, its portfolio of water equipment assets is rather broad and it is one of the more respected names in the field. There is an old joke about Watts Water for stock geeks… “Watts Water?… It is the stuff you drink, silly.”  Our take is that Watts Water is no joke even if its chart since April has been ugly and painful.

Watts has a 1.4 to 1 price to book ratio, making it one of the better values currently; but its earnings multiple is slightly higher than average at 15.4.   Its 6.2% return on equity probably doesn’t scream value and we won’t try to argue too much about it since its stock has failed to achieve that mega-reward for water investors.  Watts Water’s $35.78 consensus target price implies a meager 8% upside against a recent close of $33.12, but its 52-week price range is $27.16 to $40.62.

Instituform Technologies Inc.  (NYSE: INSU) may seem opportunistic after its post-warning slide and now that shares are very close to 52-week lows.  It is opportunistic, and we intend for it to be.  This is one which you want to buy after it gets hit hard.  The company is into rehabilitating sewer, water, energy, and mining piping systems and the corrosion protection of industrial pipelines.  It just signed a joint venture in Saudi Arabia as well.  The company recently said that North American sewer rehabilitation performance has continued to lag and the coming recovery has been tempered due to current market conditions and scheduling and execution issues. As a result, it lowered 2011 earnings guidance to $1.30 to $1.40 EPS and that makes it hard for us to trust the 2012 consensus target of $1.82 EPS.

Insituform boasts a price to book ratio of about 1.23, although how that compares ahead is not known exactly yet. With a market cap of $759 million, it is also smaller than many we usually consider in water but it now easily leads the value parade if it can live up to its forward P/E ratio of about 11.  Its return on equity was listed as being about 9.5% according to Finviz.   Instituform’s $25.57 consensus target price implies an upside of almost 33%, among the best of our water related companies.  The stock posted a recent close of $19.65 per share.  The 52-week price range is $18.10 to $30.00.

Calgon Carbon Corporation (NYSE: CCC) is one we like, but let’s leave it in the “Watch List” category until it gets a haircut.  It also has a fairly low market cap at $967 million and is in the sweet spot for water filtration.  Its shares rarely “go on sale” and its premium may be because some consider it a target for consolidation.  Don’t blame us that there has been no dividend.

The 2.74 to 1 price to book value ratio may seem very high, which we have tried to show why that is the case.  It also boasts a fairly P/E ratio near 18, but its return on equity is a respectable 10.2%.  Calgon Carbon’s $19.56 consensus target price implies a 12.1% upside.  A recent close placed the company’s shares at $17.44 per share.  The 52-week trading range is $11.75 to $18.20.  Again, put this in as a “watch list” stock and hope it goes on sale ahead.

LEAVING AMERICA…. GOING INTERNATIONAL IN ADRs

Veolia Environnement S.A. (NYSE: VE) is thought of as one of the largest water plays out there, but we also have to admit that ts water operations also are met with waste, energy, and transport units.  The company is based in France and it boasts over 150 years of experience managing public water and wastewater services in public-private partnerships.  It is a massive outfit as its water treatment alone recently had over 12.5 billion Euros in revenues; the unit for water claims 95,000 workers in well over 60 countries offering drinking water and wastewater services to more than 160 million people.  That being said, it is not immune from global austerity measures and it also has not escaped the world turmoil of 2011.  There won’t likely be another dividend for about 11%, but the current annual payout (with currency fluctuation risks) would translate to roughly 6.3% today.

With a $27.10 share price, Veolia’s consensus price target for U.S. investors of about $35.00 is really only from two analysts.  Shares have been punished since April’s end and that is why we are being opportunistic again in the ADR.  Shares peaked around $90 before the recession, so the global slowdown has definitely worked against it and shares have just not really ever recovered.  Valuations are low enough, what Finviz listed as about 1.14-times book value, and it trades at about 14-times earnings and was screened to show roughly 7.8% return on equity.  The 52-week price range is $21.86 to $32.00.

Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS) is up substantially since we covered this in late-2010.  The company’s ADR is an interesting equity play for Brazil and is called “SABESP” locally.  SABESP provides basic and environmental sanitation services in the Greater Sao Paulo metropolitan area for water, sewage, and industrial wastewater systems.  It also wholesales water to six more municipalities, operates in over 360 municipalities and serves more than 26 million people.  The stock still trades under 10-times earnings but its dividends have been spotty.  The ADR recently traded at $59.35 and the 52-week trading range is $37.70 to $62.88.  Brazil is hot, but you have to enter here entirely at your own risk.

THE RISKY WILD CARD IN DESALINATION

There are many much smaller companies we have reviewed from time to time, and one of the smaller and riskier bets that has the pedigree is called Energy Recovery, Inc. (NASDAQ: ERII) with a tiny market capitalization of about $161 million.  It has also severely failed to live up to the hype.  Making pumps for desalination should be a win in theory, but its chart looks like a downward staircase since its 2008 IPO.  It recently closed at $3.07 and the 52-week range is $2.35 to $4.57.  This is one where you will have to your own homework because it is now thinly followed, it suffered from declining revenues, and it is too small for us to pay much attention to.

WATER ALTERNATIVES VIA ETFs & FUNDS

Water has also had a mixed performance when it comes to the world of ETFs.  Still, there are at least some alternatives for U.S. and international water growth and these are still quite a bit higher than when we covered the full water sector in-depth in late-2010.

There is a more domestic water ETF in the PowerShares Water Resources (NYSE: PHO) that trades at $18.70 and its 52-week trading range is $14.42 to $20.61 with an average daily volume of about 200,000 shares.

Then there is the less liquid and smaller international water ETF theme via the PowerShares Global Water (NYSE: PIO).  At $19.52, its 52-week range is $15.89 to $21.50.  It trades an average of about 68,000 shares per day.

Guggenheim S&P Global Water Index (NYSE: CGW) recently closed at $20.95 and has a 52-week range of $16.46 to $22.44.  It trades an average of about 52,000 shares per day.

Lastly, there is the First Trust ISE Water Index (NYSE: FIW).  The recent close was $22.18, the 52-week range is $16.90 to $24.40, and the average volume is about 20,000 shares per day.

One alternative for water investors in open-end funds is the Calvert Global Water (CFWAX) Fund with some $62 million in assets under management.  It is a global fund and some top holdings are some of our top current picks as well.

HISTORIC M&A DEALS IN THE WATER SEGMENT

You have to wonder why the sector is hard to invest in.  For starters, because we said so.  All joking aside, here are just some of the key water deals which have been announced in recent years:

• General Electric bought Ionics for some $1.1 billion;
• 3M bought Cuno for close to $1.3 billion;
• American Water in 2007 announced the asset purchase of water system located in Ewing, Hamilton, Hopewell and Lawrence townships in New Jersey for about $100 million.
• SouthWest Water also went private in a private equity purchase this year in a 56% premium buyout by JPMorgan and Water Asset Management.
• Millipore was not only in water, but it was bought for about $6 billion by Merck KGaA.

Water is the source of life.  The developing world suffers from a lack of potable water and this issue is not one which will simply go away just because we have water fountains giving the stuff away for free here.  The sector is not without perils and not without risks for investors.

Most long-term investment portfolios need to at least have some exposure to profiting from water.  Your financial health could depend upon it.  Some additional outside water news and research is as follows:

Water Asset Management lists many of the sector fundamentals.

More than one-third of all counties in the continental-US face higher risks of water shortages by mid-century.

Back in 2008, The Futurist had a cover story called “Draining Our Future: The Growing Shortage of Freshwater.”

There really are traces of pharmaceutical compounds all throughout the water supplies of major cities.

JON C. OGG