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Water is the source of life.  Many futurists believe it is the largest concern of the world in the years ahead.  The water sector is also not the easiest to invest in.  Many of the pure-play companies have been acquired and many of the key aspects of water are dominated by subsidiaries of global conglomerates.  General Electric Co. (NYSE: GE) and 3M Co. (NYSE: MMM) are key examples of acquiring companies which have a bright future in various aspects water desalination and filtration, but these companies are fat too diversified to be true water investments.  We wanted to pursue several of our own single ‘best idea’ strategies with snapshots based on today’s valuations and trends for investing in water companies that derive a substantial part of their revenues from water and give actual stock picks in water that have real upside.

For starters, many reports have been out about water’s scarcity and that securing potable water reserves in the future will be a challenge for many nations for the decades ahead.  This is where the term “The International Water Wars” comes from.  Making a blanket investment in water has so far been a difficult trend.  The sector has given large rewards in some cases, and been very painful in other cases.

We are reviewing American Water Works Company, Inc. (NYSE: AWK), Badger Meter, Inc. (NYSE: BMI), Tetra Tech Inc. (NASDAQ: TTEK), Watts Water Technologies,  Inc. (NYSE: WTS) and Veolia Environnement S.A. (NYSE: VE).  For more diversified picks via ETFs, there are also the PowerShares Water Resources (NYSE: PHO) and the PowerShares Global Water (NYSE: PIO) to consider.  Lastly there are two BRIC stocks that will require a judgment of your own, but those are Duoyuan Global Water Inc. (NYSE: DGW) and Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS) as the international emerging wild cards.

There are some key risks ahead in water that make investing in water not as sound as investing in other futurist asset classes. For starters, many ‘water companies’ grew because they were building new large infrastructure projects for all of those new housing communities that were built from the 1990’s to 2007.  That business is gone for now, and many feel that it may be years before that business comes back in any meaningful way.  Another huge risk is that water is unfortunately not immune to the economy, even if you die after a few days without water.  Local, state, and even national governments around the world have to be able to pay for water investments via taxes, and we know how budgets are under pressure on all angles top to bottom.  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.  You have also likely heard where local communities are trying to prevent water companies from taking the local water and selling it elsewhere.  Another consideration is that there is a movement against bottled water today despite the notion that local tap water is often contaminated, tastes bad, and is believed to contain trace elements of pharmaceutical products.

CURRENT DOMESTIC STOCK PICKS IN WATER

American Water Works Company, Inc. (NYSE: AWK) is our single best pure-play in water for the U.S. investor of our investing universe.  This was one of our top defensive stock picks and it recently bumped up its dividend.  American Water is the largest public water and waste water utility in the U.S. and it serves about 16 million people spread across 35 states and two Canadian provinces.  This is not what investors would consider a home run stock, but it is also one that doesn’t strike investors out.

An implied dividend yield now of 3.8% is also a solid reward considering the investment climate for bonds and that many utility investments have mixed histories.  This one offers water investors, defensive investors, and income investors the same outcome.  At $23.15, its 52-week range is $18.91 to $23.77.  No bottled water here; think tap water, showers, sprinkler water, toilet water, and water for industries.  Investors hate paying at the 52-week highs, so any sizable pullback here should be used as a buying opportunity.

Badger Meter, Inc. (NYSE: BMI) makes and sells flow measurement and control products for water utilities, municipalities, and industrial customers worldwide to measure and control the flow of liquids in various applications.  In short, think of it the water accountant’s and transporter’s assistant.  With all the fears of wasting water and the need to account for water use and how it is distributed, Badger Meter’s future seems certain.  It is also small enough that an acquirer could always pay it a visit without ever having to bat an eye.

Shares peaked at over $50.00 in 2008 and it has been nothing but dead money for more than a year.  At $40.40, its 52-week trading range is $32.58 to $44.71 and analysts only have an average price target around $43.00.  The consideration here today is that Badger’s story is a matured company with over 100 years of operations.

Tetra Tech Inc. (NASDAQ: TTEK) is another diversified consulting and management company, but it has substantial operations in Water Resources, Groundwater Services, Watershed Management, Mining Services, Wetland Restoration, Remedial Planning and Environmental Management.  The company is involved in many large-scale projects that are tied to state and federal governments, and its shares are close enough to 52-week lows that there may be an adequate discounting of risk here when you consider that it has a history of good beats and bad misses on earnings reports and/or on guidance.  At $20.90, the 52-week trading range is $18.00 to $28.18 and the average analyst price target here is above $25.50.

The stock reflects the risk that local and national government business could be spotty.  If shares were up at 52-week highs and if the valuations were higher than 16-times forward earnings, that comfort in share price would not be the case.  The reliance upon government contracts would also be a concern if shares were higher.  With a $1.3 billion market cap this one does not have a dividend yet, so it may not be suited for many long-term investors who want a yield while they wait for the futurist trends of water investing to offer large rewards.

Watts Water Technologies,  Inc. (NYSE: WTS) has a diversified family products and companies 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.  There is a potential issue in its financial stance for some investors: it is not a cheap stock, has a low yield, and investors often have to be choosy about when they enter into the stock.

Watts has an implied dividend yield of only 1.3% and at $34.05 it has a 52-week range of $27.51 to $37.00.  It is also expected to remain short of its peak revenues from 2008 in both 2010 and 2011.  Still, its portfolio of water equipment assets is broad and it is one of the more respected names in the field.  Its stock has never really been one of those great rewards yet, and again investors generally need to be choosy here rather than just buying and hoping despite its having beat earnings expectations in each of its last four reports.  There is an old joke about Watts Water… “Watts Water?… the stuff you drink, silly”… but Watts Water is no joke.

WATER IN THE LAND OF ADRs

Veolia Environnement S.A. (NYSE: VE) is thought of as one of the largest water plays out there.  Unfortunately, its water operations also are met with waste, energy, and transport units at Veolia.  It is our sole ADR among the picks, and it is based in France.  The water division has over 150 years of experience managing public water and wastewater services in public-private partnerships, making it a world leader in water treatment with over 12.5 billion Euros in revenues.  The unit claims some 95,000 workers in 66 countries and provides drinking water and wastewater services to about 163 million people.

With a high implied dividend yield (careful, it is annual dividend and the rate fluctuates with currency), there is room for income investors and value investors alike.  The $26-handle today is met by only two U.S. analyst price targets of almost $31 and $36 and the current bias from the field of analysts is a mixed or cautious one.  Shares were punished from April to July, and there is a fear that it does have risks tied to that pesky government risk issue that is plaguing the globe.  Shares peaked around $90 in the past, so the global slowdown has definitely worked against it and shares have just not really ever recovered.  Valuations are low enough here and the stock is far enough off highs that much of the items of concern may be adequately reflected in the share prices today.

TWO ALTERNATIVES VIA ETFs

Water has also had a lackluster performance with both the Palisades Water Index and the ISE Water Index not showing any significant upside to the broad market.  There are two alternatives for mutual fund or ETF investors to consider if you want to take out the guesswork.  There is a more domestic water ETF in the PowerShares Water Resources (NYSE: PHO) that trades at $16.60 and its trading range of the last year has been close to $14.50 to $18.50.  Then there is the less liquid and smaller international water ETF theme via the PowerShares Global Water (NYSE: PIO).  At $17.98, its 52-week range is $15.60 to $19.00.  Neither of these have recovered their former glory, and I think the holdings inside of each are often too diversified in other areas of operation not really tied to water.

EMERGING MARKET CONUNDRUM VIA THE BRICs

China and Brazil are two of the great growth where investors still flock to when they can.  When it comes to water investing for Americans, there are a couple of alternatives here.  And the caveat… enter at your own risk.

Duoyuan Global Water Inc. (NYSE: DGW) is supposed to be a water treatment equipment play for China.  Don’t get caught just hearing “China and water” in the stock.  The problem is that shares have fallen since the 2009 IPO from over $40 down to nearly $10 and shares got crushed in September while the broad market was strong.  The promise here has only been met so far with pain, and class action suits against the company.

Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE: SBS) is an interesting play for Brazil, and it is called “SABESP” locally.  The company 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 366 municipalities and serves more than 26 million people.  The stock trades at well under 10-times earnings but its dividends have been spotty and are not currently paid and the stock is at 52-week highs.  Again, enter at your own risk.

ELSEWHERE IN H2O

Again, water is a tricky investment class.  The fact that T. Boone Pickens has bought up water rights does not make the water stocks a safe asset class.  Many of our favorite names depend on valuations through time and greatly depend upon the timing because prices and valuations can get out of whack.  There are many much smaller names we have perused from time to time, but the promise often fails to live up to the hype.  Making pumps for desalination should be a win in theory, but Energy Recovery, Inc. (NASDAQ: ERII) has lost nearly 60% of its value since its 2008 IPO and its business has never really taken off in a major fashion.   SouthWest Water also went private in a private equity purchase this year in a 56% premium buyout by JPMorgan and Water Asset Management.

Miscellaneous news in the sector:

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