2 Water Scarcity Picks for Secular Growth and Value

In periods of uncertainty, investors often turn to some of the less volatile sectors that are expected to experience secular growth and steady earnings. Investors will want to be in these areas of the market rather than in the riskier high-valuation and momentum stocks. Credit Suisse has released a new series of HOLT picks for the start of October that represent opportunities with selective secular themes.

One such theme is water scarcity, and Credit Suisse believes that investing in companies that address the world’s water resource challenges may be a significant growth opportunity.

The two companies covered in Tuesday’s report were Xylem Inc. (NYSE: XYL) and Pentair PLC (NYSE: PNR) as two attractive industrial plays on water scarcity. What was interesting about these being featured is that Credit Suisse is not exactly very positive on these companies in their formal analyst coverage recommendations.

Credit Suisse showed that the water scarcity group has multiple drivers working in its favor:

  • Low expectations relative to consensus-derived forecasts.
  • Priced for cash flow return on investment (CFROI) below longer-term historical levels.
  • Future demand for clean water globally is projected to increasingly exceed supply, absent significant productivity enhancements.
  • And a substantial commercial opportunity that may underpin solid growth for years to come.

Xylem is called out as having sustained CFROI over 15% in recent years, and the company is generating ample cash to continue funding sizable reinvestment in its secularly growing water businesses. The firm also noted that market expectations for moderate erosion in CFROI and low-single-digit asset growth appear to be undemanding.

Interestingly enough, Credit Suisse previously downgraded Xylem to Neutral from Outperform back on August 2, 2019.

While it is not rated at the firm formally, Credit Suisse’s HOLT team shows Pentair to be among the most profitable industrials companies globally, and it is valued currently at a historically wide discount compared with the firm’s water portfolio as a whole. The firm calls it a pure-play in water that it is well positioned for continued value creation, and points out that Pentair’s management is focused on accelerating what it called value-enhancing growth initiatives, specifically pointing toward taking advantage of global water filtration opportunities and driving growth in its profitable pools business.

Also boosting Pentair is that a forecast CFROI of 20% and higher places it in the 95th percentile among global industrial companies. Roughly two-thirds of its revenues are said to be derived from aftermarket parts and services tied to its large installed base. The company’s prior asset growth has been constrained due to recent divestitures (noting the nVent spin in 2018, the valves and controls sale in 2017, and the ongoing share repurchases of about $2.5 billion since 2013).

Xylem was trading at $75.50 on Wednesday, and it has a 52-week range of $60.65 to $85.39. Back on September 20, Jefferies started it with a Buy rating and a $90 target.

Pentair has not performed well in 2019 and hasn’t so far been able to hold on to any of its major recovery efforts. It traded at $36.05, in a 52-week range of $34.50 to $45.70.

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