Three ways to profit from America's problem pipes

America's ailing infrastructure is on the verge of collapse. To prevent more home-swallowing sinkholes and disease-spreading sewage spills, heavy investment is needed. We pick three stocks set to benefit.

As the hurricane season approaches in the US, homeowners are battening down the hatches for what could be a particularly brutal few months. But the real threat may be right beneath their feet America's ailing water infrastructure is on the verge of collapse. "A little-known secret," says Thomas Rooney, president of Insituform Technologies, "is the fact that the large-diameter pipes are starting to leak in Los Angeles, New York and other major cities. When these pipes go it will be front-page news." And as pipes burst and sewage spills into the water system and into the headlines, there will be a huge demand for companies that can replace the existing pipelines.

In the US, the network of drinking water pipes extends more than 700,000 miles more than four times the length of the national highway system. Much of this infrastructure is more than 100 years old and is now unsurprisingly in a state of utter disrepair. The reality of this crisis is starting to be felt all across the States. In Los Angeles this year, a broken water main created a sinkhole 30ft deep and shut down half of the Pacific Coast Highway near Malibu. In Brooklyn, meanwhile, a 64-year-old woman fell into a 5ft sinkhole in front of her house.

These collapses may come as nasty shocks for their victims, but the sinkholes have been a long time in the making. As pipes below the city deteriorate, dirt leaks into the piping and is carried downstream by the water, weakening the ground between the pipes and the city's roadways. Sooner or later that ground gives way, swallowing up cars, trucks and even houses.

Worse still, in many ways, are sewage spills. Last year alone, more than 3.5 million people in America became ill from Escherichia coli and other toxins released from more than 40,000 effluent spills in the US, according to the US Environmental Protection Agency (EPA). In Hawaii last year, Waikiki Beach had to close after 40 million gallons of raw sewage flowed into the water when a main pipe broke.

In fact, last year was the worst on record for sinkholes and sewage spills in US history. And it's only going to get worse. According to the EPA, nearly 25% of the nation's water pipes are "poor, very poor or elapsed". Even worse, the EPA expects the percentage of ailing pipes to increase to 45% by 2020. "Most water and sewer pipes in the US were built 60 years ago but were meant to last 50 years," notes Rooney in the LA Times.

He makes the comparison with the state of the US power grid before the blackout in 2003, which left 40 million people across eight states without power for up to 24 hours. The issue hadn't been on the public radar until that point, but the collapse led to a massive initiative to replace the power system. A similar plan for water infrastructure is sure to follow, meaning US pipeline companies will ride a wave of investment for years to come.

The American Water Works Association reckons that domestic water utilities will need to invest $250bn over the next 30 years to replace ageing pipes, note John Dickerson and Rob Anfuso in their Summit Water Report. The cost of pipes for new developments, security upgrades, advanced treatment methods, and other needs may raise that bill to $500bn. Chris Mayer concludes in The Rude Awakening: "The bull market in water-related stocks is not even close to reaching boiling point."

US water leaks: the best bets in the sector

One of the most attractive plays on water infrastructure investment is Northwest Pipe Company (Nasdaq: NWPX). It specialises in the large-diameter, high-pressure steel pipes that will form a fundamental part of a renewed water infrastructure. The company has a 30% share of the US market and a record backlog of projects, ending the last quarter with $192m of backlogged bookings. The shares trade on a forward p/e of 12 for 2008. You should also consider Mueller Water Products (NYSE: MWA). Mueller is the largest supplier of water flow control products fire hydrants, valves, pipes with 74% of its sales coming from products in which it holds number one or two market positions. Ninety per cent of America's 55,000 water districts specify Mueller equipment and it manufactures about half the fire hydrants in the country. Despite this, the shares trade on a forward p/e of 15.4, a significant discount to the industry average of 18.3.

PW Eagle (Nasdaq: PWEI) is another interesting choice. The company sells the PVC pipes used to transport water, electricity and sewage. PVC's ability to bend allows it to compensate for the earth movements that have been cracking existing rigid pipelines. The company's valuation has fallen on worries about its exposure to the US housing boom, but the shares look cheap on a p/e of 6.6 and the company has good exposure to investment in water infrastructure as well as the residential market.

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