Why you should invest in US water utilities now

Billions of gallons of water are lost in the US every day through old, leaky pipes and mains. This may sound like a multi-million dollar crisis, but it’s also the next big investment opportunity.

The Roosevelt Hotel is one of the great old hotels in New York. It opened its doors in 1924. It's in a prime location, on Madison Avenue and 45th Street in Midtown. A vintage bronze relief of Teddy Roosevelt stands watch over the main lobby, as he has for over 80 years.

The hotel also illustrates the seen and unseen in the architecture of the physical economy in the US. What we see is a grand old hotel. What we don't see is behind the walls and underground - all the pipes, pumps, valves and more. These things get old. And they need replacements and repairs. Now imagine that entire unseen infrastructure on a national scale.

Investing in water: the next big investment theme?

What you have is a multibillion-dollar crisis...or is it an opportunity? It's a bit of both. For us, it's an opportunity. In fact, it may be the next great

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

investment theme.

I was at The Roosevelt Hotel attending Gabelli & Co.'s First Annual Water Infrastructure Conference. Here, 11 executives told their story to a small group of investors - including famed billionaire Mario Gabelli himself. All of these companies are involved in water infrastructure in some way.

What struck me was the consistency of their stories. They all see the same thing - a whole lot of work that needs to be done. And estimates for the amount of work just keeping going up. It's like tapping into a keg that

just gets bigger and fuller the more partygoers drink. For investors in their shares, it's also going to be a long stretch of good years.

Surprisingly, there were no more than two dozen or so attendees at this conference - fewer in the morning hours. But one day soon, conferences like this will be standing room only. The foam is on the lager. There is no going back in the keg. Only most investors haven't caught on yet.

When you think of the water industry, what kind of business do you think of? Most people think of water utilities - for good reason. Water utilities are the big slice of the pie in the water industry. They have the potential to be an even bigger slice. That's because most of our water still comes from government-owned water utilities. Investor-owned utilities have only 15%

of the market.

However, investor ownership of water utilities is on the rise. I'll tell you why in a moment. But first, I want to show you what a good investment water utilities have been over the years. I'm betting the results will surprise most investors.

Investing in water: the case for water stocks

Water utilities have crushed the markets in the US - even in the slow markets over the last five years. Water utilities chugged along at an 18% annual clip, while the rest of the market barely eked out a positive return

(and the Nasdaq, in fact, posted a negative return).

John Dickerson of Summit Global Management has long made the case for water stocks. And lest you think the last 10 years represent some special circumstance, Dickerson has gone back further. He looked at data going back 25 years. He found that 'Water utilities usually topped the list of the best-performing industry groups in the US stock market on a total return basis.'

It's even better than it looks. As Dickerson points out, these tables understate the results. Merger and acquisition activity over the years has thinned the ranks. The indexes drop the acquired utilities. They are not included in the foregoing tables. 'Many of the better-performing US companies are no longer part of the group,' Dickerson wrote, 'and some of the laggards remain.'

Perhaps some of this surprises you. After all, these are just utilities, aren't they? Well, when you think about the business it's not hard to see all the good things that go into making those stellar returns. Water

utilities are unlike other utilities - or any other business, for that matter.

For one thing, demand for water is as steady as she comes. Demand is immune to the larger macro forces that so bedevil other investments at times. Demand is unmoved by recession, inflation or fickle consumers. There are no substitutes for water. Then, too, water utilities are monopolies in the regions they serve. More than the big fish in the pond, water utilities, in fact, own the pond.

There are other issues that make water unique. Electricity can move over the grid so that cooler northern cities can help meet demand on hot days in Baltimore. Likewise, gas from St Louis can move through the pipeline system to provide heating oil in Boston.

In the world of water, such shifts are uneconomical. No one transports water from the Mississippi region to alleviate drought in California. Water is prohibitively expensive to move over any significant distance. Why?

Basically, water is too cheap. You can ship coal or iron ore because you can sell it for more than your transportation costs. Not so with water - at least not yet. As a result, water is an intensely local issue.

In fact, there are over 53,000 water systems in America. The great bulk of these are tiny, serving fewer than 4,000 homes. It's in these smaller systems, though, where there are looming problems. Most are under the

purview of local politicians. Typical of government-run enterprises, they are poorly maintained and inefficient.

Investing in water: upgrades and repairs

The US loses 60 billion gallons of water every day through old, leaky pipes and mains. That's enough water to serve the state of California. There are lots of stories about breakdowns in aging pipes leading to interruption of service - or worse, leading to dangerous contaminants in the water itself.

The Environmental Protection Agency estimates US water systems need hundreds of billions of dollars in upgrades and repairs. By its estimates, water is the single largest expenditure in the entire US economy - behind only defense spending and Social Security.

Many water systems are beyond the ability of local municipalities to finance repairs - even if they wanted to. They have two options. They can merge their systems with others. Or they can sell them to the investor-owned


Not surprisingly, the investor-owned businesses are efficient and well financed. They are buying up these assets at cheap prices from cash-strapped municipalities. It is a buyer's market with prices so low that even accounting for the substantial investments needed, the buyer is looking at good, persistent long-term returns.

Investing in water: the beginning of a trend

An example of the steady acquirers over the years is Aqua America. It made 26 acquisitions in 2004 and 30 in 2005. Over the last 10 years, Aqua America purchased 175 water utilities. There is a lot more to go. We are just at the beginning of this trend. Thousands of water systems remain for the investor-owned companies to collect. The privatization of America's water systems is still in its toddler years.

The larger companies are consolidating, too. There were once 23 publicly traded utilities. Now there are only 11. As consolidation continues, a further shortening of this list would not surprise me.

In a big-picture sense, water utilities look like a great place to be. The conditions that helped produce those great returns in the past look only more favourable going forward. The basics of the business have not changed - supplying water is as important as ever. And we have many small decrepit water utilities, which provide a rich source of new growth and returns for the existing utilities.

By Chris Mayer for The Daily Reckoning. You can read more from Chris and many others at www.dailyreckoning.co.uk.