An Investment Idea the Sequester Can’t Stop

Rudy Martin

In times of uncertainty, it seems like the only sure bet is something we can’t live without — water.

“Water is the new oil,” as legendary petroleum magnate T. Boone Pickens and other successful entrepreneurs have echoed.

What you may not realize is that millions of gallons of water are being used as part of the oil (and natural gas) extraction process. So, if Pickens and other experts say it, we can probably trust that they know what they are talking about!

With muted economic growth and corporate profitability now endemic in much of the world — including the U.S. — measures such as corporate earnings trends and GDP data are no longer the prime drivers of securities prices. 

Stock prices can get hammered mercilessly lower by indecisive election results in Italy. Then the next day they rebound smartly from a minor calming of southern European sovereign-bond markets.

For this reason, I suggest investors start to take a longer-term view of the market and focus on global trends. That’s because the not just desire but need for clean water, and the companies that make it possible and available, is a trend that’s only going to grow with time..

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‘The New Middle’ is Shaping

A Massive Investment Trend

I’ve been talking about the emergence of the new middle class as one of the four big global mega-trends I’m following for profits in 2013.

That’s because now, for the first time in history, a truly global middle class is emerging. By 2030, it will more than double in size — from 2 billion today to 4.9 billion.

Meanwhile, Brookings Institution scholar Homi Kharas estimates that the European and American middle classes will shrink from 50% of the total to just 22%.

Rapid growth in China, India, Indonesia, Vietnam, Thailand and Malaysia will cause Asia’s share of “the new middle” to more than double from its current 30%. By 2030, Asia will host 64% of the global middle class and account for over 40% of global middle-class consumption.

And this new middle class will put an incredible strain on global resources.

A few years ago, McKinsey & Co. issued a report and pointed to a “water gap” primarily driven by four countries that collectively account for 40% of the world’s population and 30% of global GDP — China, India, South Africa and Brazil.

Each has drastically different water issues and will collectively account for 42% of projected water demand in 2030.

There are several ways to play this:

  1. We could focus on the clean-water aspects.

  2. We could focus on the healthy-consumer-beverage angle.

  3. Or we can just find the best water companies out there today and start building positions in them.

Of these, I’m looking to get in on the purest global water plays — an investment idea the sequester won’t stop — in water utilities like these:

American Water Works (AWK)

Among the U.S. contenders is California-based American Water Works. As the nation’s largest investor-owned water utility, it serves more than 15 million customers across 32 states and Canada. Notably, it provides water to military bases in North Carolina and Texas.

American Water Works also manages the largest desalination (or, mineral-removal) operation in the country. In its most-recent earnings announcement last week, it said revenues increased almost 8% year-over-year, to $2.9 billion. Net income rose 22.7% to $374 million for the year, and operating cash flows jumped 18.2% to $955.6 million.

Not too shabby, especially because this includes results from a tough fourth quarter.

Natural disasters bring our attention to the necessity of clean and available water. But for many people around the world, water shortages are, or will become, a year-round concern.

The company’s fourth-quarter income fell 14% because of increased costs and reduced sales after Hurricane Sandy. Yet the management believes they can still have a solid year. I think they can, too.

For a more-global play, let’s look at …

Veolia Environnement (VE)

Voorhees, N.J.-based Veolia, with a $6.5 billion market cap, operates utility and public transportation businesses in 69 countries. That’s global!

And after a round of divestments and de-leveraging, the company is repositioning on high-growth markets, recording some superb successes with our new business models.

These new business models — including water — led to successes in the United States (including New York, California and Pennsylvania), Canada and France. But that’s only a small geographic representation of the impact the company is making.

It’s also making a splash in India, operating a drinking water network to serve the 2.7 million people who live in the city of Nagpur. Recent results are still slow-moving. But watch the steady pace of cash payments flow from new territories.

And for what could be the purest water play of all, I like the largest water utility I’m tracking right now, which is an $11 billion Brazilian beauty …

Companhia de Saneamento Basico do Estado de Sao Paulo (SBS)

With a water franchise on one of the most-dynamic business regions on earth, Brazil’s SABESP hit a new high today of $48.68 per share, and could provide a flood of profits over the longer term.

The utility has its sights squarely set on expanding to serve every city in the prosperous Sao Paulo state.

With more than 5 million sewage connects, it also provides sewage services to nearly 20 million people. On top of that, it sells treated water on a wholesale basis to six municipalities with a total estimated population of more than 3 million people.

Majority controlled by the Sao Paulo state government, 49.8% is owned by the firm’s private shareholders. The firm provides water and sewage services to most municipalities in the Brazil’s state of Sao Paulo, with more than 7 million water connections serving nearly 25 million people.

Furthermore, in 2006 a law was passed that allowed SABESP to expand its activities into other Brazilian states and internationally. It has signed cooperation agreements in Spain, Israel and Costa Rica.

As would be expected of a utility carrying debt (currently at levels roughly equal to 65% of the firm’s equity), the share price took a hit along with most every other stock during the 2007-‘08 worldwide financial crisis.

But since October 2008, SBS has steadily risen from less than $9 per share to the recent level just a shared shy of $50 — more than a fivefold gain in just over four years. Plus, it carries a 2.5% yield. Not bad for a water utility!

That’s my take on it …  get some water stocks before you go back to discussing dry sequestration politics!

Happy Trading!

Rudy