Investing in water stocks is about to become one of the hottest trends in 2012.
That's because the days of easy access to cheap commodities are drawing rapidly to a close. In the coming years, the prices of commodities are going to skyrocket – thanks to exponential growth.
Exponential growth in the Earth's population – over 7 billion people and counting – means that all of the planet's finite resources are going to have to stretch farther to feed and fuel even more people. Everything from oil and gas to corn, wheat, potash, rare earth metals, timber – everything – is going to be harder to come by, and more expensive to procure.
We're also seeing similar growth in the population of the world's middle class, which means a rise in demand for everything a middle class existence entails, including meat (which requires more feed and processing – which means oil – to bring to the table), smartphones, cars, flat screen televisions, and everything else that we in the West enjoy, and even take for granted.
Including clean water.
Population Growth Creates a New "Water Market"
In the United States each person uses around 150 gallons of water per day, compared with around 20 gallons per day in emerging economies.
But global water usage is surging. What we take for granted in the West is in many cases just becoming the standard in many emerging markets around the world.
In fact, China and India already have the two largest water footprints (a broad measurement that aims to quantify global water use and consumption) of any country on the planet. And they're about to get even bigger as their consumption of commodities – water included – skyrockets.
But while other commodities are essential to our economy as it currently functions, water is the only commodity that is absolutely essential to our survival, and cannot be substituted. As the existing supply of potable water gets smaller, and the population grows, more experts and analysts are predicting the formation of a "water market."
In 2009, Jonathan Adler, director of the Center for Business Law and Regulation at Case Western University School of Law, wrote, "Without substantial reforms, existing water institutions will have difficulty meeting current demands, let alone the increased demands of the future."
Last year, Citigroup Inc. (NYSE: C) chief economist Willem Buiter said he expects to see water make the transition to an asset class within 30 years.
"Once the spot markets for water are integrated, futures markets and other derivative water-based financial instruments – puts, calls, swaps – both exchange-traded and OTC will follow," said Buiter.
A water market would simply mean that water would be bought and sold the same way that oil and other commodities are today. Whether this happens or not, the price of water would go up (you've probably seen your municipal water bill rise steadily over the past five years), which means that companies that control the water supply – water management and utility companies – stand to benefit tremendously.
In 2010, the last year for which there's comprehensive data, worldwide revenues from water totaled more than half a trillion dollars. Almost half of that total, some $226 billion, was collected by water utilities, treatment plants, and distribution centers around the world.
Investing in Water Stocks
The water business is booming, and delivering clean water at a premium is something Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE ADR: SBS) does very well.
We still like the Brazilian utility for a number of reasons, not the least of which is its location. SBS sits in one of the world's leading emerging economies, and in one of the best regions for growth – especially growth in the middle class.
Beyond that, it's a well-run company. It's got a market cap over $9 billion, trades on volume, and has a very attractive price/earnings (P/E) ratio of 11.90. Since we last checked on the stock, SBS has climbed another 4.7%.
American States Water Co. (NYSE: AWR) is a California-based utility that owns 120,000 acre-feet of water to meet the demands of its customers.
AWR operates two wholly-owned subsidiaries, Golden State Water Co. (GSWC) and American States Utility Services Inc. (ASUS). GSWC is a public utility company regulated by the California Public Utilities Commission, and engages primarily in the delivery of water service to over one million people. ASUS operates and maintains the water and wastewater systems at numerous military bases around the country through 50-year government contracts.
Since March, the stock is up almost 12%. It has a P/E of just over 15, which is well below the industry average. With a beta of 0.51, AWR is just over half as volatile as the markets, making it a great defensive position, too.
Heading into the 2008 financial crisis, Veolia Environment SA (NYSE: VE) was massively over-leveraged, and shareholders have since paid the price. In 2007, the stock was all the way at $97; today, it's trading around $11.
But the French water management company has been selling off non-core assets, selling its UK water and European solid waste businesses for $1.9 billion each. Debt remains high, but the company plans to cut that from $23.7 billion to $14.7 billion by the end of 2013. To achieve this, the company will divest its transportation business as well as its solid waste business in the US.
This is all in an effort to lower operating costs, boost margins, and reposition itself as a low-cost alternative in core competencies, with a serious eye toward expansion in the developing markets in Eastern Europe and China.
After a much-needed cut in the company's dividend, VE still yields 7.4%. It has a forward P/E of about 8.0, a peg of around .90, and it's trading at less than two-thirds of book value.
Patrick Vail is a Money Morning contributing writer.