Investor Essentials Daily

Not every water infrastructure company is cheap

June 21, 2024

Water scarcity is a significant long-term trend with substantial opportunities in the water infrastructure industry.

Population growth and climate change are increasing the demand for upgraded water systems, valued at over $655 billion.

The 2021 Bipartisan Infrastructure Law in the U.S. has allocated over $50 billion for water infrastructure, creating investment opportunities.

Companies like American Water Works Company (AWK) benefit from this emerging trend.

Despite growth potential, the company’s stock may not be cheap, and much of the projected upside for water infrastructure equities might already be priced in.

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We discussed yesterday that water scarcity is one of the bigger long-term trends, according to UBS.

The global water crisis presents significant long-term opportunities for companies operating in the water infrastructure industry.

As population growth and climate change exacerbate water scarcity worldwide, upgrading and expanding water systems will be crucial to ensure reliable access to clean drinking water for communities and support economic development.

Water scarcity valued at over $655 billion, is expected to grow at a mid-single-digit annual rate over the next few years.

Over $50 billion has been allocated for water infrastructure through the 2021 Bipartisan Infrastructure Law in the United States.

This influx of capital is creating investment opportunities across the water sector for water utilities, engineering and construction firms, technology providers, and infrastructure funds focused on water.

One of these was Consolidated Water (CWCO) as we discussed yesterday. Another big winner is American Water Works Company (AWK).

American Water is the largest water and wastewater utility company in the United States, serving over 14 million people with regulated operations in 14 states and on 18 military installations.

In addition to regulated water and wastewater services, the company also operates a contracted services segment that builds and maintains water and wastewater infrastructure for municipal and industrial clients.

In addition to the overall water investment, interest rate cuts could boost American Water going forward.

As a capital-intensive utility, the company benefits from lower borrowing costs enabled by decreases in the federal funds rate.

Cheaper debt funding supports investment in infrastructure projects and acquisitions. American Water has $8-10 billion of identified growth opportunities over the next 5 years.

While American Water faces risks from regulatory proceedings, the overall rate case environment has been constructive in recent years.

Regulators have generally approved rate increase requests to allow cost recovery and investments in system reliability. This regulatory compact reduces uncertainty around the company’s earnings potential.

American Water remains well-positioned for growth given its scale advantages and exposure to the sizable U.S. water market. However, our EEA shows that the stock may not be cheap at the current levels.

For the company to justify its stock price based on a 7% sustainable growth rate (above historical averages), it would need to achieve an all-time high Uniform return on assets (ROA) of 6.2%.

The market may have already priced in most of the projected upside for certain water infrastructure equities.

Going forward, water infrastructure companies expanding into new geographies, entering adjacent sectors, or demonstrating an ability to consistently exceed estimates may be more rewarding for investors.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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