Profit from the world's most important commodity
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Associate Editor
David Stevenson Oct 26, 2009
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Demand for water is only going to rise
Investors around the world have recently been piling into virtually anything to do with commodities. But one raw material - the most important of the lot - has pretty much missed out on the fun.
Water.
That's probably because we take it for granted – we just turn on the tap, and out it pours. Whatever the reason, many water-related shares have been almost completely ignored in the latest market surge.
Until now, that is. Right now could be the perfect time to buy into water stocks again...
Water has been overlooked
"The reason water doesn't grab all that much attention is that it's not traded on an exchange as a commodity all by itself", says Steve Kerch of MarketWatch. "Thank goodness, since a financial meltdown on a water exchange could make faucets, not credit, dry up".
Another reason why investors don't pay as much attention to water as they should is because it's easy to assume that there's no real shortage of the stuff. After all, about 70% of the earth's surface is covered by oceans.
Trouble is, only 3% of the global water supply is drinkable freshwater. And of that, only a third, i.e. just 1% of the overall total, is readily available for drinking, manufacturing, agriculture and personal use. Meanwhile, on the demand side, a staggering 1 billion people, about a sixth of the planet's headcount, already have to manage without clean drinking water. With the world's population set to keep on growing, much more freshwater will be needed in the future.
And unless there are rapid, major strides in the development of desalination technology, i.e. making salt water fit for human consumption (for more on this, see: How to make big profits from water desalination), water scarcity and demand will only increase. So over the medium-to-long term, investing in water supply-related stocks looks a good idea.
"Water is simply the most valuable resource of the 21st century", says Steve Hoffman of Palisades Water Index Associates. "By most accounts the water industry is the third- or fourth-largest industry in the world, behind electricity, oil and gas, and perhaps tourism. But the value of water across a broad range of socio-economic aspects will rival oil". In fact, earlier this year a report by the environmental group CERES warned that dwindling water supplies are a greater risk to business than the world's oil reserves running out.
Investment opportunities in the water industry range from infrastructure suppliers to utilities – those firms that actually pump the stuff to consumers. And some of these stocks have already generated plenty of interest. For example, shares in the China-based water treatment equipment firm Duoyuan Global Water (NYSE: DGW) have nearly doubled since their heavily oversubscribed New York flotation four months ago.
So water stocks are cheap
But generally, the market's attention has been elsewhere. Investors have been focusing on the likes of oil companies, and the commodity producers and cyclical manufacturers whose profits are highly geared to an economic recovery – which may or may not happen.
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Water-related businesses on the other hand, are generally considered 'defensive' shares because they don't rely on strong economic growth for their profits. So they've been left behind. The good news is that this means "there are plenty of ways that investors can capitalize" on the water sector, says Kerch, "including stocks that provide water infrastructure and water treatment, as well as ETFs" (exchange-traded funds).
If you trawl through the list of the actively managed funds and ETFs that invest in water businesses, you'll find several that have undershot the overall market. The PowerShares Water Resources Portfolio (NYSE: PHO), which aims to match the performance of the Palisades Water index of treatment and supply companies, is up by less than 14% in 2009 compared with an increase in the MSCI World index of almost 27% (measured in US dollars).
And among the actively managed funds, the story is similar. The Kinetics Water Infrastructure Fund (NYSE: KWINX) invests in businesses with a "specific water theme", mainly in the US, while the PFW Water Fund (NYSE: PFW) does something similar. Both are 'open-ended' funds, i.e. they are priced at current net asset value.
This year to date, both have achieved dollar returns of only just over 10%. So there's still a chance here to buy into a sector that shorter-term has underperformed, but in the long run should do well.
Of course, as water is ultimately controlled by governments, there's some added regulatory risk. We saw recently in Britain how three months ago the regulator Ofwat poured cold water on the UK suppliers' plans to raise customer prices between 2010 and 2015, boiling up worries that dividends may have to be cut.
This, though, could be serving up a chance to buy water suppliers - which are now factoring in payout hits - at depressed prices. When the final Ofwat decision on 26 November is published, investors may well take a more positive view of the sector.
Two water stocks to snap up
We mentioned international water utility Severn Trent (LSE: SVT) a couple of months ago, since when the price has slipped back slightly to 972p. It's on a 7%-plus yield for the current year, so even if the payout were cut by a third, the yield would still be a decent near-5%. For the future, Severn Trent Services is booking bigger deals in China, including building and supplying a customised water treatment operation to serve more than 3.3m residents in Zhejiang Province.
Alternatively, sewage and waste management operator Pennon Group (LSE: PNN) has also fallen foul of investors' aversion to the sector. But the dividend should be safe here, leaving the shares at 456p on a current year yield of 4.8% which is forecast to rise to 5% next year. The p/e is a reasonable 12.8.
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