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3 Water Supply Stocks to Tap Amid Industry's Aging Infrastructure Woes

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·8 min read
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The 24x7 supply of clean potable water and reliable sewer services are essential for healthy and hygienic living. The water utilities across the United States are silently doing this important task day in and day out to meet the demand of millions of Americans.

Water utilities continue with their upgrade and maintenance projects amid the pandemic to minimize disruption in operation. American Water Works Company (AWK) with its widespread operation and systematic capital expenditure, to further strengthen its existing assets, offers an excellent opportunity to stay invested in the water utility space. Other utilities worth retaining in one’s portfolio include Essential Utilities (WTRG), California Water Service Group (CWT).

About the Industry

The Zacks Utility - Water Supply industry includes companies that are involved in providing drinking water and wastewater services to industrial, commercial and residential customer classes. The water utilities also provide services to numerous military bases across the United States.

Water utility operators own more than two million miles of pipelines that are buried under the soil with old pipelines being replaced and new pipelines added each day to expand operations. Moreover, they own storage tanks, water treatment plants and desalination plants to supply uninterrupted potable water across customer classes. The U.S. Geological Survey (USGS) compiles a total water usage survey of the United States every five years. Per the last report, water usage in the United States was 322 billion gallons per day in 2015 with surface water accounting for nearly 74% of water usage and the rest coming from underground water.

3 Trends That are Pivotal for Shaping the Water Supply Industry’s Future

Aging Water and Wastewater Infrastructure: The water and wastewater infrastructure is aging and is gradually nearing the end of its effective service life. Per the findings of the American Society of Civil Engineers, water main breaks occur every two minutes in the United States due to the aging of existing water infrastructure. The breaks in the pipeline result in wastage of 6 billion gallons of potable water each day and add to the loss of water utility operators. Per the Water and Wastewater Equipment Manufacturers Association, an estimated $750 billion investment is necessary to maintain and expand the drinking water and wastewater service to meet demand over the next 20 years. The U.S. Environmental Protection Agency (EPA) has announced the availability of $2.7 billion for State Revolving Funds to assist the water utility operators. The current funding plan appears to be much less taking into consideration the total requirement. So huge effort is needed from private operators to upgrade and maintain aging water and wastewater facilities.

Consolidation in Fragmented Water Utility Space: Since the U.S. water utility industry is fragmented, upgrading the aging assets to provide quality services is the need of the hour. Per EPA, at present, more than 53,000 community water systems and 16,000 community wastewater systems in the United States are providing water solutions to customers. This highly fragmented industry creates operational challenges in meeting the requirement for replacement, and adding to aging water and wastewater infrastructure. At present, only 7% of the country’s systems serve a population of more than 10,000 and a mere 1% of the systems serve a population of more than 100,000. Acquisitions of small water utilities by bigger companies ensure the extension of high-quality services to customers and regular investment required for the upgrade of assets of small service providers. Water conservation and initiatives taken by large water operators in educating their consumers on efficient usage and appliances to detect leakage would help to prevent wastage.

Efficient Usage is Saving Precious Water: An interesting trend being observed in the water industry is a reduction in per capita water usage. The reasons behind the drop are usage of water-efficient techniques, education of customers by the water utilities, usage of advanced water-efficient appliances and actions taken to fix leaks in the pipelines. Lower usage per person allows the water utilities to meet the need of an expanding customer base without increasing capacity to a great extent. Per USGS, lower usage of water in thermoelectric power plants also contributed to the decline in overall water usage. This in a way keeps the water rates unchanged for a longer period for consumers and assists the water utility operators to increase their earnings by serving a larger population with unchanged water supply capacity.

Zacks Industry Rank Indicates Weak Prospects

This Zacks Utility Water Supply industry is a 12-stock group within the broader Zacks Utilities sector. The industry currently carries a Zacks Industry Rank #204, which places it in the bottom 20% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates solid near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 20% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are not so optimistic about this group’s earnings growth potential. The Water Utility industry’s 2021 earnings estimates have declined 0.5% since December 2020 to $2.07.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and valuation.

Industry Lags S&P 500 But Outperforms Sector

The Zacks Utility Water Supply industry has outperformed its own sector but lagged the Zacks S&P 500 composite over the past 12 months. The industry has gained 14.6% compared with its sector’s rally of 14.4% in the past 12 months. The S&P 500 has risen 50.8% in the said time frame.

One Year Price Performance

Industry’s Current Valuation

On the basis of the trailing 12-month enterprise value to EBITDA (EV/EBITDA), which is a commonly used multiple for valuing water utility stocks, the industry is currently trading at 16.07X compared with the S&P 500’s 18.57X. It is trading below the sector’s trailing 12-month EV/EBITDA of 20.67X.

Over the past five years, the industry has traded as high as 16.66X, as low as 9.92X and at the median of 11.98X.

Water Supply Industry vs S&P 500 ( Past 5 yrs)

Water Supply Industry vs Utility Sector ( Past 5 yrs)

3 Water Utility Industry Stocks to Keep a Close Watch On

American Water Works Company: Camden, NJ-based American Water along with its subsidiaries provides water and wastewater services to millions of Americans. The company continues to expand operations through acquisitions and organic means. American Water Works plans to invest $10.4 billion in the 2021-2025 time period and $22-$25 billion in the next decade to strengthen and expand its infrastructure.

The Zacks Consensus Estimate for American Water’s 2021 earnings and revenues suggests a year-over-year rise of 8.7% and 4.2%, respectively. The Zacks Consensus Estimate for American Water’s 2022 earnings and revenues suggests a year-over-year rise of 7% and 4.3%, respectively. The stock has gained 19.8% over the past 12 months. American Water currently has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: AWK

Essential Utilities, Inc: Bryn Mawr, PA-based Essential Utilities along with its subsidiaries provides water, wastewater and natural gas services to its customers. The company has a well spread out water infrastructure to provide quality services to its expanding customer base. It has diversified operations through the acquisition of Peoples Gas, a natural gas distribution utility. Its long-term plan is to invest $3 billion in through 2023 to rehabilitate and strengthen water and natural gas pipeline systems.

The Zacks Consensus Estimate for Essential Utilities’ 2021 earnings and revenues suggests a year-over-year rise of 5.1% and 35.1%, respectively. The Zacks Consensus Estimate for Essential Utilities’ 2022 earnings and revenues suggests a year-over-year rise of 7.6% and 3.4%, respectively. The stock has gained 9.4% over the past 12 months. Essential Utilities currently has a Zacks Rank #3.

Price and Consensus: WTRG

California Water Service Group: San Jose, CA-based California Water Service provides water and wastewater services in a few states. Recently, the company completed the Palos Verdes Peninsula Water Reliability Project that will support the existing 60-year-old drinking water pipeline and provide assistance to the system during natural disasters. The company aims to invest in the range of $270- $300 million 2021 to strengthen its infrastructure. The company expects to increase its capital expenditures in the next five years due to the increasing needs to replace and maintain infrastructure.

Over the past 60 days, the Zacks Consensus Estimate for 2021 and 2022 earnings has moved up by 3.5% and 6.8% respectively. The stock has gained 13.7% over the past 12 months. California Water Service currently has a Zacks Rank #2.

Price and Consensus:CWT

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