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Water Utility Industry Outlook Muddy With Aging Assets

Jewel Saha

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.

The water utility operators own millions of miles of water pipelines that are buried under soil. Moreover, they own water treatment plants and desalination plants to supply 24X7 potable water across customer classes.

Let’s take a look at the industry’s three major themes:
 

  • The U.S. Environmental Protection Agency (“EPA”) announced contribution of $2.6 billion to the State Revolving Funds to ensure that Americans have safe water for drinking and recreation. In the last three decades, the State Revolving Funds have provided more than $170 billion in financial assistance to over 39,900 water quality infrastructure projects and 14,500 drinking water projects across the country. Per EPA estimates, more than $743 billion is needed for U.S. water and wastewater infrastructure improvements. Recent contribution of EPA to State Revolving Funds appears to be negligible compared with the total requirements. Government funding is not expected to increase dramatically in the near term, so regulated companies in the industry will have to take an initiative to upgrade water infrastructure. Revision in the existing water rates in the United States, which is comparatively less than other developed countries, will help in funding the massive investment required for the overhaul of water infrastruure.

 

  • Per an American Water Works Association report, more than 200,000 water lines break per year in the United States with more than 7 billion gallons of water leaking out of aging pipes. In addition to upgrading aging water infrastructure, the Source Water Collaborative, which consists of 27 national organizations are united to protect America's drinking water at its source. The Source Water Collaborative also takes initiatives to prevent contamination and preserve land needed to protect the quality of current and future sources of drinking water.

 

  • There are more than 53,000 water systems in the United States providing water solutions to customers. The highly fragmented water industry creates operational challenges in meeting increasing requirement for water. 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. So, consolidation in this highly fragmented industry is essential. Big water companies are trying to acquire small water utilities and extend quality services.


Zacks Industry Rank Indicates Weak Prospects

The Zacks Utility Water Supply industry is a 14-stock group within the broader Zacks Utilities sector. The industry currently carries a Zacks Industry Rank #157, which places it at the bottom 39% 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 bleak 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 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions it appears that analysts are pessimistic about this group’s earnings growth potential. Since Jul 31, 2018, the industry’s earnings estimates for the current year have declined by 3.8%.
 
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 Outperforms S&P 500 and Sector

The Zacks Utility Water Supply industry has outperformed its own sector and the Zacks S&P 500 composite over the past 12 months. The industry has gained 38.8% in the past 12 months compared with its sector and the S&P 500’s increase of 11.8% and 6%, respectively.

One Year Price  Performance




The Industry’s Current Valuation

On the basis of 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 14.55X compared with the S&P 500’s 11.11X. It is higher than the sector’s trailing 12-month EV/EBITDA of 12.54X.

Over the past five years, the industry has traded as high as 15.81X, low of 9.03X and at the median of 12.33X.
 

EV/EBITDA 

 

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




Water  Supply Industry vs  Utility Sector ( Past 5 yrs)

 

Summing Up

Demand for potable water and wastewater services is steadily increasing, thereby creating ample opportunities for growth and expansion for the industry. However, the huge gap between the actual investment needed and the amount invested in the water industry is alarming.

Demand for potable water is increasing in the United States due to growing population and desalination plants are catering to this need. Per an International Desalination Association report, more than 2,000 desalination facilities are operational in the United States and the number of these projects is gradually rising.

Below we present four stocks — one sporting a Zacks Rank #1 (Strong Buy), one carrying a Zacks Rank #2 (Buy) and two holding a Zacks Rank #3 (Hold) — that are well positioned to grow in this fragmented water space. You can see the complete list of today’s Zacks #1 Rank stocks here.


Middlesex Water Company (MSEX), based in Iselin, NJ, owns and operates regulated water utility and wastewater systems. The Zacks Consensus Estimate for 2019 EPS has improved 5.9% over the last 90 days. Additionally, the company has expected 2019 earnings growth of 10.71% on a year-over-year basis. The stock sports a Zacks Rank #1.

 

Price & Consensus: MSEX




Global Water Resources, Inc. (GWRS), based in Phoenix, AZ, owns, operates and manages regulated water, wastewater and recycled water utilities primarily in metropolitan Phoenix. The Zacks Consensus Estimate for 2019 EPS has improved 15.4% over the last 90 days. The stock carries a Zacks Rank #2.


 

Price & Consensus: GWRS



American Water Works (AWK), based in Camden, NJ, is engaged in providing water services to over 15 million customers in 47 states, the District of Columbia and Ontario, Canada. The Zacks Consensus Estimate for 2019 EPS has improved 0.6% over the last 90 days. Additionally, the company has expected 2019 earnings growth of 9.09% on a year-over-year basis. The stock carries a Zacks Rank #3.

 

Price & Consensus: AWK



California Water Service Group (CWT), based in San Jose, CA, is a provider of water utility and other related services in California, Washington and New Mexico. The Zacks Consensus Estimate for 2019 EPS has improved 0.7% over the last 60 days. Additionally, the company has expected 2019 earnings growth of 2.94% on a year-over-year basis. The stock sports a Zacks Rank #3.

 

Price & Consensus: CWT


 

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Middlesex Water Company (MSEX) : Free Stock Analysis Report
 
Global Water Resources, Inc. (GWRS) : Free Stock Analysis Report
 
California Water Service Group (CWT) : Free Stock Analysis Report
 
American Water Works Company, Inc. (AWK) : Free Stock Analysis Report
 
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