Sunday, October 27

Week 121 - Water Utilities Among the Dividend Achievers

Situation: Globally, water use is growing twice as fast as the population. This represents more intensive water use than in the past. For example, a recent study out of Columbia University notes that withdrawals from US municipal water systems increased 130% since 1950 while the population was increasing by 99%. Is exponential growth in water use sustainable? Not as long as water remains so cheap. If you use withdrawals under a regime of improved conservation measures to estimate sustainable water use, how many people can be supported going forward and still allow rainfall and snowpack to halt the depletion of our aquifers? About 5 Billion, which is 2 Billion fewer people than we have now and half the population the planet will have by 2060. Can desalination of ocean water make up the difference? Yes, but it is energy-intensive, expensive, and polluting. The new desalination plant at San Diego County has cost more than a billion dollars to build. The water it produces will have to be priced at twice the current rate, i.e., at $1,000 for a family of four for one year instead of $500. And, the pace of building desalination plants in the Western Hemisphere is much too slow to address the problem. In the Eastern Hemisphere, a wider acknowledgement of the problem has led to appropriate investment in desalination plants but the pace needs to pick up.

Most experts expect the pricing of water to increase rapidly, given the rate of population growth and the fact that 70-80% of water has historically been used for agriculture. The water distribution problem is compounded by global warming, and the fact that a billion people already live in regions undergoing desertification where water must be imported. A global water crisis can be expected in the next 10-15 yrs, unless the construction of desalination plants (and the expansion of water allocation regimes) “scale-up” much faster than is currently envisaged. For example, farmers in California have long prevented the legislature from imposing an allocation regime for groundwater use (wells), and resist metering.

Water utilities often take the form of municipal or regional cooperatives, using a clean water source combined with rate-based financing of the distribution system. However, the use of fertilizer by farmers can introduce excess nitrates into these water systems, necessitating the construction of water treatment plants. That requires financing, which may include issuance of common stock. Water rights can be expensive, which also requires upfront financing. This week’s blog looks at 7 water utilities that have increased their dividends annually for at least the past 10 yrs (see Table). Note: all values in the Table are current as of October 26, 2013. Red highlights denote values that are inferior to benchmark (VBINX) values. The main “takeaway” from the Table is in Column J, where you see that 5 of the 7 companies already have unsustainably high valuations. In other words, investors are well aware that water is undervalued and are betting that the dividends paid by these companies will grow faster.

Bottom Line: There aren’t many solid growth industries but water utilities certainly represent one. Clean water is destined to become more valuable than oil in our lifetimes. All 7 of the water utilities in this week’s blog represent worthwhile investments in terms of long-term Finance Value (Column E of the Table). In terms of dividend growth plus dividend yield, Aqua America (WTR) stands out. It is also a large enough company to have a Standard & Poors stock rating (A/L).

Risk Rating: 3

Full Disclosure: I don’t own any shares issued by these companies.

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