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As concerns grow about a looming scarcity of water, some investors are looking for ways to cash in on so-called blue gold.
The theory is that clean, bountiful water will become more and more precious in the years ahead as an expanding world population increases demand while pollution and climate change deplete supplies.
For Canadian investors, though, water is a difficult theme to play at home. The country's two best growth names in the sector, Trojan Technologies and Zenon Environmental, were snapped up years ago by U.S. companies eager to acquire water purification technologies.
So where in the world should investors go to get meaningful exposure to the sector? For an answer, I turned to Simon Gottelier.
He's a portfolio manager at Impax Asset Management in London and runs a $312-million (U.S.) fund specializing in water investments that has outperformed the MSCI World index by about four percentage points a year since its inception in 2009.
Mr. Gottelier was in Toronto recently, pitching the water idea to institutional investors and correcting misconceptions.
Some people have incorrectly thought that the big money to be made in water will be from projects that can export some of Canada's natural bounty to a thirsty world. All sorts of hare-brained ideas have been advanced, such as towing icebergs to the Middle East or reversing the course of Canada's northern rivers and funnelling the water to the parched U.S. southwest.
The reality is far more mundane, according to Mr. Gottelier. For profitable opportunities, think valves, disinfecting chemicals, pipes, pollution control devices and water utilities, among other items.
Around the world, there is a $500-billion-a-year market in expenditures related to water, a sum growing at an attractive 7 per cent a year, or roughly twice the increase in global GDP. The market is huge because the need for water is ubiquitous, while growth is being driven by long-term trends, such as the urbanization of populations in emerging markets and the need to replace aging infrastructure in developed countries.
"Clearly, there is a tremendous shift in terms of increased demand for sanitation and water emerging with the ... growing middle class" in emerging markets, Mr. Gottelier says. In the U.S. and other western countries, meanwhile, "we've seen systematic underinvestment for decades."
Mr. Gottelier has some favourite stocks that he thinks will crest on the wave of enthusiasm for water-related investments.
China Everbright International Ltd. is a Hong Kong-listed construction company specializing in water treatment projects. According to Mr. Gottelier, it is "one of the prime beneficiaries of Chinese government spending in this space" and "one of the most interesting Asian opportunities."
Pentair Ltd. also meets with his approval. The U.S.-based company supplies pipes, valves and filtration equipment. Mr. Gottelier likes the company because it merged with Tyco International's flow control business last year and should be able to wring out $250-million in synergies. "We think that there is quite a nice potential margin uplift coming out of that."
Another of his picks, Pall Corp., makes water filters and should benefit because of increased municipal capital spending on water infrastructure. Mr. Gottelier likens filters to razor blades – once buyers make an initial purchase, they tend to keep replacing the product as it wears out, providing manufacturers with a recurring revenue stream.
Then there is Rexnord Corp., which is undertaking a strategic review of its businesses, which include a water management company, along with industrial products such as ball bearings. Mr. Gottelier says the water operations are Rexnord's crown jewels, and there are a number of logical buyers who would pay up for the division. If a sale goes through, Rexnord shares should pop upward.
A potential acquisition target in the water business is Itron Inc., whose specialty is automated meter reading for water, gas and electric utility customers. Mr. Gottelier says it might be attractive to a buyer such as GE or Siemens. Mr. Gottelier says a deal would likely take place at a 25 per cent premium to current cash flow multiples.
Another pick is Xylem Inc., a maker of pumps, water treatment gear and pollution monitoring equipment. It is a spin out from conglomerate ITT and "probably offers the most diversified exposure to global water across the value chain that there is out there."