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Water Stocks: Great Promise But at What Cost?

According to the Water Research Foundation, the 30 largest US municipal water systems will need to spend $88 billion on infrastructure over the next decade to ensure safe water supplies for the communities they serve.

And this estimate doesn’t include the capital expenditures needed to maintain and expand the roughly 50,000 systems that provide potable water and wastewater services to the other 75 percent of the population.

These outlays represent a crushing burden to state and local governments, and by extension taxpayers, who also ratepayers.

Based on the Water Research Foundation’s breakdown of the expenditures needed, investors can profit from two major areas of opportunity.

First, companies that provide construction, engineering, contracting, equipment and communications services to water systems stand to reap a windfall.

The group has suffered a severe shakeout in recent years, as municipalities have balked at placing work orders. But with standards tightening and risks of untreated water growing, the work can’t be put off much longer. And the survivors will reap the spoils.

Second, the handful of investor-owned water utilities will benefit from a growing rate base as they increase their level of investment. And with cash-strapped municipalities looking to monetize assets, these publicly traded companies have ample opportunity to grow via acquisitions.

Suez Environnement (Paris: SEV, OTC: SZEVY) and Veolia Environnement (Paris: VIE, NYSE: VE) already control a huge share of the global water-services market and stand to profit the most from growing investment in these systems.

But water systems are only one piece of the pie for these environmental-services giants, which also generate a hefty portion of their revenue from waste management, mainly in Europe.

The European Central Bank’s efforts to stimulate economic activity by cutting interest rates and buying bonds should help both companies, though conditions in France remain challenging.

Suez Environnement also risks losing its largest drinking-water contract if it can’t meet local authorities’ bid requirements.