Water is the source of life. It also makes for one hell of an investment over the long term. Water usage also grows in times economic expansion. And water is the ultimate defensive theme you can consider in adverse market conditions – after all, have you tried living without it? Most Americans think about water only when their utility bill arrives. That’s sad because many areas in America are facing severe water shortages that will pose problems quite soon if they haven’t already. And in many places in the world there has been and will continue to be an absolute scarcity of clean and potable water.

Taking a tactical view is generally more of a “now” approach, and taking a secular view means it is for many years into the future. If you are a water investor chances are high that this is more of a secular theme for your portfolio than it is tactical. Again, water usage grows in good times and it’s the ultimate defensive investment when the market is in turmoil. At this point in time, water is both secular and tactical.

Tactical Bulls does not always just focus on tactical stocks, ETFs and asset classes that may outperform in a short period time. There are always secular themes that need to be considered for long-term investing plans. Water is absolutely one of those themes.

As it is mid-September of 2024, the tactical nature of water as an investment is coming from the U.S. Federal Reserve and its impending rate-cutting campaign. Operating utilities and taking on capital equipment and services in water are expensive propositions and require lots of capital. That capital is usually financed with long-term debt.

If interest rates begin to go back to a normal posture, water utilities and those capital equipment and services players in water should see a large financial benefit. And they likely will not have to lower prices at all.

This is a quick-hit report that will show specifics why a secular investment theme is currently tactical as well. Investors should understand and expect that the tactical nature of investing in water may only last for a fairly short period of time before it’s just another secular theme again.

THE TOP TWO HOLDINGS OF THEM ALL

Tactical Bulls is focusing on the of holdings of the four top Water ETFs. American Water Works Co. (NYSE: AWK) is in the top two holdings in most funds, but a surprise name in the top five holdings at some of largest water ETFs is Veralto Corporation (NYSE: VLTO).

American Water Works is the largest water utility in America by far and a simple explanation with millions of individuals and countless businesses and municipalities as its customers. With a market cap of almost $29 billion, it is larger than all other public water utilities combined. Its stock is up 12% YTD but at $148 it only yields about 2% on its dividend.

For a pre-hike (interest rates) reference, AWK reached a $190 stock price back before the interest rate hike campaign began. If this doesn’t sound capital intensive that would be helped by lower interest rates then nothing else will — AWK now plans to invest $16 billion to $17 billion on infrastructure upgrades from 2024 to 2028. The company is also continuing to grow its footprint acquiring smaller municipal water systems, usually at prices which are deemed to be value accretive to the company from the time of purchase.

Veralto Corporation was formerly known as DH EAS Holding Corp. and it provides multiple water services around the globe in two business segments — Water Quality and Product Quality & Innovation. The company just became Veralto by its current name in 2022 and it has only traded as a stock since 2023. That newness makes a more difficult evaluation and it already has a $27 billion market cap and a small 0.3% dividend yield. Annual revenues in 2023 of $5.02 billion are projected to be $5.46 billion by the end of 2025. Veralto’s consensus analyst price target of $112.75 (per FinViz) is just above the current $110 share price.

UBS only recently issued a new Hold rating and $118 price target. CFRA has a Hold rating and only a $105 price target, but the firm sees VLTO’s gross margins rising to 59.3% (2024) from 57.8% (2023) because of price execution, cost optimization, and productivity enhancements in its enterprise system.

The current take on Veralto from an independent view is that the stock looks expensive on the surface and most analysts which follow the stock have target prices closer to the current price. It might be good to buy into pullbacks when they come, but admittedly the stock just hasn’t seemed to offer any sizable pullback at all with even a 10% pullback being a rare event.

ALSO READ: A BIG BOLD TACTICAL CALL FOR STEEL STOCKS 

WHAT ABOUT WATER FUNDS & ETFs?

Invesco Water Resources ETF (NYSE: PHO) has about $2.3 billion in assets and is up 11.9% YTD. Here are its top 5 holdings:

• American Water Works 8.3%
• Ecolab Inc. 8.2%
• Roper Technologies 7.9%
• Ferguson Enterprises 7.6%
• Veralto Corp. 7.4

First Trust Water ETF (NYSEArca: FIW) has $1.8 billion in assets and is up 11% YTD. These are its top 5 holdings:

• Veralto Corp. 4.7%
• American Water Works 4.4%
• Ecolab Inc. 4.07%
• Xylem Inc. 3.9%
• Mueller Industries 3.8%

Global X Clean Water ETF (NYSEArca: AQWA) has only about $10.5 million in assets. Here are its top 5 holdings:

• Ecolab Inc. 9.1%
• American Water Works 8.5%
• Xylem Inc. 8.1%
• Ferguson Enterprises 7.5%
• Pentair 7.2%

The Ecofin Global Water ESG Fund (NYSEArca: EBLU) has more of an international focus but is still up 9.1% YTD. Its top five holdings are — Geberit AG (Swiss, 7.4%); Veolia Environnement (France, 7.4%; Stantec (Canada, 4.7%; Severn Trent PLC (UK, 4.6%); and United Utilities Group PLC (UK, 4.6%). But now look at the next top holdings n order which are mainly U.S. companies:

• American Water Works 4.3%
• Pentair plc (PNR) 4.3%
• Tetra Tech, Inc. (TTEK) 4.2%
• Ecolab Inc. (ECL) 4%
• Veralto Corporation 4%

There is also a mutual fund (not an ETF) called the Calvert Global Water Fund (CFWIX) with $590 million in assets under management. It is more diversified and none of the top holdings make up even 2% of the portfolio and its performance is about 10% YTD. Its top 5 holdings should look familiar:

• Ecolab
• Veralto
• American Water Works
• Pentair
• Xylem

REGIONAL UTILITIES UNDERPERFORMING (SO FAR)

Also, there are several U.S. public water utilities which operate outside the State of California. Tactical Bulls does not focus on California utilities because of unique regulations, taxation and other issues that make California more difficult to invest in (think of the companies and successful people giving up and moving out of the state). Unlike the other players these regional water utilities are severely underperforming in 2024. Could they be even larger winners once the Fed’s interest rate noose is released? Here are four of those regional water utilities.

Middlesex Water Co. (NASDAQ: MSEX) has seen a -1.3% performance YTD. It has a $1.15 billion market cap and is a water utility serving communities in New Jersey and Delaware. Its dividend yield is 2.02% and its shares are only about half of their value since peaking at $120 at the very end of 2021.

The York Water Company (NASDAQ: YORW) is a $561 million water utility serving water customers around Pennsylvania. Its stock is up just 1.3% YTD and its dividend yield is 2.1%. The company’s press releases show the company dates back to 1816 and that it is the oldest publicly traded U.S. company and it has never missed a dividend in more than 208 years.

Artesian Resources Corp. (NASDAQ: ARTNA) has a market cap of $395 million and it has a 3.05% dividend yield. It provides water, wastewater, and other services in Delaware, Maryland, and Pennsylvania. Its stock performance is -7.4% YTD and it is still only about two-thirds of its peak stock price from the end of 2022.

Global Water Resources Inc. (NASDAQ: GWRS) offers water, wastewater, and recycling services in the metro areas of Phoenix and Tucson, Arizona, serving approximately 82,000 people in approximately 32,000 homes. With a $317 million market cap it has a 2.3% current dividend yield. Its stock has been rangebound in 2024 but is still only about two-thirds of its stock value from its $20 peak in 2021.

ALSO READ: ARE CALIFORNIA UTILITIES FINALLY SAFE INVESTMENTS?

OUTSIDE MACRO RESEARCH

Many outside research firms have covered water resources as an investing theme. There are too many to list and too many datapoints to count from each but Tactical Bulls has pulled some of those views. There are also actually 11 water ETFs and mutual funds available for water investors that expands on the funds mentioned above.

According to a 2022 outlook research view of Morgan Stanley Research — Worldwide demand for fresh water could rise about 30% by 2050. Population growth, climate change and pollution are playing a role as threats to ample water supplies… addressing water issues will likely require significant investments in infrastructure and technology, policy changes that price water closer to its true value and full-sail changes in water use by businesses across industries.

According to Kiplinger in April-2024 — As the importance of water sustainability becomes ever more apparent, so too do the potential rewards of investing in water… All 8 billion humans on this planet need water. And as worldwide water shortages grow, so too does interest in water investing – that is, in companies that help treat, distribute and dispense water.

According to Investopedia in August-2023 — Recent years have seen an upswing in demand for investments that profit from the need for fresh, clean water. If the trend continues, investors can expect to see a host of new investments that provide exposure to this precious commodity and to the firms that deliver it to the marketplace. 

Morningstar in March-2024 — As access to clean water becomes ever more scarce, a thematic investment opportunity arises. Water contributes significantly to industries such as agriculture, food production, and even semiconductor manufacturing. It is a scant resource without many alternatives. Given the central role it plays in many industries, the case for investing in water is strengthened by its increasing demand and unstable supply.

Citi Insights March-2022 — As with any other scarcity, we believe the freshwater shortage creates investable opportunities. Although not immune to the market volatility of early 2022, since 2011 the S&P Global Water Index has outperformed the global equity market (…by over 1.5% a year…). The potential water investment opportunity set includes entities involved in the water business, its conservation, and its purification.

According to Fidelity in November-2023 — The water sector is less sensitive than the overall market to economic cycles… government spending should help further position water stocks as defensive plays during downturns. The ongoing necessity to provide clean water, upgrade fragile infrastructure, and generate innovative water-management strategies should provide a tailwind to the sector. In fact, water-related stocks have made a splash for investors over the long term…