The water industry has undergone a major transformation over the last 25 years and is today rich with publicly traded companies delivering some of the most innovative solutions to the global problems around water scarcity. As the world celebrates the United Nations’ 33rd World Water Day, it is perhaps a good time to reflect and to consider how investing in water might look over the course of the next quarter century.
Rise up
While there were already some small water stocks in the market at the time, the modern water investing theme was really born at the height of the technology, media and telecommunications ("TMT") bubble. Over a few short years around the turn of the century, we saw the European and U.S. conglomerates start to declare their interest in the water market.
Two French water utilities, who had merged with conglomerates, set their sights on acquisition targets, with Vivendi acquiring exciting roll-up water company, US Filter, and Suez buying Nalco. Danaher, Roper, and GE were also seeing the opportunity to grow in the water markets with acquisitions of water technology companies.
Pair up and break up
The industry players have changed a lot over the years, with not only numerous combinations but also separations. In the early 2000s, Vivendi split off its environmental business (now known as "Veolia") and Suez started focusing much more on its environmental businesses. Soon after, the two large French water companies changed course and exited their big US Filter and Nalco deals, with both trading hands multiple times until they ended up with Xylem and Ecolab, respectively. (Xylem, itself, is the product of a water roll-up under conglomerate ITT before its 2011 IPO.) The U.S. conglomerates’ water acquisitions have also evolved, with GE Water being sold to Suez, Danaher spinning off its water business in an IPO under the name Veralto, and recent news indicating that Roper may part ways with water metering company, Neptune. Veolia acquired Suez during the pandemic.
There have been many other water companies trading hands over the years. The family trees on the current line-up of water companies — and often management teams too — trace a complex lineage. And the trend will undoubtedly continue. Today, based on our analysis, most of the larger publicly traded water companies have very healthy balance sheets, with a stated strategy of inorganic growth and robust M&A pipelines.
Clean up
The pre-Great Financial Crisis acquisitions and sometimes questionable integration of businesses in the housing boom-led market strength really tested the companies during the financial crisis of 2008/2009 and the following years of austerity and housing indigestion. Coming out of the financial crisis, many of the companies were looking in the rear-view mirror, licking wounds, and restructuring their global operations. The mini crises continued over the years with the European recession and the so-called industrial recession, which further challenged water companies on their strategy and operations.
Trade up
What precipitated out of that tough period was a realignment of the industry around core niches. Companies started looking through the windshield again and began to seek out #1 or 2 positions across the wide diversity of water markets and invest in growth. Many shrunk or exited bad or non-core businesses and grew or acquired much better businesses, including taking advantage of emerging digital solutions that advance margins, growth rates and competitive differentiation. Management teams got better at procurement and pricing thanks to geopolitical pressures in Trump’s first term, which came in valuable during the pandemic and again today with Trump’s second term.
Prove up
Speaking of the pandemic, the early months had a lot of uncertainty about how water companies would fare given the changing nature of the companies over the years, and the great financial crash was not a great roadmap for analyzing what would happen in a pandemic. But the experience proved out the water companies’ essential nature, their ability to navigate significant adversity, and be valued partners for industry and governments as they address pain points. Earnings proved to be helpfully more resilient.
Glow up
What has emerged after 25 years is an industry that is sitting pretty. The water companies and markets have grown in confidence and maturity, ready to tackle the years ahead. We believe that few industries can demonstrate the same level of robust positioning. Using the framework of Porter’s Five Forces, the water industry today has significant barriers to entry, minimal substitution or technological obsolescence risk, lots of customers and suppliers, and rational competition in almost all niches. The key drivers of the investment strategy articulated 25 years ago are stronger today, pushed forward by population growth, industrialization (including artificial intelligence and reshoring trends), urbanization, infrastructure rehabilitation and increasing regulation. This is furthered by what climate scientists are warning might be an exceptional period of warming, rising seas, and ultimately an accelerated water cycle leading to more severe weather, flooding and droughts. And while China in the 2010s and India more recently have been exciting growth markets for water, we would expect the next 25 years to benefit from recent signs of growth from the U.K. and Brazil and ultimately strong growth from developing regions such as Africa and Southeast Asia.
Investors gravitate towards thematic investing, in general, because they believe the long-term drivers of the markets and/or competitive structural nature facilitates outgrowth in performance over time. We continue to be excited to see how the next 25 years play out.
Matt Sheldon is senior portfolio manager for KBI Global Investors' water strategy. He is based in Boston. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I’s editorial team.
