California drought not helping water funds, but stocks prosper

Reuters News
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Posted: Jun 05, 2015 1:13 AM

By David Randall

NEW YORK (Reuters) - The record California drought, now in its fourth year, is prompting fund managers to dive into the shares of water technology companies.

Fund managers from T. Rowe Price, Janus, and Mairs & Power are among those that have increased their stakes in firms such as Ecolab Inc, Roper Technologies Inc and Flowserve Corp that make smart meters, efficient heaters, and software that helps restaurants, hotels and homeowners cut back on their water usage.

Shares of Roper Technologies Inc, which makes leak testing and flow measurement equipment, are up nearly 13 percent for the year. Shares of Ecolab, meanwhile, which among other businesses makes commercial laundry systems that cut water consumption by 40 percent, are up 10 percent for the year.

The rally in water technology companies should continue even if the California drought ends soon, analysts said. Global spending on water-related technology is set to grow to an estimated $25 billion by 2018, up from $15 billion in 2010, according Global Water Intelligence, an Oxford, England-based research firm.

"It's clear that water scarcity is only going to increase, and we think that there will be a several-year investment cycle as homes and businesses look at ways to maximize the water they do have," said Pete Johnson, an analyst at the $4.3 billion Mairs & Power Growth fund.

WATER PLAYS

Despite the rush to water-related stocks, active and passive funds that focus on water are struggling, largely as a result of outsized positions in water utilities whose shares have been hit by concerns about the effects of mandatory usage cutbacks in California and the likelihood of rising interest rates.

The $868 million PowerShares Water Resources ETF, for instance, has approximately one fifth of its portfolio invested in water utilities, such as California Water Service Group, the third-largest water utility in the country. Thanks to a 1.1-percent decline in the shares of California Water Service and other water utilities like it, the fund has gained less than 1 percent this year, compared to a 3.3 percent gain in the benchmark Standard & Poor's 500.

Instead, funds that do not focus exclusively on water are benefiting. The Mairs & Power Growth fund, for instance, is the largest shareholder of Badger Meter Inc, a $929 million market cap company based in Milwaukee that makes water meters for municipal water utilities. Shares of the company are up 8.2 percent for the year to date.

Rich Meeusen, the chief executive of the company, told analysts April 21 that while the California drought is "tragic for the state," it "does represent an opportunity for Badger Meter."

The company estimates that there are more than 235,000 homes and businesses in California that pay a flat fee for water, regardless of amount consumed. With homeowners typically cutting usage by up to 20 percent once their usage is monitored, Meeusen said the company is in discussion with many California water utilities to provide either meters or software that allows homeowners to monitor daily water consumption.

The $15.9 billion T. Rowe Price New Horizons fund and the $8.6 billion T. Rowe Price Small Cap Value fund, meanwhile, have been increasing their positions in A.O. Smith Corp, a $6.4 billion market cap company that makes residential and commercial water heating systems. While the funds were originally attracted to the company due to its growth in China, its expanding line of high-efficiency water heaters geared for restaurants and hotels also make it attractive, said Curt Organt, an analyst at T. Rowe Price.

"There's a very strong positive mix shift story going on" as more businesses look to high-efficiency models - the company's highest-margin business - to conserve water, Organt said.

Shares of the company are up 27.4 percent for the year to date, and hit a record closing high of $72.30 on June 3.

Aaron Schaechterle, an analyst who works on several funds at Janus, said that, in addition to A.O. Smith, his funds have been adding shares of Rexnord Corp, a $2.6 billion company that is expanding its Zurn line of low-flow toilets. Shares of the company are down 7.8 percent for the year after the company's sales fell in the last quarter, which the company attributed to the stronger dollar and a slower than expected growth in new construction.

Yet Schaechterle said that the company's investments in technology should help it gain market share over time.

"We're not playing a water scarcity theme per se, but instead the companies that are investing aggressively in technology products even in an old line industry," he said.

(Reporting by David Randall. Editing by Linda Stern and John Pickering)