To emerging-markets countries clean drinking water in the 21st century may well be what oil was in the 20th: the resource most essential for economic development. Yet historically only a paltry share of emerging-markets infrastructure spending has flowed into water and sanitation — just 3 percent of the total between 1991 and 2006, according to a Goldman, Sachs & Co. report. Investment strategists say a few companies are poised to benefit by transferring technology they have previously applied elsewhere — notably into oil production and refining — to water purification, desalination and transmission.
One example is Irving, Texas–based Flowserve Corp., a supplier of pumps, valves and other equipment and services to the energy industry. Flowserve, which reported $2.2 billion in sales in the first half of 2008 and net earnings that more than doubled, to $211 million, says that only 7 percent of its business is in water. That compares with 50 percent in the oil and gas and power-generation sectors, 24 percent in chemicals and pharmaceuticals, and smaller amounts in food and beverages, construction and other areas. But water revenues are growing at a 33 percent annual rate. The company’s share price rose 89 percent, to $133.07, in the 12 months through August 27, and it’s trading at a price-earnings multiple of 21. Yet Kevin Gaughan, a senior portfolio manager with Wells Capital Management in Milwaukee who has invested
in Flowserve, says he expects its performance to exceed expectations, given its “ability to gain share, exhibit pricing power and expand margins.”
Flowserve says that 22 percent of its annual sales come from the Asia-Pacific and Latin American regions. Growth in China is strong, fueled by a joint venture water project with the Changsha Pump Works Co. as well as recently completed agreements with China Petroleum & Chemical Corp. (Sinopec Corp.) and China National Nuclear Corp. As potable water becomes scarcer, Flowserve’s desalination technology should produce revenue opportunities even in mature markets.
France’s Veolia Environnement, which reported a 14 percent revenue increase last year, to €32.7 billion ($49 billion), 34 percent of it water-related, has similarly been taking its efforts into international markets. Twenty percent of revenues come from outside of Europe (including 8 percent from the U.S. and 7 percent from Asia-Pacific). But Veolia’s shares, which ended 2007 at €62.45, traded as low as €30.65 on July 15, partially because of the effects of a declining U.S. dollar on its euro-denominated profits. The stock then rebounded with the dollar, to €36.72 on August 27. A $40 million water production and services contract with Saudi Arabia’s Ministry of Water and Electricity, announced in April, indicates that Veolia’s emerging-markets efforts are bearing fruit.
Robert Longfield, executive vice president and senior consultant at Memphis-based investment advisory firm CSG, notes that water is not just an emerging-markets concern and opportunity. The U.S. faces drinking-water supply challenges in fast-growing parts of the West, and Longfield points out that other infrastructure requirements in roads, energy and transportation should not be overlooked. He sees returns on such investments in emerging areas being higher but more volatile than the 8 to 12 percent returns in developed markets. Because governments sponsor infrastructure projects, successful companies will likely be those that have a history of managing public-private partnerships and can both attract institutional investments and help to overcome logistical obstacles that are especially common in developing markets. A case in point: In June, Swedish-Swiss engineering giant ABB Group announced a $233 million contract with South Korea’s Hyundai Engineering & Construction Corp. for part of a $3.7 billion power generation and water desalination project in Qatar.
Investors seeking emerging-markets water opportunities have limited options. The International Securities Exchange’s ISE water index, for instance, is seven eighths weighted in U.S.-based companies whose revenue is predominantly domestic. Longfield believes, though, that infrastructure investing may ultimately evolve into something resembling real estate investment trusts. That way, capital returned to private investors could be converted into equity and provide lasting value to public buyers.
