Water utilities work day in and day out to ensure an uninterrupted supply of clean, potable water and reliable sewer services to millions of customers in the United States. These are essential for healthy and hygienic living.
The aging of pipelines is concerning, but water utilities continue with their upgrade and maintenance projects to minimize disruptions in operations. American Water Works Company AWK, with its widespread operations, provides services to domestic customers and military bases and offers an excellent opportunity to stay invested in the water utility space. Other water utilities worth adding to your portfolio are SJW Group SJW and Middlesex Water Company MSEX.
About the Water Supply Industry
The Zacks Utility - Water Supply industry includes companies that provide drinking water and wastewater services to industrial, commercial and residential customers and military bases. Water utility operators own nearly 2.2 million miles of pipelines that are getting old. Utilities continuously replace old pipelines and add new ones to expand operations. Utility operators own storage tanks, treatment plants and desalination plants to supply customers with uninterrupted potable water. The highly fragmented industry creates operational challenges, but increasing efficient water usage by individuals and other industries helps ensure that water is not wasted. Capital-intensive water utility operators will benefit from the interest rate cuts and continue their capital expenditures at reduced capital servicing expenses.
3 Trends Pivotal for Shaping the Water Supply Industry's Future
Interest Rate Decline is a Tailwind: To maintain, upgrade and expand operations, utilities approach capital markets for loans. Multiple rate hikes by the Federal Reserve took the benchmark rate to the 5.25-5.50% range, adversely impacting utility operators. The U.S. Federal Reserve has lowered the benchmark rate by two times for a total of 75 basis points, bringing down rates to a range of 4.50%-4.75%. One more rate decline is expected in December when Fed officials meet again. Capital-intensive domestic-focused utilities will benefit from the Fed’s decision to reduce interest rates. The drop in interest rates is a big positive for utility operators planning large investments in infrastructure upgrades.
Aging Infrastructure Needs Huge Investments: The water and wastewater infrastructure is aging and gradually nearing the end of its effective service life. Per the findings of the American Society of Civil Engineers (“ASCE”), water main breaks occur every two minutes in the United States due to the aging of the existing water infrastructure. It is evident that this industry needs more investments for maintenance and upgrade. Per the U.S. Environmental Protection Agency (“EPA”), an estimated $963 billion investment is necessary to maintain and expand the drinking water and wastewater service to meet demand over the next 20 years. The massive investment requirement also creates an opportunity for growth among operators in this space. The Bipartisan Infrastructure Law provided $50 billion to EPA to strengthen the drinking water and wastewater systems of the United States. A major portion of the investment will be directed toward upgrading water infrastructure serving disadvantaged communities. ASCE gives a C- rating to the U.S. drinking water infrastructure and a D+ to the U.S. wastewater infrastructure.
Fragmented Water Industry Needs Consolidation: Since the U.S. water utility industry is highly fragmented, upgrading aging assets to provide quality services is the need of the hour. Per the ASCE, at present, 50,000 community water systems and 14,000 wastewater treatment systems in the United States are providing water solutions to customers. Per the ASCE finding, due to the delay in pipeline repairs and maintenance, billions of gallons of treated water are lost every year in the United States. The wastage of water will continue to increase the operating expenses of the water utilities. The fragmented industry creates operational challenges as small water utilities have limited financial capabilities to meet the requirement for replacement and maintenance of the aging water and wastewater infrastructure. Large water utility companies continue to acquire small players to ensure the extension of high-quality services to customers and the investment required to upgrade old and acquired assets. Since the mergers and acquisitions are taking place at a very slow pace, more consolidation is essential to reap the benefits.
Zacks Industry Rank Indicates Dull Prospects
The Zacks Utility Water Supply industry is a 12-stock group within the broader Zacks Utilities sector. The industry currently carries a Zacks Industry Rank #154, which places it in the bottom 38% among 249 Zacks industries.
The group’s Zacks Industry Rank, which is the average of the Zacks Rank of all the member stocks, indicates bearish prospects for the near term. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than two to one. Since July 2024, earnings estimates for the industry have gone down by 44.9%.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and valuation.
Water Supply Industry Lags S&P 500 & Sector
The Zacks Utility Water Supply industry has underperformed the Zacks S&P 500 composite and its sector in the past 12 months. The industry has declined 0.4% against the Utility sector’s rally of 13.5%. The Zacks S&P 500 composite has advanced 29.7% in the same time frame.
Water Supply Industry One-Year Price Performance
Industry Trading at a Discount to Sector & S&P 500
On the basis of the trailing 12-month enterprise value to EBITDA (EV/EBITDA), which is a commonly used multiple for valuing water utility stocks, the industry is currently trading at 9.41X compared with the S&P 500’s 18.87X and the sector’s trailing 12-month EV/EBITDA of 14.88X.
Over the past five years, the water supply industry has traded as high as 24.74X, as low as 9.41X and at the median of 16.42X.
Water Supply Industry vs. S&P 500 (Past 5 Years)
Water Supply Industry vs. Utility Sector (Past 5 Years)
Water Utility Industry Stocks to Watch Now
Below, we have discussed four stocks from the Zacks Utility - Water Supply industry with strong growth potential. Two of these stocks have a Zacks Rank #2 (Buy) each, and one has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
SJW Group: The San Jose, CA-based company, along with its subsidiaries, provides water services to its customers in the United States. The company looks for opportunistic water and wastewater system acquisitions that will continue to support its growth potential. SJW Group aims to invest nearly $1.6 billion during the 2024-2028 period to build and maintain its water and wastewater operations, and water and wastewater infrastructure to provide a safe and reliable service to its customers.
Over the past 60 days, the Zacks Consensus Estimate for 2025 earnings has moved up 0.4% to $2.98 per share. The company’s long-term (three to five years) earnings growth rate is 6.07%. SJW reported an average earnings surprise of 4.3% in the last four quarters. The current dividend yield is 2.97%, better than the Zacks S&P composite’s yield of 1.49%. SJW currently has a Zacks Rank #2.
Price and Consensus: SJW
Middlesex Water Company: Iselin, NJ-based Middlesex Water, along with its subsidiaries, provides water and wastewater services to its customers. Middlesex Water has plans to invest $226 million during the 2024-2026 period to strengthen its water and wastewater infrastructure.
Over the past 60 days, the Zacks Consensus Estimate for 2025 earnings has moved up by 2.5%. The MSEX stock reported an average earnings surprise of 3.07% in the last four quarters. The current dividend yield of the company is 2.3%. Middlesex Water currently has a Zacks Rank #2.
Price and Consensus: MSEX
American Water Works Company: Camden, NJ-based American Water, along with its subsidiaries, provides water and wastewater services to millions of Americans. The company continues to expand operations through acquisitions and organic means. American Water Works plans to invest $3.3 billion in 2025 to strengthen and expand its existing infrastructure. AWK aims to invest in the range of $17-$18 billion during the 2022-2029 period.
Over the past 60 days, the Zacks Consensus Estimate for 2024 earnings has moved up by nearly 0.2%. The long-term earnings growth of the company is currently pegged at 8.15%. The current dividend yield of the company is 2.37%. The company currently has a Zacks Rank #3.
Price and Consensus: AWK
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