Failing U.S. Water Infrastructure

Failing U.S. Water Infrastructure: A Trillion-Dollar Market Waiting to Happen

In the Atlanta, Georgia, suburb of Dallas in 2010, the water department faced a problem that’s all too common in the U.S.: leaky pipes. The department knew some of its water wasn’t getting to customers, but it didn’t know how much.

This water leak wasted valuable resources and money — adding up to almost a million gallons of clean water per week and costing the city/utility company thousands of dollars a year.

We call the water that’s “lost” before it reaches a consumer “non-revenue water.”

In a 2014 New York Times piece “The Art of Water Recovery,” journalist David Bornstein compared the problem facing water utility companies to bottled water producers:

You spend lots of money, and use lots of energy, pumping the water out of the ground, purifying it and transporting it for sale. Then, one day, you discover that a large number of bottles never make it to the stores. They are falling through holes in the trucks. Wouldn’t you want to know what could be done about it? Wouldn’t you be crazy to allow the situation to continue?

In this example, non-revenue water is akin to bottles falling out of a truck.

Realizing precious money and resources were going to waste, the residents of Dallas, Georgia, decided to invest in new “smart” infrastructure. that paid for itself right away.

Their example made me realize how massive the water infrastructure market will be. And if we own the companies updating those pipes from the 1900s to 2021, we can make a lot of money while they do a lot of good.

Here’s why…

The sad truth about American water infrastructure is that it’s old. In fact, large sections of it date back 100 years or more.

As a result, nearly every city in the U.S. has a problem with leaky supply lines — pipes that take water from the source to our homes.

These pipes are an “out of sight, out of mind” piece of infrastructure. But that needs to change, because we’re wasting unnecessary water and tax dollars.

A 2019 Pew Charitable Trusts article perfectly summed up the problem:

Due to our complacency, only a serious crisis that could leave people without access to tap water is likely to free up the financial resources needed to bring water infrastructure — which in many places still includes pipes from the 1800s — into the 21st century. Absent an emergency, cash-strapped water utility managers will continue to deal with aging water systems by economizing on routine maintenance and deferring upgrades for as long as possible.

For governments, water pipes are easy to ignore … as long as residents continue to get water out of the tap.

But enormous problems are starting to emerge that can no longer be swept under the rug, including water loss and toxic contaminants.

In 2017, the American Society of Civil Engineers (ASCE) gave the U.S. water supply a “D” grade. According to the 2017 ASCE Report, we’ll need to spend over $1 trillion in the next 25 years to combat that problem.

A trillion dollars is a huge addressable market. And it means a lot of companies will vie to come up with solutions to America’s water supply issues.

The U.S. government has committed billions of dollars to solving this problem, with much more to come by 2025. And already, great companies have emerged with elegant solutions to upgrade our aging infrastructure.

In this issue of The Intentional Investor, we’ll follow recent big-dollar investments into our nation’s water supply. Not only will these companies reduce waste and make our lives better, but investing in them will also earn us money.

Water Infrastructure Is a Trillion-Dollar Industry

Water issues aren’t new to the U.S.

We addressed a similar crisis in the 70s when pollution was killing our lakes and streams. Back then, we couldn’t swim or catch fish in many parts of America because there were no fish left to catch.

The problem became such a focal point for politicians that the U.S. eventually spent $60 billion to clean up its waterways. That’s equal to about $190 billion today.

Fifty years later, we’re seeing similar political pressure building in regard to our drinking water.

Earlier, I told you about one Atlanta suburb’s problem: leaky pipes that lost nearly a million gallons of clean water a week.

To combat this issue, Georgia passed the Water Stewardship Act of 2010 to reduce water losses across the state. The legislation laid out a “multi-faceted approach to water conservation” for public water systems serving populations of more than 3,300 people.

It included…

• Conducting an annual water system audit.
• Implementing a water loss detection program.

It also meant massive investments in technology for about 250 water providers.

To meet the new requirements, Dallas Georgia leaders invested in innovative electromagnetic water meters, which are far more accurate than traditional meters. They don’t have any moving parts to wear out or get stuck. And they’re particularly good at measuring low flows that can indicate leaks.

Equipped with “smart” technology, these new meters can upload data to the cloud. They can also pinpoint areas of waterlines that have leaks — from cracked pipes to leaky valves to open fire hydrants.

The legislation’s goal is to reduce lost water by almost 80%, from 47 million gallons in 2019 to less than 10 million gallons by 2030.

It’s an encouraging start, yet more needs to be done to combat our nation’s water losses.

A 2015 report from the Environmental Protection Agency (EPA) said that water loss will steadily worsen throughout the country.

To solve the problem, the agency estimates that the U.S. needs to spend $200 billion by 2025. Of that, $97 billion needs to go toward water loss prevention.

In the U.S., public water supplies lose about 6.2 billion gallons — or 16% — of water every day. That’s enough to fill 120 million bathtubs!

All told, we lose roughly 2.3 trillion gallons of water annually from our public water supplies. That’s enough water to fill Las Vegas’ famed Bellagio Fountains nearly 25,000 times a day … for a year.

To put the value of these losses into perspective, a gallon of water costs about one cent. But when you waste that much water, it gets expensive — to the tune of around $14 billion per year.

And the problem goes beyond just municipal water systems. According to the EPA, the average family wastes 9,400 gallons of water per year.

The EPA’s report further goes on to state that the U.S. has over 1 million miles of drinking water pipelines. Designed to last between 75 and 100 years, many of those pipelines are well past their expiration age.

That leads to another water waste problem – water main breaks. We average about 240,000 water main breaks per year. That means household leaks waste nearly 900 billion gallons of water every year — which is enough water to supply 11 million homes.

As you can see in the chart below, half of Philadelphia’s water mains are over 90 years old:

And as bad as all this is, leaks aren’t the country’s only water problem.

The Reality of Dirty Drinking Water

We can’t live without clean water. It’s a basic human need.

An adult human is made up of about 60% water. While we can survive without food for over a month, we’d only last three or four days without water.

As I said before, our water infrastructure is “out of sight, out of mind” for most politicians. So, our community needs leaders who are focused on providing clean, safe water to their residents.

In the U.S., over 286 million people use municipal water supplies. And most of us expect that water (at least the stuff that makes it to us) to be safe and clean. But it turns out the water in our homes may not be as pure as we thought.

About 44% of U.S. water pipes fall into one of three categories:

• Poor…
• Very poor…
• Or life elapsed.

Those leaky pipes lose about 2 trillion gallons of treated water every year. And about 900 billion gallons of raw sewage ends up in our streams and waterways.

According to the EPA, more than 30 million Americans — about 10% of the population — live in areas with water systems that don’t meet safety codes.

With more than 155,693 public water systems and 52,110 community water utilities countrywide, they’re difficult to manage. Some are small rural towns far from urban areas — but many aren’t.

And our urban infrastructure is clearly at risk.

Example No. 1: Newark

In 2017, more than 10% of homes in Newark, New Jersey, had dangerously high levels of lead in their drinking water supply. The problem was that the 100-year-old water-supply pipes leeched lead into the water, forcing 15,000 residents to switch to bottled water.

After failing water tests in both 2017 and 2018, the city responded by providing 40,000 filters to its residents. But what it really needed was new infrastructure and new pipes.

So, on August 19, 2019, Newark borrowed $120 million to replace all the lead service lines in the city.

To date, Newark replaced 23,189 lead service pipes. That’s well above the 18,000 line target they set originally. The cost to replace a lead service line with copper runs between $5,000 and $10,000 each. Newark’s Lead Service Line Replacement program takes care of the lead pipes at no cost to the home owner.

That’s the sad reality in America today. We need government to correct these problems or it could bankrupt the individuals.

While New Jersey made headlines for its water crisis, the problems in Newark aren’t isolated. In fact, according to The Economist, millions of Americans still get their water through lead pipes.

Example No. 2: Flint

In 2014, Flint, Michigan — the original home of carmaker General Motors — made changes to its drinking water supply system and kicked off a water crisis.

The city changed from Detroit’s water system to the Flint River.

The river water corroded pipes and sent foul-smelling, lead-rich water into homes in the community.

Over 40% of water samples collected from over 250 homes had high levels of lead. And the levels of lead in children’s blood nearly tripled in some neighborhoods.

This shouldn’t happen anywhere in the world, let alone in America. We shouldn’t be at risk from the water that comes into our homes.

So now, the fight is on.

The Catalyst to Invest in Water

In 2014, Congress passed the Water Infrastructure Finance and Innovation Act (WIFIA) under the EPA.

This established a federal credit program for water and wastewater projects. Eligible borrowers include government entities, partnerships, corporations, trusts and State Revolving Fund Programs.

The program lends money to these entities to offset the costs of building, renovating and replacing water infrastructure. Initially, it earmarked $2.5 billion for lending.

However, in 2019, it ramped up the fund to $6 billion due to strong interest. As of February 2021, applicants had submitted 156 projects totaling $21 billion in WIFIA loans.

By the end of 2019, WIFIA closed 14 loans for $3.5 billion in financing. Its projects addressed issues in 18 states that affected 24 million people.

It invited 89 additional projects to apply for financing. Those projects affect another 62 million people and need $13 billion in financing, which can be broken down into:

• $3.9 billion for drinking water.
• $6.6 billion for wastewater.
• $1.3 billion for recycling water.
• $1.7 billion for combined wastewater/drinking water.

The WIFIA program shows that many areas need help. And one of the simplest ways to put Americans back to work post-pandemic is through a massive infrastructure spending bill.

The Biden administration targeted water issues in the Infrastructure Law and American Rescue Plan. The law created a lead task force made up of state officials, water utilities, labor unions, and other non-governmental organizations to accelerate replacement of lead pipes. More than $1.2 billion in funds targeted at lead pipes already went to 23 states so far.

That’s why now is the time to invest in water companies. Over the next four-plus years, these companies will be critical to improving and revitalizing our water systems.

So, here’s how we’ll invest… The Water Technology Stock Leading the Industry

Xylem Inc. (NYSE: XYL), was actually responsible for installing the smart meters in Dallas, Georgia. And I believe that its water tech will play a major role in modernizing much of the nation’s 100-year-old pipes, just as it did for Dallas.

In turn, this will give the company plenty of room to grow over the next couple of years.

Xylem is an $18 billion water technology stock that employs 17,000 people at 350 locations worldwide.

The pie chart below shows where Xylem makes its money:

The company focuses on three main areas:

• Systems intelligence (smart meters, etc.).
• Industrial water services.
• Advanced and industrial water treatment.

An example of Xylem’s innovative solutions is its PipeDiver Laser system.

Traditionally, measuring the gaps in water pipes required shutting down and draining the entire system. However, Xylem’s tool can measure gaps and pipe conditions while the system is in use.

The PipeDiver Laser is part of a portfolio of “decision intelligence” tools that use digital technology to transform water utilities. In other words, it’s a quantum leap forward for an industry that relies on 100-year-old equipment.

The pie chart below shows the sector breakdown for Xylem’s revenue:

Xylem’s shares are up nearly 69% over the past two years, but I believe they’ll do much better over the next two. After all, the tools that Xylem provides will be in great demand as the U.S. improves its water infrastructure.

Xylem’s Recent Performance is Just the Start of Something Big

Additionally, we can rest assured that Xylem is a profitable company.

It generated $5.7 billion in sales over the past 12 months. It booked $2.2 billion in gross profit over that period.

For the second year in a row, Newsweek named Xylem one of America’s Most Responsible Companies based on three different scoring factors: environmental, social and corporate governance.

In 2019, it ranked 55 out of 400. In 2023, it moved up to 11th. It sits at the top of its industry as well.

The company also releases an annual sustainability report, in which Xylem’s General Council and Chief Sustainability Officer, Claudia Toussaint, wrote:

As a global water and critical infrastructure technology provider, we have a unique opportunity to accelerate innovation and adoption across the water and wastewater cycles. By combining our sharper focus on advancing sustainability for our customers with our work to advance sustainability across our company and in our communities, we knew we could make a significant difference.

In addition to making Newsweek’s list, Xylem has received several other notable recognitions:

1. Forbes and Just Capital named Xylem one of the 100 Most JUST Companies.
2. Barron’s named it one of its 100 Most Sustainable Companies.
3. And the Human Rights Campaign Foundation gave Xylem a 100% score in its Corporate Equality Index.

In other words, Xylem checks all of our boxes when it comes to investing in a company that will make the world a better place.

Xylem is the sixteenth-largest company in the specialized industrial machinery group. Here’s how it stacks up against its closest peers (in terms of size):

While the COVID-19 pandemic took a toll on Xylem’s earnings in 2020, it bounced back in 2021 and never looked back.

The company’s forward price-to-earnings are high, at 30.0. However, thanks to Biden’s massive infrastructure bill, the outlook for water stocks is excellent over the next several years.

And I believe it’s set to grow substantially as water infrastructure improvements continue.

Recommendation: Buy shares of Xylem Inc. (NYSE: XYL). We believe it will grow between 40% and 100% through acquisitions and expansion. Shareholders will earn a modest dividend of $1.04 per share annually on the position.

The Inflation Reduction Act is Now Law.

And it brings real aid to communities to clean up their water problems. The law allocates significant amounts to address urgent water needs in the U.S.:

• $4 billion to specifically address drought in the western U.S.
• $550 million for domestic water programs in disadvantaged communities
• $12.5 million for emergency drought funding for Tribes

And individual states are also pouring money into water infrastructure. California will spend $15 million on tribal water infrastructure. And Texas will invest $13 million to water, wastewater, and stormwater infrastructure.

After decades of neglect, community water systems finally have the attention they need. And we believe innovative companies such as American Water Works and Xylem will benefit. Hopefully, this is the start of the investment needed to bring the U.S. into a cleaner, more efficient era.

This gives us a unique opportunity to invest in “for the good” companies making a difference in our nation’s water supply before their share prices start to move higher.

So, in this case, everyone wins.

Good Investing,

Matt Badiali