California Drought ‘Opens the Door’ for Water Technology Companies

Posted on Apr 16, 2015

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NEW YORK (TheStreet) — California is drying up, but the unprecedented drought could bring more liquidity to companies that specialize in water reuse and conservation. The crisis is so dire the state is now requiring residents to scale back water usage by 25%. So high-tech water systems will see increased demand.  

“The 25% reduction will be a powerful driver for the installation of more water efficient technologies,” said Charles Iceland, senior associate at the Washington D.C.-based World Resources Institute, an environmental and natural resources think tank. “It opens the door for businesses to sell all sorts of water-efficiency improvement technologies and services.”

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That could mean more profits for companies like Rexnord (RXN – Get Report), which specializes in water-efficient plumbing on the commercial side. Shares are down 9.6% year-to-date and its water business accounts for just under 40% of total revenue. Wedbush Securities analyst David Rose has an outperform rating on the stock.

“The mandate, the 25% reduction, will really force municipalities to put into their codes more water-efficient devices, and companies like Rexnord will see a small benefit going forward,” Rose said.

And the state’s water conservation initiatives could become even more stringent.

“If the drought persists, more conservation measures are going to be required,” said Richard Frank, professor of environmental practice and director of California Environmental Law & Policy Center at the UC Davis School of Law. “How severe those cutbacks are is going to depend on the severity of drought conditions.”

Rose foresees upside in six months for Rexnord, but there are a few names well-positioned to profit over the long haul.

Part of coping with any drought is tracking just how much water is used. Mueller Water Products (MWA – Get Report) has water metering technology that could come in handy, as consumers are forced to watch every drop. Its water-related business accounts for 66% of total sales. Wedbush remains bullish and says the stock could benefit from the drought over the next year, hence its outperform rating. Shares are down about 1% since the start of the year.

“Mueller will probably see some more product activity as municipalities look to monitor and control the amount of water being used and the amount of water that’s being lost,” Rose added.

In fact, Frank says some municipalities in California don’t even have water metering technology. “It’s going to be much more difficult to achieve those numerical conservation standards if you don’t have water metering.” One of the most obvious steps to weathering a drought is requiring water monitoring, he says.

“A municipality upgrading their valves or updating metering systems — any initiatives to maximize the efficiency of their networks – would be a potential benefit” for Mueller, said Cowen & Company analyst Joseph Giordano, who maintains an outperform rating on the stock.

Currently, the water conservation efforts imposed by the state of California only extend to residents. Should drought conditions worsen, the state’s agricultural industry may be forced to track its water consumption, too.

“California Gov. Jerry Brown took plenty of criticism for not imposing the same level of conservation measures on the agriculture space, which in California consumes about 75% to 80% of all water allocations in the state,” Frank added. “I think if the drought persists, it’s also quite likely you’ll see these numerical limits applied to the agriculture sector.”

That would make the need for water metering even more pressing.

Another method for dealing with drought conditions involves disinfecting waste water, bringing it back to usable standards. That’s where Xylem (XYL – Get Report) comes into play.

“Xylem has the broadest portfolio of water products from pumps, disinfection products and analytics,” Rose said.

Water is Xylem’s bread and butter, representing about 95% of sales, according to Wedbush, which also maintains an outperform rating. Shares are down 7.3% year-to-date.

“Disinfection is something Xylem does, so to the extent that’s part of the solution for the drought, it would probably help them,” said Susquehanna International Group analyst Robert Barry, who has a neutral rating on the stock.

But it’s not just conditions in California that are opening up opportunities for these companies, though Rose said Mueller and Xylem have relationships with California to address its drought woes. Analysts say there’s room for growth abroad as the world experiences the impact of climate change.

“Xylem has probably the broadest footprint, participating in projects from Brazil to China to India,” Rose added. “I think there’s a great opportunity for companies like these to benefit from global water challenges.”

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