The Hidden Bull Market in Water Technology

Technology Trends

While artificial intelligence (AI) grabs most of the financial news headlines in 2023, there is another area of technology that’s increasingly in the spotlight.

This technology is related to the one thing everything else on the planet relies on: water.

Earlier this year, the United Nations World Water Development Report 2023 made for grim reading. Here’s a summary of some of the key points…

Globally, 2 billion people (26% of the population) do not have safe drinking water and 3.6 billion (46%) lack access to safely managed sanitation. Between two and three billion people experience water shortages for at least one month per year, posing severe risks, notably through food security and access to electricity.

The global urban population facing water scarcity could double from 930 million in 2016 to between 1.7 billion and 2.4 billion people in 2050. The UN report added that the growing incidence of extreme and prolonged droughts is also stressing ecosystems, with dire consequences for both plants and animals.

Investor interest in water technology has been on the rise of late, as concern mounts about widespread shortages and contamination, and as companies rush to shore up their water supplies.

Water scarcity will become a defining characteristic of the next few decades. This will end up creating both new opportunities and new risks for investors.

Invest Now in Water Technologies

Demand for fresh water is rising in tandem with the human population and growing prosperity in the developing world. By 2030, water demand will be 40% higher than supply, according to a study by consultancy McKinsey.

A team of analysts at Jefferies recently said that “now is the time” for investors to look at companies working to provide clean water, and I totally agree. The analysts noted that companies are getting increasingly nervous about their water supply, as the effects from climate change become more apparent.

One piece of good news, though, is that government policy is finally starting to offer attractive financial incentives in this space. For example, there are investment credits offered for certain types of wastewater treatment in the Inflation Reduction Act (IRA).

So how can the growing water scarcity problem be tackled?

A recent opinion piece from the Financial Times’ Lex team provides some of the answers.

Bridging the Gap

The article suggested that bridging the expanding gap between supply and demand for fresh water will require investment into three main water technologies.

The lowest cost method involves water conservation, which is particularly important in agriculture. This industry accounts for 70% of water consumed globally.

Some companies, like Lindsay Corporation (LNN), focus on irrigation. Founded in 1955, Lindsay is a leading global manufacturer and distributor of irrigation equipment and technology. Other firms are developing drought-tolerant crops because of growing freshwater shortages.

Next up on the cost scale are technologies to treat and re-use water. Water scarcity poses a major threat to businesses, such as mining companies, that are heavy water users. Unless they can create closed-loop water systems, they risk losing their licenses to operate in many countries.

This creates opportunities for “water-tech” entrepreneurs. Recently, we saw the very first water technologies unicorn, Gradiant. This company has devised new ways of purifying industrial wastewater that contain toxins.

Gradiant promises customers that its technology will allow them to purify and reuse larger amounts of water, reducing the amount they need to source externally. The science seems sound and has attracted corporate powerhouses from a number of industries: chipmakers such as Taiwan Semiconductor and Micron Technology; miners BHP Group and Rio Tinto; and automakers Hyundai and BMW.

Most expensive on the water-tech cost curve is desalination, where a viable technology always seems  to be just around the corner. However, over the last 15 years, the cost of making fresh water from seawater has declined a lot—from $1.50 to $0.50 per cubic meter (264.172 gallons). A number of companies offer exposure to this sector, such as Japan’s Hitachi Zosen (HIZOF).

My thought is to invest in a water technologies company that does a little bit of everything.

Xylem: Let’s Solve Water

The company I have in mind is Xylem (XYL), which sells sensor technologies, smart metering, and data analytics for underground infrastructure. It is focused on solving the world’s most challenging water issues—in fact, its company motto is “Let’s Solve Water.”

Xylem’s products and services improve the way water is used, managed, conserved, and re-used. Xylem serves public utilities, as well as commercial, agricultural, industrial, and residential customers. It operates three business segments: water infrastructure, applied water, and measurement and control solutions.

In May 2023, Xylem acquired Evoqua Water Technologies, a water treatment solutions and services company, in an all-stock transaction valued at $7.5 billion. The combination created the world’s largest pure-play water technology company. Management expects the combined company to unlock new growth opportunities and provide cost synergies of $140 million within three years.

In an earlier deal, in January 2023, Xylem took a minority stake in Idrica, a leader in data management and analytics. The two companies will partner to offer an integrated software and analytics platform that enables water and wastewater utilities to manage all applications and data in one place. The platform is already in use by more than 300 customers.

Finally, after recent acquisitions of smart meter and leak detection companies, Xylem can offer utilities a comprehensive portfolio of products aimed at addressing the problem of non-revenue water (from leaks, etc.).

To sum up, in the past, water-tech adoption has proceeded at a glacial pace. However, the recent round of weather extremes (droughts, record heat, severe storms, etc.) may—finally—encourage investment to flow.

Growing demand for fresh water in developing countries and the need to replace aging infrastructure in developed countries will create long-term growth opportunities for Xylem.

XYL stock is up 42% over the past year, but is unchanged year-to-date as investors shift their focus from so-called boring companies like Xylem to the excitement of AI. Nevertheless, it is a buy anywhere in the $100 to $113 range.