Time to Get Into Water

NEW YORK ( TheStreet) -- I'm a proponent of the notion that water should be viewed as an asset class, appropriate for inclusion in investor's portfolios, but in small amounts.

We certainly can't live without water, and in general, potable water is in short supply. It has been estimated that 97.5% of the earth's water supply contains too much salt for human consumption, leaving just 2.5% that is fresh water. But two-thirds of the fresh water is frozen in glaciers and ice caps, so the supply is indeed limited.

Unlike oil, however, water is a renewable resource. Theoretically, the supply does not change over time; what is consumed or evaporated eventually returns. The problem is that it does not always return to the places where it is needed, and what is taken for granted in some areas is in very short supply in others. Or, there's simply too much of it, and devastating floods are the result.

The choices for obtaining exposure to water in a portfolio sense are somewhat limited. However, it can be done. I've obtained my exposure via companies that own water in the ground, although this is often just a part of their operation.

One example is La Jolla, California-based PICO Holdings ( PICO), a mini-conglomerate, which owns the Vidler Water Company. Vidler develops new sources of water primarily in the southwestern part of the US, an area known for being very dry. The company owns a significant array of water and water assets, primarily in Nevada and Arizona.

Vidler generates its revenue by selling water resources for both residential and industrial use, and through water storage. One of the company's major projects, the Fish Springs Ranch (Vidler is 51% owner) was the construction of a 35 mile pipeline designed to deliver 8,000 acre feet annually to an area north of Reno Nevada. Unfortunately, this project has suffered due to the poor economy.

Vidler Water represents a small fraction of PICO's total revenue, but 46% of the company's net assets. PICO's performance has been disappointing in recent years, to say the least, and it has been a difficult company for investors to understand.

PICO's other businesses include distressed residential land in California, a new canola oil operation in Minnesota that is now up and running, and until last week, the ownership of two small insurance companies in "run-off" (meaning that they were not writing new policies, just managing existing ones), which the company recently sold.

A more mainstream approach to owning water exposure is via water utilities. Overall, this is a highly fragmented business, with an estimated 52,000 community water systems in the U.S., and there's been a move toward consolidation. There are currently fewer than a dozen publicly traded water utilities and just four with market caps in excess of $500 million. These companies are typically involved in the transmission of water, and are not necessarily asset plays for owned water in the ground. They also feature decent dividend yields.

American Water Works ( AWK) is the largest, with a $5.8 billion market cap (3% yield). Aqua America ( WTR) ($3.4 billion market cap, 2.7% yield) has been at the forefront of the consolidation movement, making more than 100 acquisitions in the past seven years. California Water Services ( CWT) ($744 million, 3.5%) and American States Water ( AWR) ($720 million, 2.9%) round out the list of the largest publicly traded water utilities.

The simplest way for most investors that desire exposure to water is to take the scattergun approach via exchange-traded funds.

PowerShares Water Resources ( PHO)), for instance, owns a portfolio of 29 companies, including water utilities, water treatment companies, pipe and pump makers, and others involved in the industry. There are also a couple of ETFs that include international water exposure in the mix such as the Guggenheim S&P Global Water Index ( CGW) and the PowerShares Global Water Portfolio ( PIO).

As a value investor, I prefer to get my exposure to water via individual names, some of which are too small and/or esoteric for a wide audience.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
At the time of publication, the author was long PICO.

Jonathan Heller, CFA, is president of KEJ Financial Advisors, his fee-only financial planning company. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.

Jon is also the founder of the Cheap Stocks Web site, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.

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