Broker Check

Our Water Infrastructure Thesis and How Revenues Boost Earnings

| September 13, 2021
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We've spent some time talking about infrastructure-related investment themes and the opportunities that lie within. This theme has become more popular than even we anticipated, as 2021 inflows into infrastructure exchange traded funds reached $4.2 billion in June (per First Trust Advisors L.P.) with still another six months more data to collect.

While there are many different types of “infrastructure” to consider – roads, buildings, technology infrastructure, even home health care (just kidding, but not really) – in this post we want to focus on water. Specifically, we want to drill down on why the water subcategory is particularly compelling to us, both in the short- and long-term.

Water infrastructure is often taken for granted in the U.S. Amazingly, clean, reliable drinking water is transported via 2.2 million miles of pipe to millions of people each day. Wastewater pipelines also stretch an additional 1.3 million miles.

This critical infrastructure lies mostly underground and out of sight, where it's been for decades. However, water infrastructure has a finite lifespan. In fact, many of today's water systems were originally installed after World War II or after the passage of the Clean Water Act in 1972. As a result, much of the nation's critical water infrastructure has reached or exceeded its useful life and now requires significant capital investment.

For instance, according to the American Society of Civil Engineers, about 2.1 trillion gallons of treated drinking water are lost each year in the U.S. due just to leakage. Additionally, water main breaks have increased by 27% from 2012-18 and now occur every two minutes.

Cost estimates from the same group for the U.S. to update its water infrastructure by 2039 total $3.3 trillion. That’s the capital investment required to bring it up to an A or B grade from a C-.

Additionally, investments in water infrastructure today extend beyond simply replacing pipes and valves. New technologies such as smart meters and monitoring systems allow water utility operators to detect leaks sooner, forecast when maintenance may be needed, and avoid unplanned repairs.

Expanding to a global view, the United Nations expects water infrastructure spending to reach between $900 billion and $1.5 trillion per year by 2030. That would account for 20% of all global infrastructure spending. These long-term trends are also supported in the near term by a few catalysts:

  1. The release of pent-up demand due to lockdown-induced delays of capital investments
  2. A full economic reopening will boost demand for water resources (especially in manufacturing)
  3. Fiscal stimulus in past and future infrastructure bills will bump spending up

Therefore, in our view, long-term trends related to water scarcity, the need for large infrastructure investments, as well as several compelling short-term catalysts, provide a strong investment thesis for water investing. We think it’s true now and in the years ahead.

If you don't believe us, see what Dr. Michael Burry from “The Big Short” has to say about water investing.

To Boost Earnings, Increase Revenue

As we’ve discussed before, the final months of the year tend to be more bullish for the market than the summer doldrums. In general, the last quarter brings significantly increasing volumes, allowing trends to develop.

In the short-term analysis, as we pointed out last week, the Big Money Index (BMI) from MAPsignals, which measures institutional investor activity, continued to head north earlier than expected. Thus, it’s another strong, bullish data point for investors.

Last week we saw another exemplary buying week with 430 buys and only 94 sells. That's two weeks of strong buying activity, with quality stocks being bought the most, which continues to support the BMI’s increase:

Buying is picking up after an unusually strong August. So, we want to quickly frame a context for what’s potentially coming.

It’s interesting what is being bought. Last week we saw huge buying in real estate, technology, communications, and health care stocks. These industries have felt the pressure over many of the prior frustrating months.

These current data provide a potentially bullish setup through the end of the year. Remember, it was just last month the data said stocks were heading lower with aggressive selling. Then just like that, it changed, once again rewarding stockholders who concentrate on the long run.

In order to further support this long-term bullish outlook and for the market to trend higher, we believe corporate earnings will need to grow. And perhaps the best catalyst for growing earnings is to “merely” increase revenues (the concept is simple, but executing it isn’t).

As indicated in the table below, Bloomberg’s 2021-23 consensus year-over-year revenue growth rate estimates for the S&P 500 are 14.8%, 7.1%, and 5.2%, respectively. Obviously, revenue growth has been poised to rebound robustly in 2021 after the COVID-induced business and economic hits in 2020. That’s why we wanted to include projections through 2023 in this analysis.

For reference, growth rates of 5% or more sit comfortably above the S&P 500 Index’s 15-year average of 3.3%. As you can see, all 11 major sectors reflect more than 5% year-over-year revenue growth in 2021, with six also hitting the mark in both 2022 and 2023 as well. The sectors standing out the most in 2022 and 2023 are communication services, consumer discretionary, industrials, and information technology.

To put this in perspective, the outlook for the S&P 500 Index earnings according to the Bloomberg Consensus for 2020-22 are 44.9%, 9.0%, and 9.6%, respectively. This type of top- and bottom-line growth is more than sufficient to support a long-term bullish outlook for U.S. equity markets.

Securities sold through CoreCap Investments, Inc., a registered broker-dealer and member FINRA/SIPC; advisory services offered by CoreCap Advisors, Inc., a registered investment advisor. Cornerstone Financial and CoreCap are separate and unaffiliated entities.

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