PHO - PHO: Sustainable Demand For Clean Water Solutions

2023-03-09 06:37:56 ET

Summary

• PHO offers diversified exposure to water conservation and treatment solutions.
• The demand growth for the industry will be driven by increased investment in water infrastructure upgrades in the US.
• The valuation model suggests a moderate contribution from the favored sectors, which adds up to a 13% upside potential for PHO investors.

The reduction of existing water resources and the scarcity of fresh water are becoming a warning sign of global problems. The Invesco Water Resources Portfolio ETF ( PHO ) includes companies from various sectors of the economy that provides tools to solve the issues of inefficient use of resources throughout the chain: monitoring, quality control, water treatment; modernization of water infrastructure; optimization of the water distribution network. I believe the business of the companies that make up the ETF portfolio will continue to expand as the importance of the environmental agenda nowadays is growing, and the water-related issues are underpinned by significant infrastructure investment projects.

Overview

The Invesco Water Resources ETF was established to track the NASDAQ OMX US Water Index, which includes companies that manufacture water conservation and treatment products for private homes and industrial facilities. The ETF has a fairly broad focus with main exposure to industrials play (47.7%), utilities (19.4%) and healthcare (12.1%). Other sectors that PHO favors are technology (11.5%) and materials (9.5%).

The fund allocates $1.52 billion in assets to the portfolio of 39 holdings, which comes at a 0.60% expense ratio to the shareholders. The top 5 positions include Ferguson ( FERG ) (9.76%), Ecolab ( ECL ) (8.56%), Roper Technologies ( ROP ) (7.79%) Danaher ( DHR ) (7.28%) and American Water Works ( AWK ) (6.95%), while the top 10 holdings account for 61%, being quite concentrated.

In terms of performance, over the past 5 years, the fund has managed to outperform the broad market represented by SPY as a proxy for the S&P500.

Outlook

The importance of water resources has risen sharply in recent years, as global water scarcity has become an increasingly urgent problem against the backdrop of factors such as global population and climate change, economic development and changing consumption patterns. The problem of fresh water pollution is one of the reasons for the reduction of existing reserves. Thus, the various purification systems for reuse of polluted water will be in high demand, where forecasts stipulate the market for water and wastewater systems to grow at a CAGR of 7.1% in the current decade.

The growth driver for the PHO constituents will be the expansion of investments in the renewal of water infrastructure in the US. The $1.2 trillion infrastructure bill allocates $55 billion to upgrade water pipelines and water supply networks. In addition, the state budget for 2023 requests a 29% increase in funding, or $11.9 billion , for investment projects aimed to improve water infrastructure, including replacement of lead pipes and reclaiming contaminated and idled land.

In terms of health care spending, the US leads the world and this trend is set to continue. As the population increases, and as the chronic illnesses of millions of Americans worsen because of the pandemic, the costs will continue to rise. According to forecasts, by 2030 the National Health Expenditures will grow by 5.1% a year , accounting for 20% of GDP. This pattern implies favorable conditions for the healthcare sector, which has a significant weight in the portfolio.

Valuation

I decided to assess the potential of the PHO based on the weighted average consensus target prices of the fund's holdings. The model yields an upside of 12.8%, which implies a target price of $59.5 and corresponds to the Buy rating.

Danaher (7.27%), Roper Technologies (7.80%), American Water Works (6.93%), Advanced Drainage Systems ( WMS ) (3.76%) and Essential Utilities ( WTRG ) (3.49%) are the largest contributors to PHO's growth potential and account for the half of the implied upside. Segment-wise, Industrials should deliver 5.9%, followed by Utilities with 2.5% and Health care with 2.2% upside potential. At the same time, the fund can't boast with its quarterly dividend policy, which yielded 0.40% on average in the last 5Y.

Risk factors

The main risks for the fund holding's performance are elevated costs amid high inflationary pressures and supply chain problems. In addition, the state infrastructure investment projects could be crowded out or postponed in the event of a severe macro downturn.

Conclusion

I believe PHO offers an attractive upside potential through a diversified exposure to industrials, utilities and technology. The fund also has a significant presence in the medical device and healthcare analytics segments, which retain growth potential in the long term. Going forward, state infrastructure spending should provide a fulcrum for the demand for water conservation and treatment solutions, especially against the backdrop of the rising awareness of resource scarcity.

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