PHO - PHO: Water Is A Long Term Play

2023-09-21 03:46:08 ET

Summary

• Invesco Water Resources ETF focuses on the water industry and related industries, holding about 40-45 water-related stocks.
• The fund's holdings include companies in healthcare, life sciences, diagnostic products, and plumbing, in addition to purely water companies.
• The fund has resulted in total returns of 290% and share price return of 250% since inception, but trading in and out of the ETF can be difficult due to periods of inaction and sudden growth spurts.
• Water industry is undergoing some changes and its effects might be felt decades from today, so this is a long-term play only.

Invesco Water Resources ETF ( PHO ) is an equity fund that focuses on the water industry and related industries.

The fund holds about 40-45 water related stocks but the fund's holdings aren't limited to water industry either. For example the fund's top holding is Danaher Corporation ( DHR ) which is basically a healthcare and life sciences company but it has some business segments related to clean water. The second biggest holding of the fund is Roper Technologies ( ROP ) which develops and sells diagnostic and laboratory information management products to several industries including the water industry. The fund's third largest holding Ecolab ( ECL ) also provides some water related products and services but essentially not purely a water company and its fourth largest holding is Ferguson ( FERG ) which is basically a plumbing company. We have to get to the 5th largest holding of the fund to finally find a component that is purely a water company which is American Water Works ( AWK ). It's clear that this water ETF offers a lot more than just the utility side of the industry.

The fund has been around for quite some time and it resulted in total returns of 290% and share price return of 250% since inception. As you can see in the chart below, the fund went through long periods of time with very little movement and some growth bursts along the way so if you didn't buy and hold for a long time, you might have missed on some of those large gains. It would be also very difficult to trade in and out of this ETF due to its inaction for long periods of time and sudden growth spurts.

Obviously water is very important for all of us and life couldn't sustain without it. No matter where someone lives and how they live, they need water infrastructure in or near their home. As human population grows and cities grow denser, it is becoming increasingly more difficult to find enough water to address the need even without all the challenges we are experiencing with the climate including widespread droughts. Sure there is lots of water in the ocean but it's incredibly costly (both in terms of money, energy and resources) to turn it into some drinkable format and transport it into cities so that humans, animals and plants can consume it. This is also why it's important to be invested in not just water companies and water utilities but also other side industries that support the water industry, which is what this ETF seems to be doing.

To be honest the fund's holdings don't look compellingly cheap. When I look at the top 6 holdings of the fund which account for close to half of its total weight, I see P/E ratios ranging from 17 to 43 with mid-point being around 25. On one side, this valuation could make sense since water is considered an essential utility and water companies have a "captive audience" but on the other hand water prices tend to be fairly stable and there is very limited growth in this particular commodity and a P/E of 25 might be pricey for limited growth.

Some of these companies are still posting solid growth though because they are not all purely water companies and they have other businesses as well. When we look at 3-year revenue growth for this fund's top holdings, we find that growth rates range from 6% to 48% with the slowest growth coming from our purely water play American Water Works which is not surprising. What surprises me most is that the biggest growth came from Advanced Drainage Systems ( WMS ) which posted 48% revenue growth in 3 years. When we consider the average 3-year growth rate to be about 25%, the average P/E of 25 doesn't look so bad anymore but it's still not cheap either. Remember these are not annual growth rates, we are looking at 3 years combined.

The fund's dividend history is all over the place. It generally seems to trend up in the long term but its annual movements are hard to predict. Then again thee fund has a low dividend yield of 0.75% which isn't much and I can't imagine anyone buying this fund for dividends alone. By all intends and purposes this fund is far from an income play.

Earlier this year, Arizona announced some restrictions in construction in Phoenix area because the state is concerned about sustainability of its groundwater levels. Phoenix is one of the fastest growing cities in America with a lot of construction activity going on but it also happens to be one of the driest cities due to having high temperatures and limited amount of rain. Still, this issue might not be limited to Phoenix and we might see more news stories like this in the future coming from different parts of the country (and the world). This reminds me of the historical times when most major cities would be built next to big sources of clean freshwater such as rivers which played a huge part in development of basically all major civilizations over eons. This could have implications on where people move and where future cities are built so that our water sources can be more sustainable.

This could also have implications for investing in water related industries. In the future cities are likely to shift to locations where there is easier access to clean drinkable water and this might require building large amounts of new infrastructure in the future. Of course this won't happen overnight and unlikely to affect water stocks in the short term since the shift is likely to happen in the next 20-30 years. This means the implications will likely be only relevant to long term holders of these stocks but should have very little implications for traders or short term holders. As fresh water becomes more scarce, water prices could start rising in the future like a commodity. We could also see higher costs for producing water since there will have to be new techniques developed in order to convert ocean water into drinkable water which takes a lot of energy and resources. Basically the new trends in human water consumption might provide both opportunities and risks for water companies.

There is also the issue of water safety and effort to keep water clean. Modern agriculture and modern manufacturing puts a strain on water resources not only in terms of reducing their available quantity but also introducing a bunch of risky materials and chemicals which threaten safety of water. Additional filtering processes and methods had to be developed in order to keep water clean but these can also be costly to implement. In the future water companies will have to make further investments to keep water clean but some of those products will also come from companies within this ETF as I mentioned above so if you are invested in PHO, those extra costs might actually turn into extra returns for you.

One issue with this ETF is its relatively high cost of 0.60% which is likely to eat into your profits. Since the fund only holds about 40 stocks and most of the weight is in top 6 stocks, you might be able to replicate a good portion of this ETF by yourself if you don't feel like paying this expense fee.

Water is a long term play and this ETF is only for buy-and-hold investors who have a horizon of many years in front of them.

For further details see: