- FIW tracks 36 stocks that derive a substantial portion of their revenues from the potable and wastewater industry. It has a 0.53% expense ratio and just over $1B in AUM.
- Fundamentally, FIW scores poorly. It's much less volatile than the overall market, but its valuation is rich and FIW lacks the growth potential of other small- and mid-cap peers.
- However, recent earnings reports for top holdings like Danaher are encouraging. With the majority of constituents reporting over the next 3 weeks, FIW could be a nice short-term play.
- I don't buy into thematic ETFs, so FIW isn't for me. But for current shareholders, I think it's worth holding through the remainder of the Q2 earnings season.
Investment Thesis
The First Trust Water ETF ( FIW ) could be poised for some significant short-term upside. I say that cautiously, as its fundamentals don't leave much to be desired. However, all constituents reporting thus far in Q2 have delivered impressive earnings beats, which should bode well for the industry over the next few weeks. Expensive thematic ETFs like FIW aren't for me, so I am only initiating coverage on it with a "hold" rating. However, it's an exciting way to add more small- and mid-cap exposure without the usual high risk, and I look forward to taking you through how the ETF is constructed and what I expect to see going forward.
ETF Overview
FIW tracks the modified-market-capitalization weighted ISE Clean Edge Water Index. According to the Index Fact Sheet , constituents "derive a substantial portion of their revenues from the potable and wastewater industry." Examples include water distribution, infrastructure, water solutions, and other ancillary services. The Index's current price of 405.32 implies an annualized 13.03% return over its December 29, 2000 base price of 28.80, excluding fees.
Since FIW's launch in May 2007, it's gained an annualized 9.72% (including fees), 3.20% better than the Invesco Water Resources ETF ( PHO ). It's also outperformed the SPDR S&P 500 ETF ( SPY ), albeit with higher volatility.
This historical performance is impressive considering FIW's annual fees are 0.53%. Furthermore, its success isn't dependent on just a couple of periods of massive growth. FIW has outperformed SPY by 9/16 years since its inception.
The Index is rebalanced semi-annually in March and September and weights by market capitalization according to the following rules:
- Securities 1-10: 4.00%
- Securities 11-15: 3.50%
- Securities 16-20: 3.00%
- Securities 21-30: 2.00%
- Securities 31-36: 1.25%
These weights are reflected in FIW's top 20 holdings, listed below. Essential Utilities ( WTRG ), IDEX Corporation ( IEX ), and Danaher Corporation ( DHR ) are three companies that have outperformed since FIW last rebalanced. Together, these 20 total 71.60%, which is very concentrated like most thematic ETFs.
Q2 Earnings Season Is Encouraging So Far
We're still very early into the Q2 earnings season, but five constituents of FIV have reported, and all have beaten analyst earnings expectations. Furthermore, four of the five have topped revenue estimates, and the entire Industrials sector is performing well so far.
Danaher Corporation
Danaher had an excellent quarter, beating revenue and earnings expectations by 6.33% and 18.09%, respectively. It marked at least the 12th consecutive quarterly beat on both top and bottom lines, and Danaher now trades at 26.14x forward earnings. It's not cheap, but it's deserved. The company has delivered a 615% total return over the last ten years.
Roper Technologies ( ROP )
Roper Technologies is primarily an application software company, but Neptune Technology Group is a subsidiary that manufactures advanced water meters and other related equipment. Last quarter , it missed revenue estimates by 14.87% but kept its positive earnings surprise streak going with a 2.48% beat. Importantly, management raised guidance for the year, contributing to a relatively strong B+ EPS Revisions Score. For context, the average S&P 500 company has a C Score.
Valmont Industries ( VMI )
Valmont Industries has an even more impressive A+ EPS Revisions Score, aided by increased management guidance after a solid quarter. That marks nine consecutive sales beats and ten consecutive earnings beats, and the stock trades at a reasonable 18.29x forward earnings.
Mueller Industries ( MLI )
Mueller Industries manufactures copper, brass, aluminum, and plastic products useful in a variety of markets, including water. In operation for over 100 years, MLI has an EPS Revisions Grade of A and beat on sales and earnings last quarter. Few analysts follow the stock, but the results are still encouraging.
Badger Meter ( BMI )
Badger Meter is another company benefiting from forward P/E expansion (currently at 39.63), but it's at least partially justified with several double-digit earnings beats sprinkled throughout the last three years. The latest was 10.68% , accompanied by a 4.42% sales surprise. The utility water and wastewater solutions company also has a solid B+ EPS Revision Grade, with all four analysts covering the stock upgrading expectations in the last 90 days.
These are just five examples, with 11 more to report in July and 18 scheduled for August. Anything can happen, but these results provide a solid foundation for a short-term play. The downside, as mentioned earlier, is the fundamentals, so let's examine them next.
Fundamental Analysis
The following table highlights selected fundamentals for FIW's top 20 holdings. I've also provided summary metrics in the final row alongside PHO and SPY's metrics for additional context.
Fundamentally, both water ETFs are inferior to SPY. Five-year historical revenue growth rates are six points less and estimated revenue and earnings per share growth lag by about 4%. FIW is also more expensive based on forward earnings (26.34 vs. 23.33) and trailing cash flow (26.26 vs. 20.57). Profitability is also an issue, as suggested by Seeking Alpha's Profitability Grade (B- vs. A).
Readers should also consider PHO because its fundamentals look slightly stronger overall. The higher weighted-average market capitalization indicates its constituents are more established, as does its superior Profitability Grade (B vs. B-) and EPS Revisions Grade (C+ vs. C). The key downside is the weaker diversification. While FIW's 36 constituents touch 15 unique GICS industries, PHO only touches 12 and overweights companies like Danaher and Roper Technologies that have already reported.
Investment Recommendation
Based on early positive earnings reports, FIW is a solid short-term opportunity that investors can benefit from since most holdings have yet to report. Companies like Danaher are especially strong, and management at others like Roper Technologies has raised guidance for the remainder of the year. There's a good chance we'll see more of this over the next few weeks, and FIW's share price should increase.
The key downsides are relatively weak fundamentals compared to the broader market and a high 0.53% expense ratio. PHO, a direct competitor to FIW, may be a better choice based on Seeking Alpha's Quant Grades on profitability and earnings revisions. Still, even though thematic investing isn't for me, I see some short-term upside with FIW and will follow it closely to see how the thesis plays out. Thank you for reading, and I look forward to answering any questions in the comments section below.
For further details see:
First Trust Water ETF: Early Q2 Earnings Results Are Encouraging