by Mike Kapsch, Investment U Research
Wednesday, December 5, 2012
Last week, I argued for water companies, such as Aqua America (NYSE: WTR), pipelining water to shale oil and gas drillers as a “backdoor” way to play the shale oil and natural gas boom in the United States.
This week, I’m going to add a second water utility firm quickly ramping up its services to drillers.
It’s the largest investor-owned U.S.water and wastewater utility company, American Water Works Company (NYSE: AWK). And it’s in a position to benefit tremendously as energy companies ramp up their fracking operations.
125 Years and Still Going Strong
Like Aqua America, American Water Works also focuses its attention on the Marcellus Shale region. The water company has contracts with at least a dozen firms and about 35 different water distribution points.
But this number is likely heading much higher.
For instance, last quarter, the company signed two agreements with XTO Energy, a subsidiary of ExxonMobil (NYSE: XOM), to construct pipelines for supplying water to support shale gas drilling operations as well as provide public water service in Butler County, Pennsylvania.
There are an additional 18 areas of interest American Water could build new pipelines or setup distribution points. Yet, Forbes reports, if energy experts are correct, drilling activity is pinged to “grow sevenfold over the next 10 years in the Marcellus Shale.” So even this number is likely to soar in the coming years.
Considering the average fractured gas well in the Marcellus requires 3.8 million gallons, this could add considerably to American Water’s bottom line each year.
But what I like best about American Water Works is that it’s already a solid company.
As the nation’s largest water and wastewater utility firm, it serves an estimated 15 million customers in 30 states, including parts ofCanada.
The company has been in business for over a century and old age isn’t hurting it one bit.
Quarterly revenue and earnings are growing at about 9% and 12% per year. Operating margins just increased to 39%. Profit margins are in the double digits at 12%. Other than its high debts, there isn’t much to dislike about American Water.
In fact, its solid growth and emerging opportunities have pushed shares up 20% this year. There’s much more room to go higher, too.
That’s because I haven’t even discussed the biggest opportunity Aqua America and American Water Works are facing.
It’s over a $3-billion-a-year opportunity in the Marcellus Shale alone. And The Wall Street Journal even called it a “gold rush among water treatment companies.”
Recycle, Recycle, Recycle
What’s the biggest concern among environmentalists and regulators when it comes to fracking?
Hint: It’s our topic of discussion.
The fracking process not only requires a lot of water, it also dirties the water both through the chemical solution companies add to it and by its exposure to elements found deep in the earth.
In the fracking industry, this wastewater is called “produced water.” And it has some water companies, especially those operating in the Marcellus Shale region, primed to perform very well over the coming years.
You see, according to Forbes, “Historically, the industry has disposed of produced water by injecting it underground in ‘disposal wells.’”
But due to geological factors in the Marcellus Shale region, this wastewater disposal method isn’t permitted. So drillers there have to subcontract water companies to treat their wastewater from fracking.
With their current positioning among drillers in the Marcellus, Aqua America and American Water could both make a lot of money by getting more involved in the produced water business.
Not only will it allow them to charge oil and gas companies for the water they’re providing for drilling upfront, they can charge them again to treat any wastewater from the project.
Currently, neither Aqua America nor American Water Works are involved in the produced water business. But both companies have publicly acknowledged their interests in it and there’s no reason they shouldn’t make a big push into it very soon. Because as soon as they do, shares will be looking to head higher.
MikeA “Backdoor” Way to Play America’s Coming Energy Independence (Part 2),