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Sun, Oct 30, 2005 - Page 12 News List

Water stocks skyrocket

Investors are bullish in the industry now that private firms are securing control of supplies

NY TIMES NEWS SERVICE , NEW YORK

A worker tests water at Aqua America's plant in Bryn Mawr, Pennysylvania, earlier this month. While most of what flows through the nation's water taps is supplied by publicly run municipal systems, a growing number of rural and suburban water systems are owned by a handful of publicly traded utilities. The shares of these companies have skyrocketed this year.

PHOTO: NY TIMES NEWS SERVICE

Oil and gold have had a great run in the markets this year.

So, too, has water.

While most of what flows through the nation's water taps is supplied by publicly run municipal systems, a growing number of rural and suburban water systems are owned by a handful of publicly traded utilities, like Aqua America. The shares of these companies have skyrocketed this year, and despite a selloff earlier this month, they are still at levels that might seem more appropriate for rarer commodities, like precious metals or petroleum.

The prices have surprised some analysts because water utilities, after all, inhabit a pokey, highly regulated universe whose infrastructure is likely to require an expensive upgrade. But investors who are bullish on the industry say that it is about to undergo a historic change -- moving oceans of municipal water into the hands of for-profit companies.

New regulations

The catalyst for the transformation will be the final draft of new water quality regulations, which the Environmental Protection Agency is expected to issue later this year, said Michael Gaugler, a stock analyst at Boenning & Scattergood, a brokerage firm in Pennsylvania, near Philadelphia.

The new rules will require water systems to further reduce levels of substances like arsenic and chlorine. Many small towns will discover that they cannot afford the pricey ultraviolet reactors they will need to meet these stricter limits, Gaugler said. But he added that the new requirements were not the only consideration.

"Some of this infrastructure has been around since World War II, and the pumps and pipes are wearing out," Gaugler said. "But reality has not hit at the local level yet."

About 85 percent of the nation's nearly 55,000 municipal water systems serve fewer than 3,300 homes each, and Gaugler said that many small towns had too few customers to be able to afford the infrastructure improvements. But, he said, companies like Aqua America -- which is based in Bryn Mawr, Pennsylvania, and has 2.5 million customers in 15 states -- could cover the costs without sharply raising rates. While large cities have continued to operate their own water systems, publicly traded water utilities tend to buy small rural and suburban water systems.

Gaugler predicted that more small towns would begin selling their water systems to the for-profit companies next year and in 2007, and that the pace might pick up as the deadlines for compliance -- which range from 2011 to 2013 -- drew near. He predicted that the big water companies "will pay less for acquisitions as time goes on, because municipalities are going to get desperate to sell."

Only a handful of water utilities trade on stock exchanges -- and many of the companies are tiny, with market capitalizations of only a few hundred million dollars. This means that sudden changes in investor sentiment can cause big moves in the stocks.

Aqua America, the only publicly traded water company with a market capitalization of more than US$1 billion, started trading this year at less than US$25. The stock peaked at around US$39 on Oct. 4. Then, on Oct. 12, more than four times the usual number of shares traded hands, and the stock fell to US$32. It now trades at US$32.92. Trading in the California Water Service Group, the second-largest water utility stock, and American States Water, the third largest, has followed similar patterns.

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