An Evoqua Water Technologies clarifier, a large mechanical device for separating solids from water

Courtesy Evoqua Water Technologies

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Water is an economic paradox. Everyone needs it, but it’s often cheap because it’s usually, though not always, plentiful; it just falls from the sky. Good water stocks, however, aren’t plentiful—which makes

Evoqua Water Technologies,

a water-treatment company, a good stock to tap into.

When it comes to water, $3.9 billion market-cap Evoqua (ticker: AQUA) serves more than 38,000 customers with over 200,000 installations in industries including electronics, manufacturing, chemicals, utilities, refining, even theme parks. Someone has to treat all of the water on waterslides.

The business hasn’t always been easy for Evoqua. The company began as

Siemens

’ (SIE.Germany) water technology unit before being bought by private equity and sold to public investors in late 2017. The stock got off to a rocky start. Management struggled to meet its guidance, which caused the stock to fall from $18 at its initial public offering to under $8 a year later. The stock has gained roughly 300% from the bottom to $32.80 since then, with the same management team and nearly identical strategy. What has changed is that investors have grown more comfortable with it and its order patterns. And with demand for water treatment growing, stock gains should continue.

Finding a way to play water wouldn’t seem difficult. As with everything, there are exchange-traded funds on the theme. For instance, the

Invesco Global Water

ETF (PIO) shows what makes Evoqua unique. The ETF holds companies that make water heaters, such as

A.O. Smith

(AOS); distribute plumbing supplies, like

Ferguson

(FERG.UK); and act as water utilities, such as

American Water Works

(AWK). There’s healthcare-industrial giant

Danaher

(DHR), which has a filtration business, while

Roper Technologies

(ROP) gets some of its sales from water metering. Evoqua, however, is one of the few publicly traded companies that is all about water and plays an essential role in nearly the entire water chain.

The demand for water grows about 1% a year globally. That doesn’t sound like much, but each year more people and the same amount of water stirs scarcity fears. What’s more, the United Nations estimates that 44% of residential wastewater isn’t safely treated. All told, the global market for water services is $85 billion. Evoqua puts its addressable market at about $16 billion. And with sales of $1.5 billion forecast for 2022, there’s plenty of upside.

HeadquartersPittsburgh, PARecent Price$32.46YTD Change20%2022E Sales (mil)$1,546 2022E Net Income (mil)$110 2022E EPS$0.91 2022E P/E35.7Market Value (bil)$3.9

E=Estimate

Source: FactSet

There’s also a good chance that the Biden administration will designate PFAS, a chemical made a generation ago that has leaked into groundwater, as a hazardous substance. If that occurs, the Environmental Protection Agency could require producers to clean it up, at a cost of tens of billions of dollars, says Gordon Haskett analyst John Inch. Evoqua is one of the few companies with multiple solutions for removing PFAS from water.

It’s also probably the only water company with a national footprint that can do it. The water-treatment business is fragmented, and Evoqua faces little competition from large, publicly traded companies. That gives Evoqua the ability to add earnings through bolt-on mergers and acquisitions. The company has made nine buys since going public in late 2017. The most recent: the April 2021 purchase of Water Consulting Specialists, a designer of treatment systems, for an undisclosed sum.

Evoqua is more than a blind bet on water investing. Along with M&A, there are positives that should drive above-average earnings growth, including what RBC analyst Deane Dray calls a “highly differentiated outsourcing model.” Evoqua’s pay-by-the-gallon approach has made it the go-to treatment company for many industries. “Evoqua is building a highly profitable portfolio of outsource customers under five-year contracts with 95%-plus renewal rates that it can monitor digitally and optimize the servicing schedules,” Dray says.

As a small-cap, Evoqua’s earnings can be volatile, as its history shows. The company has missed quarterly earnings estimates nearly half of the time since it went public. Still, Evoqua is set to grow earnings at a 17% clip, compared with the 10% average annual per share earnings growth of the

S&P 500

index over the past five years, while sales are expected to hit $1.7 billion in three years, up 20% from $1.4 billion in 2020.

Growth like that comes at a price. Evoqua trades for 36 times estimated 2022 earnings of 91 cents a share, far higher than the S&P 500’s 21 times. Any solid growth stock trades at a premium, however, which is particularly true for one like Evoqua with growing market share in environmental, social, and governance–focused businesses.

Dray, for his part, has a Buy rating on Evoqua shares and a price target of $38, up more than 15% from Friday’s close. Even if the stock hit $38, Evoqua would remain a core holding for growth-oriented investors for years. “Scarcity value is a reality in the water technology sector,” says Dray. “There are simply few publicly traded companies in this space and a seemingly unquenchable investor demand.”

Write to Al Root at allen.root@dowjones.com

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