Precious Fluids (cont.)
“Probably the biggest barrier to privatization in the U.S. is politics,” bluntly states Coy. “Local politicians fear losing control and the loss of jobs.” Long-standing relationships between local officials and suppliers is also a factor. So is the grip that labor unions have on many of the systems. In some instances where companies have succeeded in persuading municipalities to sell, the companies have had to-avoid layoffs and instead reduce jobs through attrition.

American Water Works ran into unexpectedly sharp opposition when it sought last year to acquire the Santa Margarita Water District in Orange County, Calif., for $300 million, and had to back away. George Johnstone of American Water Works concedes that the pace of privatization has been frustratingly slow, but he flatly predicts, “It will happen.”

Maintenance Contracts
One area where private companies are making headway is in getting contracts to operate and maintain municipal water systems. For one thing, there are fewer legal barriers than there would be if a private company acquired a municipality’s water system. Most of the publicly traded water companies are increasingly involved in such contracts, and they view the deals as a nice source of added revenues. A problem for the U.S. companies, though, has been the entry of French and British companies. In some instances, the foreigners are accused of cutting their bid prices below cost just to win operating contracts from cities and towns.

While gas and electric utility stocks generally have performed poorly this year as interest rates have climbed, the Edward Jones Index of 15 water utilities has shown at least a slight gain in total return through the end of July, while the Standard & Poor's utility index has dipped.

Many of the publicly traded water companies expect modest earnings gains this year, yet they manage to command price-to-earnings multiples in the mid-teens, in part because they are the only natural monopolies still in existence in the U.S.

From a regulatory standpoint, the experience of water utilities has been less contentious than that of the electric utilities. Consumers seldom squawk about increased water rates, it seems. Increases in rates, granted by rate-setting commissions, have come through on a fairly predictable timetable.

The publicly traded water outfits are comparatively small in terms of stock-market value, so institutional investors haven't been big players. But enthusiasm for the shares seems to be on the increase. Clearly the favorite is American Water Works, partly because of its size, but also because of a strategy aimed at significant growth through acquisitions, along with an annually increasing flow of dividends for 21 consecutive years. The shares boast a dividend yield just under 4%, and they have had an average annual rate of return of 24% the past five years. The company rates a number of buy recommendations, including those of Edward Jones, A.G. Edwards and PaineWebber.

Water shares could get an added boost if electric utilities decide to buy into the water business. At least three utilities, Edison International, Southern Co. and Northern States Power, are reported to have looked into the possibility. Southern Co. publicly has acknowledged as much. At least one, Minnesota Power & Light Co., has owned a water utility for some time.

American Water Works would be an obvious target if an electric utility desired to get into the business, owing partly to its size, with annual revenues of around $900 million. Though he says nothing is imminent, Johnstone of American Water Works sees the possibility someday of electric or other utilities joining with a company like American in a venture to run water systems, It might take that kind of added financial firepower if the time comes when a major city decides to privatize its water system and American decides to buy a major stake or nab the operating contract. As the big privatizations begin to occur, investors in today’s acquisitive water companies are likely to feel refreshed.