Water Fund Review April 2024

April Fool – A month full of surprises

After a strong start to the year with solid gains during the first quarter, April was a rough ride, especi­ally in fixed income markets. The reason was a sharp repri­cing of infla­tion and rate expec­ta­tions. When Jay Powell announced in December that the Federal Reserve planned to cut rates by 0.25% three times in 2024, investors inter­preted this as poten­ti­ally leading to six rate cuts. As the year progressed and infla­tion did not ease as much as expected, the market’s expec­ta­tions changed radically. In the course of April, discus­sions even arose about a possible interest rate hike. This concern took hold of people’s minds, so that the state­ment from the Fed was awaited with greater antici­pa­tion. It was a relief when Powell came out saying that “it’s unlikely that the next policy rate move will be a hike”. While it was by no means a prank, it certainly shows how radical market views can change. Having said that, it is astonis­hing that the stock markets have managed to digest everything reason­ably well. The S&P 500 for example was down only 3%.

The Tareno Global Water Solutions Fund posted a perfor­mance of ‑1.57% (W‑Euro Tranche) in April.

Our month in water – It’s all about earnings

The reporting calendar was quite busy, and while most results were in line with expec­ta­tions, there were some compa­nies that pleas­antly surprised with positive outcomes. While these compa­nies were rewarded with sometimes signi­fi­cant price jumps, less optimi­stic reports did result in some stock price declines. Here are a few examples:

• Gorman Rupp earnings missed consensus as they saw a large order from a customer delayed. The stock sold off by ‑14% on the news, which we view as overdone. Accor­ding to the manage­ment it is only a timing issue, the order will be shipped later in 2024. Apart from this order, they see no slowdown on the horizon. Gorman Rupp is a well-run player in the fluid handling space, where they are a leader in many niches. We decided to add to our position accor­dingly.
• O. Smith reported a 4% rise in sales of its water treat­ment products but lowered its full year forecast for this segment. Looking at water heaters (80% of sales), Manage­ment is convinced, that repla­ce­ment demand will remain robust and sales into new residen­tial construc­tion will improve. They took a cautious approach to China (30% of sales), as they face higher marke­ting cost to launch new products short term. We still view the company as a compel­ling growth story, despite the shares selling off by 5%.
• Badger Meter posted once again blow-out numbers as EPS were up 50% year-over-year. Manage­ment discussed robust order pacing and a strong bid pipeline indica­ting further adoption of smart water metering techno­logy across utili­ties in the US. The shares are up 20% since reporting, which brings their PE up to 48. While we very much like Badger Meter, we are aware of the fact that this business can be lumpy from one quarter to another. We decided to take half of our chips off the table.

Our European holdings did well in April, but one stock clearly stood out: Kemira.

Kemira is a supplier of water treat­ment chemicals to various industries. Earnings for Q1 2024 have clearly beaten estimates and manage­ment sounded convinced, that this does not seem to be an outlier. Demand has clearly improved into Q2 accor­ding to manage­ment. An import building block of their strategy was the divest­ment of their oil and gas business during the quarter, to enhance margins. The “Industry and Water” segment’s margin was up 340Bp exclu­ding the divest­ment. The market cheered the results and Kemira’s share price is up more than 20% since the report.

PFAS: The next big thing?

It made headlines in April: The U.S. Environ­mental Protec­tion Agency has estab­lished manda­tory drinking water standards for some of the most hazar­dous PFAS chemicals. Public health advocates have praised these regula­tions as “historic,” highlighting their signi­fi­cant role in enhan­cing the safety of the country’s water supply.

The agency’s action marks the first time in 27 years it has put in place new drinking water limits for conta­mi­nants, and the rules are part of the Biden administration’s broader effort to rein in PFAS pollu­tion.

While it is still early to call it a major driver for the water treat­ment industry, we found some positive comments from compa­nies positioned to thrive from PFAS related demand. Tetra Tech, a leader in environ­mental consul­ting and enginee­ring, expects a signi­fi­cant increase in PFAS-related work due to the regula­tory changes. Speci­fi­cally, they antici­pate that the annual PFAS-related revenues could double, driven by heigh­tened demand for their investi­ga­tive and consul­ting services in light of the new regula­tions.

Sell in May and go away?

I have to admit, the thought of taking some profits is tempting given the perfor­mance since the start of the year. The key question is if the April pattern will continue or whether the bullish momentum seen in Q1 will be back at the forefront. From my perspec­tive, under­lying dynamics remain supportive for the water industry. Most recent releases of business surveys do not point to a material slowdown. Yet, US valua­tions remain stret­ched, which puts kind of a cap on expec­ta­tions going forward. On the other hand, there are some very attrac­tive valua­tions to be found in Europe and Japan. In my view it makes sense to keep a balanced portfolio in terms of growth and value, with a solid diver­si­fi­ca­tion along geogra­phies and industries. As we repea­tedly point out: the water universe offers a wide range of oppor­tu­ni­ties stret­ching from defen­sive to cyclical names. To cut a long story short: Stay invested.

We seized oppor­tu­ni­ties to take some profit in names like Mueller Industries, Badger Meter and Kemira and invested on the other hand in Itron, a US supplier of water metering systems, the Italian utility ACEA and Georg Fischer, a Swiss supplier of plastic pipes to municipal and industrial clients.

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