The pain in Spain is not about the rain
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In the past month, Spain has overtaken Greece, Ireland and Italy as the latest European debt victim dragging down world markets.
Even previously invincible Germany has been tainted, as Moody’s downgraded its German debt outlook to “negative” in late July, anticipating how much it may cost Germany to bail out its more feeble neighbors. Spain has already slipped back into recession, and its economy is expected to shrink further this year.
My family holiday this summer was a road trip in southern Spain, doing our part to bolster the local economy. Yes, it was hot, with nary a drop of rain, as expected in one of the desalination capitals of the world. But tapas and striking coal miners aside, the most striking thing about Spain was the roads. They are fantastic – beautiful new highways to not much of anywhere, tracking beside seemingly adequate older roads, both lightly traveled. By many accounts, Spain poorly planned and carelessly overbuilt dozens of major infrastructure projects on cheap credit in the past decade. Now, thanks to the interconnectedness of the global economy, we’re all paying the price for its debt overload – not dissimilar to our own real estate bust.
Smarter versus more
The Spanish lesson, I’d argue, is not that the U.S. shouldn’t spend more on infrastructure – heaven knows our water and sewer pipes are quietly crumbling beneath our feet – but that we have to spend smarter. It’s clear that the U.S. can’t afford a big infrastructure spending spree either, despite the proponents who argue that this could resolve our jobs problem as well as the “D” grades for American infrastructure that the engineers hand out by rote every year. Spain, by the way, has the highest unemployment rate in the EU – a shocking 24 percent.
It’s high time for the water industry to stop whining about lack of money and start working on new business models that will be economically as well as environmentally sustainable. More surely than the “Field of Dreams,” this is a case of if we build it (cost-efficient projects with value-driven pricing structures), they (the project finance community) will come. In fact, this conversation is beginning in many quarters: it will be a key focus of the American Water Summit in November.
Along these lines, Bayonne, N.J.’s newly announced 40-year water and sewer concession agreement with United Water and KKR – under which the city will receive a $150 million upfront payment – will be closely watched. We expect the usual naysaying among the anti-private sector set, who will righteously protest the 8.5-percent rate increase included in the contract. Of course, this is the city’s first rate increase since 2006.
Early quarterly earnings indicators
As second quarter earnings season gets underway, investors will have a chance to focus on other things besides Euro-angst. In the U.S., manufacturing activity is weakening amid “fiscal cliff” fears (the precipitous effect of $600 billion or so in tax increases and spending cuts on tap if Congress and the White House fail to compromise by year-end).
Thus far, U.S. equity markets have held up better than their European or emerging market counterparts – the declining empire still the ultimate safe haven – but U.S. markets have also started to give up their recent gains in a new fit of nervousness. The S&P 500 index is now up about 5 percent year to date, versus the 10 percent gain it sported back in April.
One bright spot is that the moribund housing market is finally showing signs of life. Housing starts in June were up 7 percent from May levels and up 24 percent from June 2011, at the highest level since October 2008, though still far below peak – or even historically normal – levels. New home sales fell in June, however, suggesting we’re not yet out of the woods.
Nevertheless, we may finally be seeing some improving demand in municipal water markets, which benefit from residential expansion. Pentair, one of the early reporting companies in the water sector, said on its quarterly conference call that while it is not quite prepared to call a bottom in the muni market, which makes up about 10 percent of its overall sales, it is seeing “signs of stabilization and an increase in quoting activity […] which may signal a return to more normal demand.” CEO Randy Hogan did note that this is still a “break and fix world”; municipalities are starting to deal with their backlog of deferred maintenance projects because they have to, while remaining cautious about taking on new capital spending.
In the end, getting back to pain and rain, the worst-in-50-years drought we’ve experienced in the U.S. this summer, along with dry conditions in other parts of the world, may become the more important driver for the water industry. Amid climate volatility, farmers, though hurting and hunkered down now, will increasingly need to invest in effective water management. Pentair said its agriculture business, though small, was its fastest growing segment in the first half of 2012, up 17 percent.
Debra G. Coy is a principal with Svanda & Coy Consulting, which serves customers in the water sector. She launched her independent consulting practice in 2010 after 20 years covering the water and environmental sectors for Wall Street firms such as Janney Montgomery Scott, Schwab Capital Markets and HSBC Securities.