Will the housing market bring the water sector back from the brink?

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The U.S. housing market appears to be bouncing back after years of lethargy. New

New housing starts in June were up 24 percent over the same time last year. According to Zillow Inc., home values increased year-over-year in June for the first time since 2007. Home values also jumped 2 percent between the first and second quarters of 2012.

This is hardly a reason for the municipal water sector to pop the cork on the champagne bottle. As Zillow chief economist Stan Humphries noted in a Fox Business interview, this is merely a sign that the housing market is turning the corner. When a market has hit rock bottom, there is no place else to go but up. Pentair CEO Randy Hogan said in his company’s 2QFY2012 conference call that although there are signs demand is creeping up in the municipal water sector, that market hasn’t quite reached its floor.

Still, there is evidence in the water sector that these economic green shoots are more than just a mirage. Mueller Water Products is currently riding a wave of optimism characterized by analysts’ expectations that its stock price, which has hovered well below $4 since last year, will soon surpass $5. Much of that has to do with the sale of U.S. Pipe and a sweet metering deal with American Water, but any turnaround in the housing market will almost surely feed its momentum.

A boom in residential construction alone won’t save water equipment stocks – just ask any of the publicly quoted industrials with significant exposure to Europe and its economic woes. In its monthly water report for July, Wedbush Securities expressed concern about how uncertainty in Europe will impact the future earnings of Watts Water Technologies, Xylem and Pentair. Wedbush revised downward its earnings per share estimates for the latter two based on the declining euro and asserted that European sluggishness could offset any gains made by Pentair from the modest recovery in the U.S. housing market.

Nevertheless, new houses mean new water connections. If municipalities see marked increases in their ratepayer bases, perhaps they won’t be shy about raising water and wastewater tariffs to fund projects that are evidently still being undertaken on an as-needed basis. Spreading rate increases over a broader base of customers means a municipality can potentially propose tariffs that are easier to swallow. Our 2012 tariff survey, to be published in next month’s magazine, will reveal if U.S. cities are going forward or backward with regard to water and wastewater rates. The revenue advantage from a more robust housing market can also make investing in water even more attractive to private equity than it already seems to be – more than a dozen investment firms appear ready to open their checkbooks to Nassau County, N.Y.