FIW ETF: Because The Planet Is Running Out Of Potable Water

The First Trust Water ETF (NYSEARCA:FIW) tracks the ISE Clean Edge Water Index and is an excellent way for investors to benefit from the growing global crisis: the lack of potable water. And for those who think the “water challenge” is only a “third-world problem”, as the photograph above of Lake Powell shows – it is a growing and severe problem here in the United States as well. Indeed, lakes Powell & Mead, the primary downstream storage reservoirs for the Colorado River, are at record lows. Indeed, as a result of a 20+ year-long drought in the western U.S., water cuts are in the short- and long-term future of major cities like Los Angeles, Las Vegas, and Phoenix, as well as for farmers on Colorado’s West Slope, California’s Imperial Valley, and in Arizona. The FIW ETF holds companies that generate the majority of their revenue from providing water solutions: water testing, treatment, infrastructure, pumps, utilities, distribution, and purification and filtration. While the fund is down 11% over the past year, it has a relatively strong 10-year average annual return of 12.6%:

Investment Thesis

The investment thesis here is relatively obvious and straightforward as UNICEF reports:

Going forward, the FIW ETF is well-positioned to address these growing problems by investing in companies that will help the planet mitigate the negative impact on potable water supplies due to global warming, population growth, and pollution. In addition, these companies should also be beneficiaries of the Biden Administration’s Bipartisan Infrastructure Law:

The Bipartisan Infrastructure Law will invest $55 billion to expand access to clean drinking water for households, businesses, schools, and child care centers all across the country.

That being the case, let’s take a look.

Top 10 Holdings

The top 10 holdings in the FIW ETF are shown below and were taken directly from the First Trust Water ETF homepage, where you can find more information on the fund. The fund is composed of 36 companies, and the top 10 equate to what I consider to be a moderately diversified 42% of the entire portfolio:

The #1 holding with a 5% weight is IDEXX Laboratories (IDXX). IDEXX has had a rough bear market (-18.5% over the past year) yet still trades with a forward P/E = 56.6x per Seeking Alpha. IDEXX’s Q3 was a beat, but the mid-point of full-year guidance was lowered to $7.81 from a previous $7.91 and a consensus of $7.95.

IDEXX Labs designs, develops, manufactures, and distributes water-testing products that test for various microbiological contaminants.

Not to be confused with IDEXX is Ideanomics (IDEX), which is the #3 holding with a 4.5% weight. Ideanomics crashed and burned in 2022 (-85%). Q3 revenue of $24.28 million was -8.7% YoY. Ideanomics describes itself as “a global company focused on accelerating the commercial adoption of electric vehicles”, which makes me wonder why it is in the FIW Water ETF unless by a tangential relationship (i.e., EVs will cut down on global warming and therefore help mitigate the potable water crisis).

IDEX helps support EV fleets by providing energy services and infrastructure for EVs: charging systems, energy storage, and energy generation, including hydrogen and solar, and associated data and management applications. IDEX also offers high-power inductive charging solutions for heavy-duty EVs and manufactures and distributes electric-powered tractors. The company also makes and sells hydrogen fuel cells and power electronics for electric, hydrogen, and hybrid-powered vehicles.

Roper Technologies (ROP) stock has been flat over the past year and is the #5 holding with a 4.3% stake. Roper designs and sells software and engineering solutions including dispensers and metering pumps, control valves, water meters, optical and electromagnetic measurement systems, as well as automated leak detection equipment.

Roper’s Q3 was a strong beat on both the top and bottom lines: revenue of $1.35 billion (+9.8% YoY) beat by $40 million and non-GAAP EPS of $3.67 was a $0.22/share beat. The company raised the midpoint of full-year EPS to $14.11 (vs consensus of $13.81) and the midpoint of Q4 adjusted EPS to $3.74, $0.07 above consensus.

American Water Works (AWK) is the #6 holding with a 4.1% weight, as I pointed out in a previous Seeking Alpha article, AWK Was Down 18% In 2022, But Is Still Richly Valued. That said, the company operates a high-quality business model that generates stable cash flow that enables the company to use free cash flow in order to grow its customer base via acquisitions.

The #10 holding is Danaher (DHR) with a 3.2% weight. DHR operates through three segments: Life Sciences, Diagnostics, and Environmental & Applied Solutions. The company makes instruments and water treatment-related equipment such as filtration, separation, and purification technologies. The stock is down 14.5% over the past year and currently trades with a forward P/E = 24x. A Seeking Alpha post last month reported that Danaher is the #2 favorite stock among large mutual and hedge fund managers.

The FIW ETF’s sub-sector allocation is shown below:

Despite the large allocation to Industrials & Utilities, FIW’s TTM distribution rate was only 0.58%. That being the case, the investment opportunity here is capital appreciation, not income.

Meantime, I noticed that the overall quality of the top 10 holdings appears to have arguably taken a step-down since my last Seeking Alpha coverage of the ETF (see here). I say that because Essential Utilities (WTRG) was the #1 holding, now is not even in the top 10, arguably to make room for IDEX, which I am less than impressed with. Big-cap Ecolab (ECL), a favorite of Bill Gates (at one time, the biggest holding in his foundation), is also no longer in FIW’s top 10 holdings.

Performance

As mentioned earlier, despite the 2022 bear market, FIW has an admirable long-term performance track record:

The graphic below compares FIW’s 5-year total returns with two competitors: Calvert Global Water Fund A (CFWAX) and the Virtus Duff & Phelps Water Fund (AWTAX):

As you can see, FIW is the class of the group. One likely reason is that FIW’s expense ratio (0.53%) is significantly less than either competitor (1.24% and 1.22%, respectively).

Risks

The expense fee, although much less than its peers, is still high enough to wipe out the little income the fund does provide.

Meantime, and despite the big downturn last year with a TTM P/E = 26x, the fund is still arguably and relatively highly valued as compared to the S&P 500 (20.4x):

However, much of that is likely due to the relatively clear line-of-sight investors have into considerable funding coming down the pike due to the Bipartisan Infrastructure Act mentioned earlier.

Summary & Conclusion

While I am a shareholder in the FIW ETF, after reading about IDEX – which is now the #3 holding in the fund (even as higher-quality companies like Ecolab and Essential Utilities exited the top10) – I am beginning to wonder why. It appears as though the portfolio has taken an overall downward path in terms of quality. That said, FIW still gets a 5-star rating from Morningstar, so perhaps the fund manager knows something about IDEX I don’t. I guess I will hold my FIW shares a bit longer… but if its performance doesn’t improve over the next quarter or so, I am tempted to just sell it and move the proceeds into my other utility related holding – the SPDR Utilities ETF (XLU). XLU is also on the receiving end of Infrastructure spending but has a significantly lower expense fee (0.10%) and a significantly higher yield (2.9%).

I’ll end with a 5-year total return comparison of FIW to XLU:

Note, the Water ETF beat-out the Electric/Gas Utility ETF by ~8%.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.