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Innovative Water Management Products from Well-Managed Companies

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Parnassus Investments seeks to invest in companies that both have a positive impact on society and are poised to generate good returns for its clients. Water management is a key area where cutting-edge products offered by skillfully managed businesses can help solve environmental problems. In this brief paper, Todd Ahlsten, CIO, discusses water shortages and quality issues, and explains why the Parnassus investment team has invested in Xylem and Pentair, two companies that sell products designed to manage water more efficiently.

Water Challenges: Shortages, Waste and Quality

Global challenges are mounting in all areas of water management, from available supply and quality to distribution. Below are a few examples of the many water problems that require flexible solutions:

  • Global water demand is expected to exceed supply by 40% over the next 15 years, according to the United Nationsi.
  • Leaks from aging infrastructure result in an estimated loss of 2.1 trillion gallons, or about one-sixth of the total drinking water in the U.S. annuallyii, while developing countries lack the water infrastructure to support developmentiii.
  • Water and wastewater utilities in the U.S. release as much CO2 each year as that released by 10 million carsiv.
  • Climate change is projected to reduce water supplies due to heat and evaporation and to increased water quality problems attributed to flooding and rising sea levelsv.
  • Companies that both possess expertise in longstanding water infrastructure and offer the latest technologies have the potential to create innovative and meaningful solutions to these challenges while building successful businesses.

    The Relevancy of Xylem and Pentair: Tackling Water Problems with Modern Technology

    Two companies in the Parnassus portfolios help address complex and varied water problems like those highlighted above by enhancing water products with cutting edge software and analytics: Xylem and Pentair.

    Xylem is the world’s largest provider of water and wastewater treatment solutions. The company holds leading positions across the water transportation, treatment and testing segments, as well as in the industrial water and irrigation markets. Highlights of the firm’s applications include:

  • Water quality analysis and measurement systems, such as monitors for automated leak detection
  • Water treatment and purification products, including emergency treatment solutions for disease outbreaks and chemical contaminations
  • Water recycling systems that combine filters, energy saving pumps, mixers and treatment technologies
  • Pump station backup systems that can prevent sewer overflows
  • Intelligent sensors that provide early warnings of water quality degradation due to flooding and rapid drainage solutions
  • Pentair also offers compelling, cost-conscious water purification solutions, including filtration and desalination products designed to expand and improve the quality of the fresh water supply. Additional water-related products offered by Pentair include wastewater pumps, water-efficient irrigation systems and flow management valves and controls. These products aim to curtail water waste and sustain productive agriculture for the growing global population.

    The Business Cases for Xylem and Pentair

    Changing demographics and population growth, increasing energy demand, shifts in food consumption and water availability will be powerful trends driving growth over the coming decades. Given the industry’s secular tailwinds, we believe that the water industry offers long-term investment opportunities.

    In addition to the growing relevancy of their businesses, both Xylem and Pentair have the investment characteristics that we require for all our holdings, including sustainable competitive advantages, strong management teams, reasonable valuations and strong environmental, social and governance (ESG) profiles.

    We view Xylem’s portfolio of products as one of the strongest in the industry. The company has a sticky installed customer base, strong brand loyalty, technology leadership and a global reach. Their large installed customer base allows Xylem to sell higher-margin aftermarket products and services. This aftermarket business represents close to 40% of the company’s revenue and provides a predictable and stable source of revenue and income. We also believe CEO Patrick Decker, who joined Xylem with a background in lean manufacturing and Six Sigma continuous improvement processes, has shown that he has the right skills and experience to lead the company.

    Likewise, Pentair implemented lean techniques nearly a decade ago with the objective of reducing costs through operational efficiencies, supply chain management and cash flow management. We think that there is more upside to Pentair’s cost synergies target. As the company continues to exercise control over its margin-improvement trajectory, its operating margin will continue to improve, and the company will depend less on volume growth to drive earnings growth.

    Incumbency and Innovation

    Xylem and Pentair bring together the heritage of deep industry experience and new tech-rich solutions to build smarter infrastructure, drive energy efficiency and improve the quality and quantity of usable water. Their management teams know how to grow businesses while contributing to positive change in society. As leaders in the water industry, their technologies provide solid competitive advantages, and their visions target solutions to key generational water themes that touch all segments of society.

    ahlsten signature
    Todd C. Ahlsten
    Parnassus Investments Chief Investment Officer
    Lead Portfolio Manager - Parnassus Core Equity Fund

    iMis, Magdalena, “’Business as usual’ will create a thirsty planet in 15 years, says UN,” March 20, 2015. http://in.reuters.com/article/environment-water-idINKBN0MG0B620150320
    iiSchaper, David, “As Infrastructure Crumbles, Trillions Of Gallons Of Water Lost,” October 29, 2014. http://www.npr.org/2014/10/29/359875321/as-infrastructure-crumbles-trillions-of-gallons-of-water-lost
    iii“World Water Council and OECD call for global action on financing water infrastructure,” April 13, 2015. http://www.worldwatercouncil.org/news/news-single/article/world-water-council-and-oecd-call-for-global-action-on-financing-water-infrastructure/
    iv“Water Efficiency Saves Energy: Reducing Global Warming Pollution Through Water Use Strategies,” March 2009. https://www.nrdc.org/sites/default/files/energywater.pdf
    iv“Climate Impacts on Water Resources,” U.S. Environmental Protection Agency website, accessed August 26, 2016. https://www3.epa.gov/climatechange/impacts/water.html
    viXylem Investor Briefing, August 2016, page 7.

    As of September 30, 2016, Xylem Inc. represented 2.7% of the Parnassus Core Equity Fund and 2.9% of the Parnassus Mid Cap Fund TNA.

    As of September 30, 2016, Pentair Ltd. represented 3.1% of the Parnassus Fund, 3.1% of the Parnassus Core Equity Fund and 3.4% of the Parnassus Mid Cap Fund TNA.

    The views expressed in The Parnassus View are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or the Parnassus Funds. Investment return and principal value will fluctuate, so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Any specific securities discussed may or may not be current or future holdings of the Funds.