TheChek News Flow

Think the real-estate market is in for a price cut? The biggest one could still come to Zillow’s stock

U.S. home seekers are desperately eyeing an expected turn in housing prices, but the best near-term deal in real estate could come from yet another price cut to Zillow’s Z -4.73% stock.

Having lost two-thirds of its value over the past 12 months on the heels of its home-flipping implosion, Zillow Group has already fallen to a market capitalization of barely $8 billion, despite the fact that virtually every U.S. adult is still “surfing” its namesake site monthly. Zillow might continue to draw a crowd, but that won’t earn a business model based on transactions much money.

More pain is likely coming. On its second-quarter conference call, even Chief Executive Rich Barton, known for his upbeat, colorful divinations, described the housing market as undergoing a “rebalancing.” In July, sales of new single-family homes fell nearly 30% on an annual basis and nearly 13% versus June. New home inventory has ballooned to the highest level in more than a decade. Zillow now expects transactions to “meaningfully contract” as inventory rises this year.

In perhaps the biggest sign that Zillow isn’t expecting a miraculous recovery in the near-term, Mr. Barton said he launched an employee-retention plan this month, including an off-cycle grant of restricted stock units to employees—ultimately accepting an expected 2% dilution over a few years in an attempt to ensure his top talent doesn’t flee over lower compensation, much of which is often based on equity value.

Yet Wall Street might not have fully digested this warning sign. Analysts’ third-quarter sales estimates for Zillow’s agent ads business (its largest) have come down by an average of just 12% since the company’s second-quarter report. On average, those estimates are still 7% above the midpoint of Zillow’s guidance.

Perhaps investors should take Zillow at its word. You might think fewer potential transactions would have agents upping their ad spending to compete for the smaller number of buyers there. But it seems that isn’t the case: Chief Financial Officer Allen Parker candidly said on the second-quarter call earlier this month that in a quickly declining macroeconomic environment, agent ad spending tends to slow down as buyer demand wanes. Importantly, he also said the slowdown in spending on Zillow’s platform tends to lead the market’s transaction declines, implying Zillow could see outsize weakness sooner rather than later.

Zillow’s agents don’t pay for idle eyeballs; they pay for motivated leads. A decline in their platform spending would suggest that, at least when the chips are down, they don’t feel like they are getting enough of those leads yet from Zillow. That might help to explain why 234 million people surf Zillow’s apps and sites monthly (a figure equivalent to over 90% of U.S. adults), but Zillow monetizes only 3% of U.S. real-estate transactions.

Longer-term, this will probably improve. Its new partnership with automated home-flipping market leader Opendoor OPEN -4.16% means Zillow will collect a referral fee when its users choose to sell directly to Opendoor. But the bigger hope is that those whom Opendoor turns down, or who decide to sell the traditional way, can be fed as quality leads to Zillow’s so-called “Premier Agents.” It also brings to the platform home sellers it can try to monetize on a subsequent home purchase, via adjacent services like mortgages, title and escrow.

Getting into bed with the company that just last year was its rival in iBuying had to be hard for Zillow, given its own failure in that business. So its decision to pursue a partnership despite that underscores Zillow’s belief in the scope of the opportunity on the seller side of transactions for its own platform.

Zillow wants to evolve from America’s favorite pastime to its best-paid quarterback on both sides of the real-estate game. The fact that its mobile app has over three times the number of monthly active users as its closest competitor means that, if anyone can do it, Zillow probably can.

On the eve of the U.S. Open, a conversation with the famously stormy NYC tennis legend, the subject of a new Showtime documentary

No tennis player is more closely associated with New York City than John McEnroe, the brilliant if volatile lefty who won his hometown U.S. Open four times and continues to cover it as a TV analyst. Next weekend (Sept. 2 for streaming, Sept. 4 on-air) Showtime premieres “McEnroe,” a fresh look at the 63-year-old’s singular impact on tennis and pop culture. This conversation has been edited and condensed for clarity.

This appears to be Serena Williams’s last U.S. Open. How do you think she’ll be remembered in tennis?

She’ll be remembered most for how great a tennis player she is. She’s up there with Michael Jordan. She’s like the ‘GOAT of GOAT’ type, like Tom Brady, Billie Jean King…to some degree Muhammad Ali. Muhammad Ali’s probably the top of all of them, but right below that are the Wayne Gretzkys of the world, Michael Jordan, LeBron James…She’s there. That’s quite an exalted area. It’s air that even champions don’t even feel.

To me, she’s the greatest female athlete in the history of any sport. Hopefully she’ll continue to be inspirational for young kids growing up, particularly kids of color, to get into the sport, because let’s face it: This story comes along once every hundred years, her and Venus. Hopefully we can narrow that down so it could happen more often.

Is it true that Donald Trump offered you a million bucks to play her?

It is true. I can’t remember the exact year, but [Serena and Venus] were coming up. [Trump] used to have that box right next to the booth. I got a letter offering me to play either one of them. Then it was like, “What’s your response [to the offer]?” I go, “Well, that’s a good start.”

Novak Djokovic won’t play the Open because of current U.S. rules stating he cannot enter the country as an unvaccinated non-citizen traveler. What is your opinion on that?

It’s a joke. It’s sad. It’s just really unfortunate that it’s come to this. Personally, as I’ve said, I would’ve gotten the vaccine, but maybe that’s why I have seven, and Novak’s got 21, because he sticks to his guns and that’s fueled him in ways that most people can’t even imagine.

Look: He got thrown out of Australia. He could have won that, obviously. He could be in a different situation. Then you take one [major] away from Rafa, or maybe two, because I’m sure [bouncing back from Australia] took three months. You could tell his head wasn’t right. Physically, it took him to Wimbledon where he was all the way back, and now he goes through this again. It’s really a shame.

I don’t get what the problem is if you say he’s willing to take a test every day, for example. I mean, it’s really too bad.

In this new documentary, one thing that comes across is that despite the family support you had early on, you were tackling a lot of this alone. How different would tennis have been for you, do you think, had you been coming up today?

Difficult to say. It seems like pretty much all the top players have some type of team around them. A lot of times it includes family. Look: I love my parents, but as I was growing older, I didn’t necessarily want to be around them all the time. I preferred being a one-man entourage, more or less. Now, with the stakes being so much higher financially, for example, and the scrutiny in sports, you always want to reach as close to your peak as you can. I think as time has gone on, the methods to do that, obviously, and recovery, preparation, all that stuff, has changed. I think on some level I would’ve been doing myself a disservice had I not made more of an effort to do that.

Sometimes I do think: What would I have done? What would I do now in order to maximize my potential?

There’s dialogue in the film about the mental component of tennis. When you see the mental-health conversation happening today among players, whether it’s Naomi Osaka, or Andy Murray, or Nick Kyrgios, does it change your perspective about the way that players in your time cycled in and out of the game, like Borg leaving at 26?

My buddy Bjorn Borg is a perfect example of someone that was going through something. You could call it sort of that mental-health thing. That has come more to the forefront, particularly with the pandemic. Then Naomi Osaka obviously started things off, to a degree, but this is something that has been going on for a long time. I think it’s important that this topic becomes more open–obviously it needs to be.

Random, but for the tennis nuts out there: On your old Maxply, how did you prefer to have it strung?

You’re talking about my wood racquet, right?

Yeah.

Funnily enough, it’s sort of similar to the synthetic gut that people are using. Looser strings. It’s that trampoline effect–that’s what a lot of players use now, because otherwise their shoulders would fall off. I like that sort of redirect, use-the-opponent’s-power. I wasn’t looking like Rafael Nadal, so I had to try to generate power and throw people off and make people think it’s coming quicker than it was, with looser strings. Generally I’d say high 40’s [tension]. Sometimes lower if it was at Wimbledon, because the balls may be a little heavier.

What do you think of potential rule changes, whether it’s people talking about no-lets, no-ad scoring, or even technological changes? One thing that sticks out from watching your matches is the net play. In a lot of cases, the racquet, the surface dictated playing style. There are ways to engineer the game–should tech options, surface options be considered?

Absolutely. It’s like watching a boxing match. If both guys are counterpunchers, it could be a little boring, so it’s nice to have contrast.

Look at this Maxime Cressy. He’s 30th in the world. They’re like, “Oh, my God, a serve/volleyer? A guy that actually does that?” He’s doing it pretty well. If the courts are quick, for example, that’s going to favor a guy or a girl who knows what the hell they’re doing at net.

That’s what Wimbledon did 20 years ago. Just think about this. You went through this period with Pete [Sampras] and Goran [Ivanisevic] and Boris [Becker], and then you saw this great match, [Patrick] Rafter-Ivanisevic. It went [9-7] in the fifth. Both players served and volleyed every point, first and second serve. The next year, [Lleyton] Hewitt plays [David] Nalbandian in the final. Neither one of them served and volleyed. I sat there, I couldn’t believe what I was watching. Now you watch Wimbledon, and I think the serve/volley percentage is like 10%, or 15% on the men’s side. It’s a drastic change.

I don’t think you should have a warm-up. These guys go in the locker room, they’re breaking a sweat, they’re on a bike. I mean, fighters go in the ring. Just think of a fighter going in a ring, and someone’s going to try to take their head off the first punch, potentially. It’s not like the first game of a tennis match, you’re going to have your head taken off. To me that would be more exciting, to have, “Ladies and gentlemen, Rafael Nadal! Then the other guy. Then you play. There are certainly things we should try to do to improve it.

Makers of cars, buildings, and bottles all use lots of glass, and are stockpiling and taking other measures to prevent shortages

BERLIN—European businesses as diverse as car makers, bottle manufacturers and skyscraper builders—not to mention artisanal glassblowers—are preparing for a possible glass shortage if the loss of Russian gas throttles production.

As Moscow reduces natural-gas exports to Europe in its face-off with the West over Ukraine, European governments have made contingency plans to encourage conservation and ration gas among energy-intensive industries should supplies run short. Glass production has become a key vulnerability. It requires melting sand, soda ash and limestone, and in Europe the energy to create the needed temperatures has largely come from Russian gas.

Glass is so ubiquitous—from windows, car windshields, computer and smartphone screens to bottles that hold medicine, soft drinks and liquor—that some business executives and industry analysts fear a serious shortage could result in another supply-chain disruption like those set off by the pandemic, post-lockdown demand and the war in Ukraine.

Russia’s “shutting off gas for Germany would cause a new parts-shortage crisis,” Silja Pieh, head of strategy at luxury car maker Audi AG, said recently, citing glass as a prime example.

The European Commission, the European Union’s executive, included glass manufacturing in July on its list of industries to be given priority if gas is rationed this winter. Companies in industries that rely heavily on glass have been stockpiling, sometimes at high cost.

German car giant Volkswagen AG , whose brands include Audi and Porsche, said it is increasing its inventory of components that use glass, such as windows and windshields, and tapping suppliers outside Europe not affected by the gas crisis.

The European beer industry is also feeling the pressure. Some bottle suppliers, including at least two that operated in Ukraine, were forced to close plants and limit production. Others have begun to increase prices.

With its cost of glass up by as much as 90%, German beer maker Brauerei C. & A. Veltins may have to raise prices next year, said spokesman Ulrich Biene. The company, which normally has bottles delivered as needed throughout the year, bought an entire year’s supply at once, he said—50 million bottles—and rented additional storage space.

In the U.K., doorstep delivery service Milk & More is attempting to extend the average lifespan of its glass bottles to about 30 deliveries from 25, Chief Executive Patrick Müller said. The company is adding coating to containers, lubricant to factory machinery, and scanners that pinpoint when bottles are damaged.

Milk & More’s goal is to buy 500,000 fewer milk bottles a year, a reduction of about 14%. “For me, the No. 1 priority of the industry is to offset costs,” Mr. Müller said.

For glassmakers, the pressure of gas-supply uncertainty is compounded by the fact that they can’t shut down quickly.

“You can’t just turn the machines off,” says Bertrand Cazes, secretary-general of the Glass Alliance, a lobby group. The hot, liquid glass would cool and harden, breaking the equipment.

On the Venetian island of Murano, a glassmaking hub since the 13th century, glassblowers have cut production of large sculptures, vases and chandeliers as gas prices have risen as much as 900% in the past year, said Luciano Gambaro, president of the Consorzio Promovetro Murano, a trade group.

The costs pose a new threat to a Murano glassmaking tradition that already has been contracting for more than a decade, said Gianluca Seguso, co-owner and president of manufacturer Seguso Vetri d’Arte. The company has begun periodically shutting down its factory for six weeks at a time, planned stoppages that allow the ovens to slowly cool and then gradually reheat.

To make up for lost production, he said, the 15 or so artisans crafting lamps, goblets and the like now work 10% or 20% more on days when the ovens are operating.

“Any change comes with pain,” said Mr. Seguso.

Before the gas shortage, some glassmakers were making plans to shift to green hydrogen or electricity from renewable sources to reduce their carbon emissions. But those long-term plans won’t mitigate the present crisis.

Some glassmakers are shifting from gas to oil or diesel. Since Russia invaded Ukraine this spring, O-I Glass Inc., a Perrysburg, Ohio-based maker of bottles and jars that operates 34 factories in the EU, has converted furnaces accounting for about 20% of its total European production capacity to run on oil.

“We expect to have up to 50% by year-end, and that is going to provide a very good protection for us to be able to have enough capacity to run without a problem to serve our demand,” Chief Executive Andres Alberto Lopez told investors on a conference call earlier this month.

Saint-Gobain SA, which makes glass and other materials for the auto and construction industries, said earlier this year that factories in Germany, Poland and the Czech Republic are curbing energy use and giving priority to glass over other products in the event of further cuts to gas supplies.

Some larger manufacturers are also considering transferring part of their production to regions where gas prices are lower. Schott AG, a big German specialty glassmaker, is investing €40 million, equivalent to $39.9 million, in a new plant in Turkey.

“The expansion makes it possible to ensure the long-term production of pharmaceutical glass for the German and European pharmaceutical industry,” said Schott CEO Frank Heinricht. At the same time, Schott says it is stockpiling propane as an alternative to natural gas and building an underground propane-storage facility for its German plants.

Plus, China’s grand football plan is in trouble, Tiger Woods swings back at Saudi golf, and much more

Having scored a couple of goals in my midweek game of football, I had a thought to ring a couple of agents to find myself a club before the close of the transfer window on Thursday. After all, English Premier League clubs have already broken their gross spend record, with a minimum of £1.5bn already committed to buying players, according to Deloitte’s Sports Business Group.

It raises the question of whether clubs are spending lavishly without giving any thought to the return on investment. Agents are quick to point out that plenty of players are failing to live up to the fee.

Perhaps this summer of transfer madness will be the subject of an eventual ESPN documentary . . . The question is whether it’ll still be part of Disney once activist investor Daniel Loeb is done. That corporate battle has big implications for sport, as you’ll find out below. Further on, we have a special dispatch from FT South China correspondent Primrose Riordan on the crisis in Chinese football. Do read on — Samuel Agini, sports business reporter

Once again, it’s Dan versus Disney.

Earlier this month, the activist investor Daniel Loeb took a $1bn stake in the entertainment conglomerate, according to a person familiar with the investment, reinvesting in Disney for the second time in as many years but now pushing for stark changes at the company. They include a shake-up of the board and cost-cutting throughout the business, as well as a potential spin-off of the company’s cable sports network ESPN.

It’s a topic that has percolated throughout Disney, and within the sports world at large, for some time. On the surface, the maths are tempting: Disney’s linear television networks yield margins of 30 per cent with operating profit of $8.4bn last year. ESPN has rights to nearly all of the top sporting events in the US, from the National Football League to the National Basketball Association to Major League Baseball to the college American football playoffs, golf, and more. Viewers are increasingly following ESPN’s sports content from its linear cable channel to its streaming product, ESPN+.

It’s for these reasons that Loeb’s Third Point believes ESPN could be an enticing standalone business. Doing so could help alleviate Disney’s $46bn debt pile. Shares have fallen 25 per cent so far this year, in part because of the increasingly competitive market for streaming which has forced Disney and competitors like Warner Bros Discovery and Netflix to rethink their approach.

But within the sports world, simply spinning off ESPN is a thorny proposition. Its value is intrinsically tied to the volume of sports rights it holds, and in recent years, leagues have held all the leverage in negotiating substantially more valuable broadcast rights agreements. In the past two years alone, US rights packages for the NFL and the Uefa Champions League have more than doubled in value. Rights for Major League Soccer and Indian Premier League have fetched record sums, while enlisting emerging media partners like Apple and, in the IPL’s case, selling streaming privileges to a start-up joint venture over incumbent Disney.

Media analysts MoffettNathan wrote it seems “financially dangerous” to divest ESPN, in part because consumer cord-cutting continues apace. Another external factor is the ongoing shake-up in US college sports: realignment of popular football- and basketball-playing universities into new conferences has led to the renegotiation of broadcast rights, as the new Big Ten deal, inked last week with CBS, Comcast’s NBC and Fox and worth $7.5bn over seven years, shows.

Loeb, for his part, has long been known as a particularly shrewd activist. In a 2013 campaign against Sotheby’s, Loeb wrote that the auction house was akin to “an old master painting in desperate need of restoration”. His tactics thus far with Disney have been softer in tone: praising the company’s trajectory and emphasising Third Point’s “confidence” in the business as the reason for his investment. Disney pushed back against Loeb’s prompt for a board refresh but said it welcomes “the views of all our investors”.

The investment case for J.D. Wetherspoon hinges on whether you believe Brits will rekindle their love affair with pubs and return in significant numbers to consume food and drink.

The London-listed group, which owns about 850 pubs and inns, and 60 hotels, is one of the largest behind Stonegate and Mitchells & Butlers , and shares (ticker: JDW.United Kingdom) have suffered from pandemic induced lockdowns. More recently, high inflation has made customers think twice before going out.

Spoons, as it is affectionately known, has issued a string of profit warnings citing rising costs. Fierce competition from grocery stores selling cut price alcohol, and older customers staying home for fear of catching Covid have not helped.

The stock has slumped 51% to 5.51 pounds sterling ($6.49) over the past 12 months, which presents an excellent buying opportunity. The company’s fundamentals that set it apart from rivals—it has a niche selling inexpensive pints of beer in unfussy venues—remain solid. Value conscious consumers are sure to find this approach attractive.

Wetherspoon is also in good shape to weather an inflationary storm. Harishankar Ramamoorthy, an analyst at Deutsche Bank, wrote in a note that if inflation is prolonged, pubs will need to increase prices. “Given its value offering, [Wetherspoon] would have more scope to flex prices, as peers also put through increases at their ends.” He estimates the shares could increase 33% to £7.35.

The business will also benefit from its strategy of owning larger pubs rather than a collection of smaller ones; that will provide savings in rent and labor. For instance, its Royal Victoria Pavilion, in Ramsgate, Kent, can hold about 1,550 customers. Wetherspoon also locked in energy prices with suppliers until 2023, which will reduce its electricity costs.

In the U.K. the number of pubs has shrunk from 61,000 in 1993 to about 46,800 now. Alex Chatterton, an analyst at broker Panmure Gordon, calculates that the number of Wetherspoon pubs during this period has increased to 872 from 67, boosting its market share to 1.9% from 0.1%. “We assume this trend will continue, with smaller operators likely to close first, and JDW likely to continue to take share longer term,” he wrote in a note.

The decline in pub numbers hasn’t hit industry sales. Revenue for the sector has actually risen—growth that has been driven by larger pubs, Wetherspoon’s area of focus. Chatterton found that Wetherspoon in 2018 had about 8% market share in terms of revenue, compared with about 2% market share in terms of the number of pubs. “We continue to believe in the long-term investment case,” he wrote.

The group was founded in 1979 by chairman Tim Martin, who retains about a fifth of the stock. The business has a market value of £696 million and employs around 42,000 workers.

Wetherspoon fetches a multiple of 13.8 times this year’s expected earnings and is valued at a 40% discount to its peers. The company posted a pretax loss of £154.7 million in fiscal 2021, wider than the £34.1 million loss in 2020. It managed 2021 revenue of £772.6 million, well below £1.3 billion in 2020.

As the English writer Samuel Johnson once said, “there is nothing which has yet been contrived by man, by which so much happiness is produced as by a good tavern.” And Wetherspoon is doing its part to make customers happy. Martin told Barron’s in an email that the company has an advantage with its “high level of staff retention and an experienced pub management team—on average pub and kitchen managers have been with the company for more than 10 years.” He added: “Having said that, our motto is that we’re only as good as our next pint or meal.”

Water is harder to pump than crude oil. It’s harder to invest in, too.

Water, believe it or not, is denser than crude oil, which makes transporting it a feat. In fact, while energy is a sector, water is an amalgamation of 17 subsectors, according to RBC Capital Markets analyst Deane Dray, including water treatment, valves, pumps, filtration, desalinization, and metering.

Water, for all of its importance to life, is also a much smaller business than oil. Dray, who has presented at United Nations water conferences, estimates the size of the global water business at about $655 billion a year, a fraction of the roughly $3 trillion worth of crude oil consumed around the globe each year.

Still, drought, climate change, population growth, and a focus on environment, social, and corporate governance investing make water a perpetually intriguing sector for investors. The trick, Dray explains, is to invest in water businesses with the best technology and not just interchangeable items.

“The world is awash in commodity water products: pipes, pumps, and valves,” Dray says. “The emphasis should be on smart water systems.”

But there’s room for water utilities, too, says Jay Rhame, portfolio manager for the Virtus Reaves UtilitiesUTES –1.31% exchange-traded fund (ticker: UTES), who points to their stability as a main selling point. Exhibit No. 1: York Water YORW –1.23% (YORW), a small utility in Pennsylvania that has paid dividends continuously since 1816. Its streak is believed to be the longest in U.S. history.

With a $620 million market capitalization, York might not be appropriate for every portfolio. The six stocks discussed on this page, however, deserve a closer look.

American Water Works

Investors like water utilities for their stability, and American Water Works AWK –2.72% (AWK) is as stable as they come. The company is expected to grow earnings at an 8% annual rate for the next three years, after increasing them by 8% a year over the past decade.

That consistency has earned American Water Works a price/earnings ratio of 32 times, in line with its three-year average. It’s not hard to see why. Everyone needs water, and just about everyone pays their water bill. What’s more, utilities are allowed to earn a return on fixing and replacing pipes. Rhame says that makes projecting their results relatively easy. The stock pays a dividend of 1.7%.

Danaher

Danaher DHR –3.66% (DHR) isn’t a pure-play water company, but it is a technology provider with a strong market position, says Dray, who estimates that 10% of its sales are directly related to water. “I have been in water plants on five continents, and they all use Danaher water test systems,” he adds.

Danaher stock trades for about 26 times estimated 2023 earnings, a small discount to its average of 28 times over the past few years. The company is expected to boost earnings at an annual rate of about 7% for the coming three years, but that might be conservative. It has historically grown profits at an average annual rate around 12%.

Essential Utilities WTRG –1.85% (WTRG), based in Bryn Mawr, Pa., isn’t a pure play—it also delivers natural gas to customers—-and that makes it a little less stable than American Water Works. Its historical results are still impressive “It’s a really well run water utility,” says Rhame,

Essential Utilities earnings have grown at a 9% annual clip for the past decade, and should increase at just under 8% a year on average for the next three years. Essential Utilities’ stock trades for about 27 times next year’s expected earnings, in line with its recent history, though not as high as American Water, due to its gas business. The shares have about a 2.3% dividend yield.

Evoqua Water Technologies

Pittsburgh’s Evoqua (AQUA) cleans water for more than 38,000 customers in industries including electronics, manufacturing, and even water parks. The stock isn’t cheap. It trades for 37 times 2023 earnings, a premium to its three-year average of 35. But earnings are expected to grow by 15% a year over the next three years, up from 10% over the past few years.

Evoqua is also one of the few companies with ways of removing “forever” chemicals, or PFAS, from water, which could be a billion-dollar business if the federal government designates them as hazardous substances. Dray rates the shares Outperform and has a $44 target for the stock, up some 15% from recent levels.

Mueller Water Products

Atlanta-based Mueller Water Products (MWA) makes fire hydrants and has one of the largest installed bases of iron-gate valves, used to stop the flow of water in mains or garden hoses, in the U.S.

Mueller’s profits are cyclical and can rise and fall with the economy. The stock dropped 10% after the company missed fiscal third-quarter earnings in August, a development it blamed on inflation and supply-chain pressure. Seaport Global analyst Water Liptak believes that the decline is an opportunity.

Earnings are expected to advance at about 13% annually for the next couple of years. At 17.5 times 2023 earnings, Mueller trades at a small discount to its three-year P/E of 18.3 times.

Xylem

Leaky pipes are a big problem. The average age of a water main in the U.S. is roughly 45 years. And Rye Brook, N.Y.–based Xylem (XYL) is here to solve it. If a utility has a leaky water main, Xylem can detect and diagnose the problem remotely. About 35% of the company’s sales come from digital products, and that should get closer to 50% by mid-decade, says Alec Lucas, an analyst at ETF provider Global X.

Xylem stock trades for about 30 times estimated 2023 earnings, well above the S&P 500’s 17. But earnings are expected to grow at an annual rate of 25% for the next three years. The digital products, which have better profit margins, help boost earnings growth, says Lucas.

When Bob Seawright moved to San Diego 27 years ago, the only thought he gave to water was about the glistening swimming pool in his backyard. These days, water—or the lack of it—is a fact of daily life. Seawright has twice been forced to evacuate his home in the suburb of Rancho Bernardo due to the threat of wildfires. And the lush vegetation that once adorned the surrounding landscape has given way to dirt, hardy ground cover, and rocks.

“We have changed all of the shrubbery and ground cover to make it much more ‘water wise,’ ” says Seawright, chief investment officer of Madison Avenue Securities, and one of the 90 million Americans living under drought conditions.

The American lawn might be the most obvious casualty of the nation’s depleted water supply, but growing water scarcity, whether caused by drought, contamination, or deteriorating infrastructure, extends to every facet of our lives: the clothes we wear, the food and beverages we consume, the cars we drive, and the search engines and electronic devices we rely on.

Nor are investment portfolios immune. Water scarcity is emerging as a threat that could heighten business disruptions, crimp profits, and jeopardize growth—especially in thirsty industries such as agriculture, fashion, computer-chip making, and data centers.

Poor water stewardship carries the added risk of reputational damage, as regulators crack down on waste and environmental issues grow in importance. At the same time, companies that address water issues offer new investment opportunities.

“Investors who fail to incorporate water risk into their portfolios risk significant future underperformance,” says Thomas Schumann, creator of the TSC Water Security Index Family, a series of three regional equity benchmark indexes that measure the performance of large-capitalization stocks, weighted by their exposure to water risk. The U.S. and euro zone indexes were launched in January 2021, and a global index will arrive early next year.

The risk methodology looks at factors such as water utilization and policies to assess whether a company is a good steward of its water resources. Companies with lower risk are overweighted, while those with higher risk are underweighted.

Water metrics—such as the amount withdrawn and the volume consumed—are valuable tools for investors to gauge the dangers related to the natural resource, according to Sustainalytics, which is owned by Morningstar MORN –2.88% (ticker: MORN). In a March report, “Water-Related Risks and Challenges,” the firm notes that just one in 10 companies reports information on water usage.

One way investors can analyze water risk—which includes scarcity, quality, and the threat of floods—in their investment portfolios is via the Investor Water Toolkit, created by sustainability nonprofit Ceres.

In most developed counties, access to H20 is as easy as turning on a tap. But just 3% of the Earth’s water is fresh, according to the U.S. Bureau of Reclamation. About 2.5% is locked up in glaciers, the polar ice caps, the atmosphere, and soil, or is highly polluted or lies too far below the surface to be extracted affordably. So, just 0.5% of the available supply is fresh, and severe droughts threaten even that.

A United Nations report, “Drought in Numbers, 2022,” notes that since 2000, the number and duration of droughts has risen by 29%, compared with those in the two previous decades, and that from 1998 to 2017 droughts caused global economic losses of roughly $124 billion.

In the U.S., the problem is especially acute in the West, where the 1,450-mile-long Colorado River, which provides water to 40 million people and more than five million acres of agricultural land, has fallen to record-low levels. Its two enormous reservoirs, Lake Mead and Lake Powell, are below 30% of capacity, exposing sunken boats and even human skeletal remains.

The federal government recently announced new mandatory water cuts and asked states to come up with a plan to save the river. Starting in 2023, Arizona will lose about 21% of its allotted annual supply of river water; Nevada, 8%; and Mexico, 7%.

As the Earth’s water resources shrink, the planet is getting thirstier.

A McKinsey analysis predicts that, by 2030, global demand will outstrip supply by 40%. The nonprofit World Resources Institute has an even grimmer forecast: It projects that the gap will be 56% by the end of this decade.

Much of that demand comes from companies that produce the goods for daily life.

While estimates vary, FoodPrint, a project of Grace Communications Foundation, says it takes 1,800 gallons of water, on average, to produce a pound of beef, and 240 gallons to manufacture a cellphone. Nearly 800 gallons are used to turn out a pair of Levi’s 501 jeans, according to the company. Levi Strauss (LEVI) launched a water stewardship program in 2011. It says that as of the end of 2020, two-thirds of its products were made using its water-saving finishing techniques or in facilities that meet its water recycle-and-reuse guidelines.

The biggest water hog is agriculture, which accounts for about 70% of global water withdrawals globally, according to the World Bank. Other thirsty sectors include apparel, energy, chemicals, pharmaceuticals, and mining. A report from nonprofit CDP found that the potential financial impacts of water risks are far greater than the costs of addressing them. In 2020, companies reported maximum financial impacts of water risks at $301 billion—more than five times higher than the $55 billion associated with mitigating them.

Tesla TSLA –2.70% (TSLA) recently faced water-related hurdles at its electric-vehicle factory near Berlin. The plant was supposed to open in July 2021 but ran into bureaucratic challenges and resistance from locals worried that the factory—which may use up to 1.4 million cubic meters of water a year—would strain the area’s water supply, which comes from local surface and groundwater sources. This supply has been shrinking for several years, due to prolonged drought, climate change, and overuse.

Tesla CEO Elon Musk laughed off a reporter’s question about water usage when he visited the plant in August 2021. “This region has so much water; look around you,” he said. “[There’s] water everywhere here. Does this seem like a desert to you?”

But a peek below the surface told a different story.

Jay Famiglietti, director of the Global Institute for Water Security at the University of Saskatchewan in Canada, has been analyzing NASA satellite data for the past two decades, as part of his continuing research.

When asked to look in detail at Germany for a public television series there on water, Famiglietti used measurements from NASA’s Gravity Recovery and Climate Experiment, which tracks changes in Earth’s gravity field primarily caused by the movement of water over and through the planet’s surface. He found that the country has been losing 2.4 cubic kilometers of water annually for the past 20 years, probably due to factors such as drought and overuse of groundwater. That’s about 1.3 times the capacity of Lake Mead, the largest reservoir in the U.S.

The Tesla factory opened in March. Local officials said the auto maker could start production, on the condition that the plant meets environmental-impact requirements, including those related to air pollution and water usage.

Water scarcity is already showing up as a liability for companies and investors via stranded assets—plants, pipelines, and mines whose value has been written down due to water issues. A recent report from nonprofits CDP and Planet Tracker found that $13.5 billion in assets are already stranded and another $2 billion are at risk.

One company acutely aware of the intensity of its water usage is U.S. chip giant Intel (INTC), whose main U.S. manufacturing facilities are in Arizona, New Mexico, and Oregon. The Arizona and New Mexico sites are in areas experiencing high water stress, based on the World Research Institute’s 2021 Aqueduct Water Risk Atlas, a mapping tool that helps companies, investors, governments, and other users understand where and how water risks and opportunities are emerging worldwide.

To understand why water is a top concern, one need look no further than the crisis facing the states that rely on the Colorado River. Amid this parched backdrop sits Chandler, Ariz., home to two of Intel’s manufacturing campuses and 12,000 of its employees. A fabrication factory, or “fab,” for making semiconductors requires vast quantities of water to operate, from the “ultrapure” water needed to prevent impurities from damaging the chips, to the water for cooling and facilities. According to Intel’s latest Corporate Social Responsibility report, the Ocotillo campus in Chandler used about 15,800 megaliters of water in 2021, or about 4.2 billion gallons.

Todd Brady, Intel’s chief sustainability officer, tells Barron’s that ultrapure water, which has had as many of the impurities removed as possible, accounts for the largest share of the water used by the company. Chips and their pathways are built up in layers and, between manufacturing steps, must be washed to remove solvents and debris from the layer completed previously.

Water is also needed in semiconductor manufacturing facilities for purposes such as cooling and removing pollutants from the air. “Water is used in most applications,” notes Brady, adding that the company uses about 14 billion gallons of fresh water a year.

Intel is trying to conserve water in its operations, collaborating on initiatives with local communities through water-restoration projects, and using technology to help others reinvent how they use the resource. The chip maker has set a goal of being “water positive”—restoring more freshwater to its local watersheds than it consumes—by 2030.

When Brady started at Intel in the mid-1990s, it took about two gallons of water to create one gallon of ultrapure water—50% efficiency. Today, it takes about 1.1 gallons of water to produce one gallon of ultrapure water, he says. The company has found ways to reuse water, and has funded more than 30 projects to restore it to local watersheds.

Brady says that, over the past 10 years, Intel’s conservation efforts saved about 44 billion gallons, enough to supply about 400,000 U.S. homes for a year. “[Water scarcity] is something that we’ve been working on for a very long time, and we’re very mindful of and continue to evaluate our risk,” Brady adds.

Intel’s sustainability efforts are paying off: The company topped the 2022 list of Barron’s 100 most sustainable companies, created by Calvert Research and Management.

Tesla also pays attention to water risk. In its recently released 2021 Impact Report, the company acknowledges that “water is becoming increasingly scarce as the climate changes,” which is why Tesla is reducing its usage throughout its operations “as much as possible.”

In August, the electric-car manufacturer asked the Shanghai government for help in dealing with a severe drought in Sichuan province that has affected hydroelectric power production there, forcing some manufacturers to close plants. Tesla didn’t respond to requests for comment.

When it comes to climate risk, water has garnered much less attention among investors than greenhouse-gas emissions. That appears to be changing.

Famiglietti of the Global Institute for Water Security says that “increasingly severe flooding and drought, melting glaciers and permafrost, groundwater depletion, and increasing water scarcity” are happening far more rapidly than climate models predicted.

Investors are waking up to the risks. The Securities and Exchange Commission’s proposed climate disclosure rule, expected later this year, could require companies to disclose material risks if their facilities are located in regions of “high or extremely high water stress.” The potential rule has elicited objections from companies that argue that it lacks clarity and would be costly to follow.

In August, Ceres launched the Valuing Water Finance Initiative, with 64 investment firms that collectively manage $9.8 trillion in assets. The initiative is intended to push some of the world’s “biggest corporate water users and polluters” to consider water as a financial risk.

Addressing the world’s growing water shortage—and its investment implications—will take more than glossy sustainability reports. It will require a collective effort across many sectors of society. Will Sarni, CEO of the Future of Water Fund, a venture fund that focuses on the Colorado River Basin, sees a silver lining. “Water scarcity drives innovation, which drives investment opportunities,” he observes.

Competition for water will grow more intense over time. And companies that safeguard the long-term availability of clean water—and investors who recognize water scarcity as a material business risk—will be better positioned to weather the dry years.