The last time water seeped into our coverage of the consumer-staples sector, the news involved slack bottled-water sales that were weighing on companies such as PepsiCo (NYSE: PEP ) and Coca-Cola (NYSE: KO ) . That trend is probably still intact, but it's time to check in on a larger watery threat that could parch sector profits.
Drip-dripping away
It's more essential to industry and daily life than oil, but much of the developed world nonetheless takes clean, fresh water for granted. Such complacency may soon dry up.
According to The 2030 Water Resources Group, a public-private consortium that includes industry heavyweights and the World Bank, current global water resources are likely to fall short of future demand by a whopping 40% come 2030. Even assuming that we can sustain historical supply and productivity gains in the use of water -- no easy task, given financially cautious governments and industries -- the outlook indicates a still massive 24% supply demand gap.
On the surface, that scenario bodes well for beverage makers: Prices for bottled water, juice, and perhaps even soda and beer would skyrocket. The key question, however, is whether global players such as Diageo (NYSE: DEO ) and Coca-Cola would be able to access sufficient quantities of blue gold at economical prices.
It's tough to imagine that beleaguered governments facing a populist outcry would place corporate profits ahead of the welfare of its citizens, while private holders of water rights would probably wield a mighty upper hand in pricing. In short, an operating environment that includes egregiously high input prices at one end of the supply chain, and consumer outrage at the other, could mean a long profit drought for the liquid-refreshment business.
Finally, consider that water shortages are expected to be the most severe in developing and emerging economies. Compared with current resource levels, China's 2030 water demand is expected to outstrip supply by 32%. The models are more frightening for India, where future demand will climb to levels that are double today's supply.
Problematically, these are some of the very regions that international consumer-staples companies are counting on to drive future growth. Witness, for instance, Kraft's push for greater emerging-markets exposure through its pending, and increasingly desperate-looking, bid for Cadbury.
Rippling outward
And it's not just beverage makers that would suffer in such a future. Agriculture sops up about 70% of global water withdrawals, so a water crisis would be likely to trigger a food crisis. Sky-high grain prices would arrive as no friend to packaged-foods producers such as General Mills and Kellogg. Of course, it's hard to imagine an industry that wouldn't suffer through such events.
What, then, is an investor to do, especially when the leading edge of a water shortage may be years or even a decade off?
Within the consumer-staples sector, one can seek out companies that are ultra-efficient users of water. Consulting firm McKinsey & Co., a key party to The 2030 Water Resources Group, identifies Nestle as an industry leader in this area. However, I also recommend looking farther afield, to a handful of companies that may actually emerge from future dystopian days as net winners.
In terms of boosting agricultural yield, fertilizer leader PotashCorp (NYSE: POT ) comes to mind, in addition to seed specialist Monsanto (NYSE: MON ) . Increasing the absolute supply of fresh water will also be a top priority, a goal that should present plenty of opportunity for companies in the desalination business, including General Electric and Veolia Environment.
In addition, several publicly traded companies include water rights among their assets. One such name is PICO Holdings (Nasdaq: PICO ) , which owns and develops water rights and storage infrastructure in the resource-strapped Southwestern United States. Although far from pure plays, integrated oil companies such as ExxonMobil (NYSE: XOM ) and Royal Dutch Shell have been filling up on U.S. water rights to support the development of oil-shale deposits. Such companies could make good investments on two counts: In the event of a global water crisis, it's likely that the price of oil and natural gas would rise in tandem with water and other commodities, as geopolitical strife and resource nationalism became the norm.
Of course, no investment makes for a guaranteed hedge. However, holding a selection of the above stocks could help offset losses in the traditionally more stable areas of your portfolio.
The bottled takeaway
There a couple of final points to keep in mind. First, assuming bold action from both government and industry, we may in fact avert or significantly reduce the magnitude of a future water crisis. Through a combination of technology and political will, The 2030 Water Resources Group asserts that the supply demand gap can be closed at an affordable cost.
Second, even though we're not talking about imminent events, investors should keep this topic on their radar screens. I'd say that goes double for portfolios that are heavy with consumer-staples names. Such stocks are popularly imagined to be set-it-and-forget-it investments, but a potential water shortage -- on top of issues such as consumer trade-down and brand extension risk -- is yet one more reason this sector demands plenty of ongoing due diligence.
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