America's infrastructure is crumbling. After decades of under-investment, the condition of our roads, bridges and pipes is affecting our country's competitiveness. Governments at all levels are already struggling with debt. An innovative system for financing and building public infrastructure, public-private partnerships, or P3, may be essential to restoring America's competitiveness and an opportunity for investors to build a portfolio of market-beating investments.
Poor infrastructure, declining competitiveness
Once every four years the American Society of Civil Engineers, or ASCE, evaluates our infrastructure. In its 2013 Report Card for America's Infrastructure it gave an overall grade of D+, slightly better than the D- earned in 2009. And it estimates that in order to improve our infrastructure to a state of good repair, $3.6 trillion must be invested by 2020.
Additionally, a report from the National Association of Manufacturers entitled Infrastructure: Essential to Manufacturing Competitiveness revealed that 70% of the more than 400 manufacturers surveyed believe American infrastructure is in fair or poor shape, and 65% believe that our infrastructure is insufficient to respond to the competitive demands of a growing economy.
America's infrastructure needs repair, and the competitiveness of our nation demands it. But who will pay?
Weak government finances
Governments across the U.S. are drowning in debt. Debt as a percentage of GDP is the best measure for assessing a government's financial health. The Congressional Budget Office projects our nation's debt as a percentage of GDP at approximately 73% -- the highest it's been since WWII. Add in government debt at the state and local levels and the figure climbs to 106% of GDP.
Governments have little financial freedom to invest in aging infrastructure. Public private partnerships are part of the solution.
Public private partnerships
A P3 infrastructure project is funded and operated through a joint effort of government and private business. Governments grant a right to companies to design, develop, build, operate, and maintain an infrastructure asset, often for decades. In exchange for assuming financial, technical and operational risk, the private businesses earn a fair rate of return on their investment.
There are many U.S. firms well positioned to benefit from the growth of infrastructure projects. Let's take a closer look at the water industry, and two of America's largest, publicly traded utilities.
Everyone needs water
The ASCE estimates that 240,000 water-main breaks occur annually in the U.S. With much of the drinking water infrastructure approaching the end of its useful life, the American Water Works Association estimates the cost of replacing the entire system at more than $1 trillion.
Investors in Aqua America (NYSE:WTR) and American Water Works (NYSE:AWK), the two largest, publicly traded utilities, should benefit from a reliable and growing dividend. Both provide a yield of around 2.7%, and neither have a particularly high payout ratio, or the amount of earnings paid as dividends. Growth will come from the acquisition of municipal water systems as local governments find themselves unable to make the necessary infrastructure investments. And regulators should look favorably upon rate increases as both companies make sizable infrastructure investments -- another growth driver.
However, as the nation's largest and most geographically diverse water utility, American Water is the undisputed leader when it comes to non-regulated or market-based operations, including the delivery of P3 projects. In 2012, its market-based unit accounted for $330 million, or 11.5% of operating revenue. For Aqua America, the comparable figure is just $18 million, or approximately 3% of revenue.
American Water's leadership in this area was recently highlighted with a 50-year contract for ownership, operation, and maintenance of the water and waste-water systems at Hill Air Force Base in Utah. This is the tenth such agreement between American Water and the U.S. military, and brings the number of market-based contracts American Water has across the United States and Canada to more than 80.
The regulated operations of American Water and Aqua America will both benefit from increased water infrastructure investment. But investors looking to capitalize on the growing importance of public private partnerships to solve America's infrastructure woes should consider adding American Water to their portfolio. Specialized expertise, local knowledge, and access to capital are a few of the advantages American Water enjoys over its smaller rivals, and will help it win many P3 projects.
Our collective prosperity depends upon our nation's competitiveness. We can't ignore the necessary upgrades to our infrastructure indefinitely, and public private partnerships are part of the solution. American Water is the best positioned to take advantage of this important trend in the water industry, offers a solid and reliable dividend, and deserves consideration from income investors.