think secular, act cyclical: the pragmatist's guide to water....

Think Secular, Act Cyclical: The Pragmatist's Guide to Water.

INVESTMENT CONCLUSION:

While catchy hyperbolic sound bites such as "The Oil of the 21st Century" have become de rigueur among mediapundits, the long-term "themes" surrounding water (water scarcity, water quality, and aging infrastructure) actually havelittle bearing on stock performance over the shorter 1-5 year horizon considered by most investors. Sure, these themesabsolutely have merit, and over the long-term allocating a portion of assets to the space will likely boost returns, but thereality is that water equipment and technology companies are for the most part cyclical businesses exhibiting volatiledemand patterns and susceptible company-specific issues (after all, oil was the oil of the 20th century, but that didn't stopTexaco from filing the then-largest bankruptcy in U.S. history in 1987). With this in mind, we believe the most practicalmeans of approaching the space is to acknowledge the compelling themes underlying the sector and screen for companiespositioned to benefit from them over time, but to base tactical investment decisions on a disciplined assessment of theunique cyclical realities facing each company. We base our tactical stock calls in large part on our framework of the FourDemand Channels: Municipal, Industrial, Construction, and Agriculture. In this deep-dive primer, we examine each ofthese key demand channels from the ground up, and also outline the adjacent regulated water utility space.

KEY POINTS:

• The "Big Three" Themes. Here are the water themes in a nutshell: (a) populations are migrating to arid regions(think Phoenix), and this is straining water resources in some areas - a.k.a. "Water Scarcity"; (b) the continuedproliferation of industrial and commercial activity creates pollution issues, requiring more stringent regulations toensure safe drinking water - a.k.a. "Water Quality"; and (c) established population centers (think NYC, Philadelphia)must continually invest to keep water systems in working order - a.k.a. "Aging Infrastructure".

• Be wary of blind theme investing. The paradox of investing in the water space is that while each of these keythemes has merit and will drive commercial opportunities, it is impossible to quantify and/or forecast the impact ofthese issues on demand even under relatively extended investment time horizons of 5+ years. As a result, we believethese themes are useful as a backdrop for thinking about the long-term opportunities on the horizon, but in terms oftactical stock picking they are useless at best and dangerous at worst (we've seen many victims, including ourselvesat times, take the thematic bait only to be caught off guard by the cyclical realities of the business).

• The Four Demand Channels: The path to alpha generation. Among the least appreciated aspects of industrialsinvesting is that in mature industries (unlike, say, technology or healthcare), major shifts in market share big enoughto drive stock calls are extremely rare. As a result, scarce time resources are best spent divining whether the pie itselfwill expand or contract (and by how much) rather than focusing on how the pie will be divvied up. Our demandchannel framework drives our research process, with the four channels being: Municipal (city Water & WWauthorities), Industrial (water-intensive industries such as energy, bio-pharma, and food & beverage), Construction(water infrastructure for use in residential and commercial structures), and Agriculture (i.e. irrigation).

• A guide to tactical investing in the water space. This primer is designed as a guide and desk reference for investorslooking at the water space, laying out the fundamental factors driving each of the four demand channels anddiscussing the key indicators we monitor to gauge the trajectory of demand. In the end, we believe that the vastmajority of stock performance in the water sector can be ascribed to directional trends in the four demand channels,and that this is where investors seeking to generate alpha in the space should focus their attention.

Ryan M. Connors 215.665.1359

[email protected]

Kenneth J. Dorell 215.665.6439

[email protected] & Agriculture

November 13, 2013

Equity Research

Industry Report

Research Analyst Certifications and Important Disclosuresare on page 65 of this report

Introduction to the Four Key Demand Channels

Secular themes supply the long-term investment rational within the subsets of the broader water industry, yet the

cyclical tendencies within each end-market make appreciating the demand determinants vital to the investment

process. As such, our analysis is structured into the four key demand channels of municipal, industrial, construction,

and agriculture, with the fifth section dedicated to the investor-owned water utility industry.

Municipal: Capital expenditures dictate growth opportunity. The budgets of municipalities are divided

between operational expenditures and capital expenditures, with the latter representing the market opportunity for

water infrastructure companies as capital spending represents incremental spending on water product upgrades

ranging from pipe, pump, and meters to the construction of entire plants. With an estimated size of $31.5 billion in

2012 (measured by U.S. Utility CapEx), the highly fragmented market is served by a variety of companies that offer

products spanning from pumps (supplied by companies like Gorman-Rupp [GRC-Buy]) to advanced infrastructure

diagnostics systems (offered by Mueller Water Products [MWA–Buy]).

Industrial: Water treatment regulations & conservation efforts provide recurring demand. Expected to grow

at an annual compounded rate of 6% through 2016, the industrial water equipment market is expanding due in large

part to two secular trends: water scarcity and water quality. With tightened regulations and a renewed focus on water

efficiency, companies are taking a proactive approach to ensure compliance with increasingly stringent regulations

governing both water usage and effluent quality. Indeed, secular drivers provide a longer-term tailwind, yet

investment in water products is largely determined by the investment cycle of each relevant industry. The industrial

demand channel exhibits a relatively high degree of correlation with the broader industrial economy, and as a result,

trends in capacity utilization, industrial production, and industrial capital investment exert a significant influence on

the trajectory of demand for relevant water products.

Construction: Residential and non-res. building erection necessitates water infrastructure. In contrast to the

―megatrend‖ growth stories in the industrial, agriculture, and municipal end markets, the construction market for

water products is more cyclical than its secular counterparts. Driven predominately by macroeconomic factors,

including financing availability, income levels and general consumer outlook, the construction market is split

between two segments: residential and nonresidential. Indeed, every structure includes some degree of water

infrastructure, but there are certain key structures that are highly water intensive. For instance, the full service

nature of a household provides a swift tailwind for plumbing products, as do commercial structures such as lodging

and hospitals. These buildings amplify many of the residential uses for water to mass scale, resulting in extremely

water intensive operations that require complex and reliable systems.

Agriculture: Industry-best practices drive irrigation adoption/applications on the farmstead. The most

influential (and direct) water end-market in agriculture belongs to irrigation, yet the application of precision

agriculture and new, more efficient farm machinery also aids in the movement to reduce water consumption. In

order to anticipate demand trends in these markets, we follow a number of different metrics that amalgamate to

convey a general direction of the ag demand channel: net farm income, farmland values, corn prices, the corn

balance sheet, and farm debt. Shifts in the market conditions typically constitute commensurate shifts in the

performance of the ag companies, though certain conditions may supply different conclusions for each product

offering.

See pages 3-4 for a detailed Table of Contents providing easy reference to the contents of this report.

o Sidenote: For those viewing this document electronically, clicking the desired title on the table of

contents will direct you to the section referenced within the document.

- 2 -

Janney Montgomery Scott Equity Research: Water & Agriculture

Table of Contents

Municipal Demand Channel: An Overview ............................................................................................. 5

Municipal Demand Channel: The Market Opportunity ........................................................................... 6

Focus Issue #1: Pipe Replacement Estimates Out of Touch with ―Urban Reality‖ ......................... 7

Municipal Demand Channel: Growth Dynamics ..................................................................................... 8

Key Upcoming Industry Events ................................................................................................................ 9

Focus Issue #2: Bottled Water Consumption Provides Homes with ―Second Line‖ ..................... 10

Municipal Demand Channel: Key Macroeconomic Indicators ............................................................... 11

Municipal Demand Channel: Sub-sectors & Key Players ...................................................................... 14

Focus Issue #3: The Role of Water Metering in Driving Conservation ........................................ 15

Municipal Demand Channel: Key Players Comparable Analysis .......................................................... 16

Industrial Demand Channel: An Overview ............................................................................................ 17

Industrial Demand Channel: The Market Opportunity ........................................................................... 18

Focus Issue #4: ―Virtual Water‖ – A Holistic Measure of Water Consumption ........................... 19

Industrial Demand Channel: Growth Dynamics ..................................................................................... 21

Focus Issue #5: The Water/Energy Nexus ..................................................................................... 22

Industrial Demand Channel: Key Macro Indicators ............................................................................... 25

Industrial Demand Channel: Subsectors and Key Players in Each ......................................................... 28

Focus Issue #6: Water Treatment Stokes Conservation ................................................................. 29

Industrial Demand Channel: Key Players Comparable Analysis ........................................................... 30

Construction Demand Channel: An Overview ...................................................................................... 31

Construction Demand Channel: Market Opportunity ............................................................................. 32

Construction Demand Channel: Residential Growth Dynamics ............................................................. 33

Construction Demand Channel: Nonresidential Growth Dynamics ....................................................... 34

Construction Demand Channel: Key Indicators ..................................................................................... 35

Commercial Demand Channel: Subsectors and Key Players in Residential Market .............................. 39

Construction Demand Channel: Subsectors and Key Players in Nonresidential Market ....................... 40

Construction Demand Channel: Key Players Comparable Analysis ...................................................... 40

Agriculture Demand Channel: Irrigation Overview ............................................................................. 42

Agriculture Demand Channel: Irrigation Market Opportunity ............................................................... 43

Focus Issue #7: Precision Ag Adoption in Early Stages (Even in Developed Countries) ............. 44

Agriculture Demand Channel: Growth Dynamics .................................................................................. 45

- 3 -


Focus Issue # 8: Influence of Net Farm Income on Demand ......................................................... 46

Agriculture Demand Channel: Key Indicators ........................................................................................ 47

Agriculture Demand Channel: Irrigation Key Players and Product Offerings ....................................... 50

Agriculture Demand Channel: Key Players Comparable Analysis ........................................................ 51

Regulated Water Utilities: An Overview ............................................................................................... 52

Regulated Water Utilities: Market Opportunity ...................................................................................... 53

Regulated Water Utilities: Growth Dynamics ........................................................................................ 54

Regulated Water Utilities: Regulatory Climate Indicator .............................................................. 55

Regulated Water Utilities: Key Players .................................................................................................. 58

Appendix .................................................................................................................................................... 59

Analyst Disclosures………………………………………………………………………………………. 65

- 4 -


Municipal Demand Channel: An Overview

A large portion of the play on water infrastructure companies is their exposure to municipal investment,

which is susceptible to numerous influences that drive the demand of water products. The budgets of

water utilities are divided between operational expenditures and capital expenditures, with the latter

representing the market opportunity for water infrastructure companies as capital spending represents the

incremental spending on water product upgrades ranging from pipe, pump, and meters to the construction

of entire plants. With an estimated size of $31.5 billion in 2012 (measured by U.S. Utility CapEx), the

highly fragmented market is served by a variety of

companies that offer products spanning from

pumps (supplied by companies like Gorman-Rupp

[GRC-Buy]) to advanced infrastructure diagnostics

systems (offered by Mueller Water Products

[MWA–Buy]). Forecasted by Global Water

Intelligence to reach a size of $46.4 billion by

2016, utility capital expenditures are expected to

expand at a 10% clip from 2012-2016, with

drinking water and wastewater capital expenditures

operating at a projected CAGR of 11.5% and 9.4%

over that time, respectively.1

The deterioration of water infrastructure in the

United States represents the primary growth driver

for water products companies, yet, as 84% of

drinking water systems (and 98% of wastewater

systems) in the United States are publicly-operated,

the financial condition of municipal governments

plays a key role in determining the trajectory of

demand in the short-term. As a result, economic

indicators that track bond issuance, hiring, pricing,

and tax collection trends of municipalities are

useful in assessing the likely trajectory of spending.

While water utilities are notoriously methodical in

their operational and investment trends, there is a

definite correlation between economic prosperity

and increased utility capital expenditures as

housing construction translates into increased

property tax revenue, a key funding mechanism for local municipalities (~80% of local tax revenue).

This influence in spending results in cyclicality for companies that serve the municipal sector, evidenced

in the sharp downturn of many companies exposed to municipal spending in 2008 (see: Badger Meter

[BMI-Neutral] or Xylem [XYL-BUY]). While Badger and Franklin Electric (FELE-NR) represent two

subsectors of the municipal market (Metering and Pumps), the sector is also served by engineering and

construction, water filtration, piping and storage, and infrastructure diagnostics firms that provide

products and services over the full lifecycle of municipal water infrastructure projects.

1 Water Market USA 2011. Oxford, United Kingdom: American Water Intelligence, 2011. Print.

New Water Network

13%

Water Network

Rehab

36%

New Water Treatment

Plant

5%

Water Treatment

Plant

Upgrades23%

New Water Resources

23%

Utility Water CapEx: 2013E

Source: AWI

Size: $15.3 bln

New Wastewater

Network

49%

Wastewater Network

Rehab

9%

New Wastewater Treatment

Plant37%

Related Assets

5%

Utility Wastewater CapEx: 2013E

Source: AWI

Size: $19.6 bln

- 5 -


Municipal Demand Channel: The Market Opportunity

Water infrastructure in the United States is

experiencing a prolonged deterioration that has

accelerated throughout the past two decades, with

renovations being deferred in many cases as a

result of trimmed budgets. Aging water and sewer

infrastructure has become so dire that it was cited

as the most important industry issue by water

utilities, above managing capital costs and funding

availability in a report by industry consultant Black

and Veatch. With macro data suggesting a rebound

is likely (seen through improvements in bond

issuance, municipal water pricing and record

property tax receipts) and pent-up projects being

unleashed, investment in some key areas of water

infrastructure is expected to increase. Alternately,

some areas of aging infrastructure are unlikely to

see ―in-kind‖ replacement as demographics shift

and consumer preference continues to shift toward

alternative delivery methods (see pages 7 & 10).

Estimates on the cost of bringing the United States‘

water infrastructure up to date within the next 20

years range from $335 billion to $1 trillion, with

the EPA estimating a cost of $384 billion to

upgrade U.S drinking water infrastructure in a

recent study. While we are somewhat skeptical of

the aging infrastructure theme, the reduced

spending in recent years by municipalities

tightening their belts has resulted in pent-up

demand for structural upgrades that we expect will

result in heightened project activity.

Distrib

65%

Treatment

19%

Storage

10%Source 5%

Other 1%

Water Infrastructure Upgrade Needs by

Function

Source: EPA

$0m

$5,000m

$10,000m

$15,000m

$20,000m

$25,000m

$30,000m

2007 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E

US Utility Capital Expenditure Profile

Utility Water Capex Utility Wastewater CAPEX

Source: American Water Intelligence

1990 2000 2005 2009 2013

Drinking Water Wastewater

B-

C

DD+

D- D-

A Deteriorating Report Card:

ASCE Grades U.S. Water Infrastructure

Source: ASCE

D- D-

D D

Major investments are needed to shore-up U.S. water

infrastructure. At 7% per year, water tariffs are growing

faster in North America than in any other region of the

world, a positive indicator that funding will be available.

- 6 -


Focus Issue #1: Pipe Replacement Estimates Out of Touch with “Urban Reality”

Officials in Youngstown, Ohio made

national news in 2006 by

acknowledging that the city was

unlikely to rebound from decades of

steep population loss, embarking on a

plan to deliberately downsize all aspects

of the city. Essentially, Youngstown‘s

still-unfolding plan (an example of what

urban planners have dubbed the

―Shrinking Cities‖ movement) boils

down to managing decline by

concentrating population in resilient

neighborhoods and decommissioning

sections of the city that are deemed to

have crossed the line of no return on the

vicious cycle of population loss, blight,

and crime. With the EPA and other

groups presuming full renovation of

infrastructure in their estimates, Youngstown‘s final step of razing whole blocks of abandoned homes,

thus eliminating the need for water mains there, leads to likely over-projections of needed investment in

similar cities. A Few cities are following Youngstown‘s lead, and with 22% of water main mileage within

declining urban populations and tightened municipal budgets (in addition to heightened public scrutiny on

overspending), other cities are likely to take similar approaches.

A reasonable counterpoint to this argument is that migration patterns will create demand in the suburbs

and Sun Belt cities that are gaining population (driving infrastructure demand). Unfortunately, while this

is true in the long-term, these areas were

developed so aggressively during the

housing boom that there is now

significantly underutilized infrastructure.

While strides towards reducing the housing

glut are being taken, a prolonged hangover

period for basic water infrastructure

demand is still impacting these areas,

causing the pipe market in particular to

meaningfully lag housing starts on the way

back up. In fact, juxtaposing the housing

overbuild in the suburbs/Sun Belt against

continued urban decline in the Rust Belt,

one way of looking at the issue is that a

considerable portion of the necessary water

infrastructure spending already took place –

in the form of water distribution networks

serving new housing developments.

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

$200

$250

$300

$350

$400

$450

$500

$550

$600

$650

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

U.S. Pipe Revenue (L, Bar) vs. U.S. Housing Starts (R, Line)

Figures in millions Source: Mueller Water Co; U.S. Census Bureau

4%

-26% -26%

92%

-61%

-35%

-57% -63%

-25% -23%

NYC

Ch

icag

o

Ph

ila.

L.A

.

Det

roit

Bal

t.

Cle

ve.

St. L

ou

is

Was

h.

Bo

sto

n

The 10 LargestU.S. Cities in 1950:

Pop. Change: 1950-2010

Source: U.S. Census Bureau

- 7 -


Municipal Demand Channel: Growth Dynamics

The growth profile of municipal spending

must be dissected in disparate ways as it is

subject to both secular and cyclical trends.

Cyclical. Municipal spending is subject to

macroeconomic conditions since it derives

much of its funding from taxes. With

property tax, sales receipts, and income tax

representing 91% of local tax revenue,

municipalities are exposed to trends in

housing (property tax), unemployment and

nonfarm payrolls (income tax) and

consumer expenditures (general sales

receipts). In the case of water infrastructure

spending, funding is principally derived

from rates charged for water consumption, which steadies the amount of spending on operational

expenditures. However, even water consumption revenue benefits from healthy macro conditions as

customer growth is driven by housing construction and commercial/industrial usage is cyclical.

Secular. While macro conditions certainly influence municipal spending (recent trends confirm this),

conventional wisdom holds that the poor condition of water infrastructure throughout the country

provides a significant long-term opportunity for companies serving the municipal market. While we

recognize this (citied in earlier estimates of water infrastructure investment needs), we believe that there

are also prominent trends that dilute the magnitude of water infrastructure needs in the U.S., most notably

the shift in favor towards bottled drinking water and shrinking cities phenomenon. Nevertheless, external

to the water infrastructure argument there remains compelling industry dynamics that present growth

opportunities for those selling into the water municipal channel. A focus on water quality and

conservation is driving demand for products ranging from advanced reverse osmosis treatment facilities

to meters fitted with AMI technology that allows for

enhanced leak detection. As consumers become

more cognizant of their water consumption and

water quality and utilities strive towards pressure

optimization of water systems to reduce non-revenue

water, the market for higher-end products that

expand beyond the basic needs of water distribution

and treatment is gaining traction rapidly.

Additionally, from a timing perspective, companies

servicing water utilities exhibit smoother returns

than those selling to industries like electric utilities,

as water projects are of much lesser size than that of

electric utilities, which leads to a reduced reliance

on large projects and a lower degree of lumpiness

for companies selling into the water utility sector.

Property Tax78%

General Sales/ Gross

Receipts

8%

Individual Income

4%

Corp Income1%

Other9%

Local Tax Revenue Distribution


Pipes36%

Pumps23%

Valves6%

Meters2%

Control/ Chemical

feed

systems1%

Filtration/ Treatment

22%

Other10%

Utility Water/WW Utility Market by

Equipment Type: 2013E

Source: AWI

- 8 -


Key Upcoming Industry Events

Water Quality Association Aquatec (WQA Aquatec)

Description:

Website: www.wqa-aquatec.com

Upcoming

Conferences:

American Water Works Assocation Annual Conference Exhibition (AWWA ACE)

Description:

Website: www.awwa.org

Upcoming

Conferences:

2014 AWWA ACE

Boston, Massachusetts

June 8th-12th, 2014

2016 AWWA ACE

Chicago, Illinois

June 12th-15th, 2016

2018 AWWA ACE

Las Vegas, NV


2015 AWWA ACE

Anaheim, CA, USA

June 7th-11th, 2015

2017 AWWA ACE

Philadelphia, Pennsylvania


Water Environment Federations Technical Exhibition Conference (WEFTEC)

Description:

Website: www.weftec.org

Upcoming

Conferences:

87th Annual WEFTEC

New Orleans Morial

Convention Center

New Orleans, LA

October 18th-22nd, 2014

WQA is “a one stop event that connects technologies, know-how, education, training, networking, and

business opportunities to multiple water industries”. The conference provides insight into the opportunities

and market conditions in the residential, commercial, and industrial end-markets for water products.

American Water Works Assocation is an organization boasting 50,000 members worldwide, including the

majority of the relevant U.S. water infrastructure companies. The Association's conference is designed to

introduce new trends, technology, and opportunities in the space as well as serving as a platform to discuss

recent ramifications from shifts in the legislative lanscape.

WEFTEC is the biggest meeting of its kind in North America and offers thousands of water quality

professionals from around the world the best water quality education and traning days available. It also

provides a water quality exhibition that provides access to the industry's cutting edge technology.

Key Water Industry Events

2014 WQA Aquatec

Orange County Convention Center

West Building, West Hall B

Orlando, Florida

March 18th-21st, 2014

- 9 -


Focus Issue #2: Bottled Water Consumption Provides Homes with “Second Line”

To understand why the inflection point in water

infrastructure investment has stubbornly failed

to realize, it helps to first consider a related

industry topic – the notion of a ―dual pipe‖ water

distribution system. Ingested water represents a

relatively small portion of household water

consumption (less than 3%), yet under a single-

pipe system, all other household applications

must utilize this expensive water. The solution,

say ―dual-pipe‖ advocates, is to have one line

bring top-quality drinking water into the home,

and another bring ―gray water‖ (water treated,

but to a lesser standard) for non-potable

applications. The dual pipe idea makes sense

from a water quality perspective (it makes no

sense to flush toilets with potable water), but

suffers from a fatal, insurmountable flaw: the

massive capital cost associated with such a system makes it a non-starter.

On the surface the solution to the aging infrastructure ―crisis‖ seems slow in materializing, yet the free

market is already dealing with the situation in real-time. An increasing number of people already

effectively operate under a virtual dual pipe system, with the existing drinking water service line

functioning as the ―gray water‖ pipe for non-potable applications and bottled water (or, increasingly,

point-of-use filtration systems) acting as the ―potable water‖ pipe. These alternatives have a strong

advantage in capital aversion, as bottled water utilizes existing civil (roads, rails) and commercial

(beverage industry bottling and distribution capabilities) infrastructure to bring drinking water to

consumers, while point-of-use filtration ―free rides‖ on the existing distribution network (inverting the

traditional utility model by transporting water first, treating it second). Equally important, bottled water

in particular leverages consumers‘ willingness to pay up for a source of drinking water they trust.

0% 20% 40% 60% 80% 100%

20-39

40-59

60+

Water Consumption by Age Group(Cups per day)

Tap Bottled

Source: USDA

Potable Water Landscape

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

5

5.5

6

6.5

7

7.5

8

8.5

9

9.5

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Bottled Water & Water Filter Sales

Bottled Water Consumption - Gallons in Billions (L-Axis)

Filters - Units in Thousands (R-Axis)

Filters 5-yr CAGR: 9.2%

Source: IRI & Bottled Water.org

Water Bottles 10-yr CAGR: 5.8%Bathing

23%

Toilets

28%

Lawn &

Pools 29%

Laundry

10%

Drink &

Cook 2% Other 9%

Water Usage by Application

Source: freedrinkingwater.com

- 10 -


Municipal Demand Channel: Key Macroeconomic Indicators

As referenced previously, there are several key economic indicators that help handicap near-term trends

in municipal infrastructure spending and investment. These include: U.S. residential housing starts and

permits, local tax receipts, municipal bond issuance, and the water & wastewater CPI.

U.S. Residential Building Permits. Residential permits offer a reliable forward-looking indicator of

trends in residential construction. As building permits expand and lead to increased construction, this

drives an incremental increase in homes needing water and wastewater services, increasing

municipalities‘ income. This increased income leads to heightened investment, a positive for companies

with exposure to the municipal demand channel. Housing Starts are also a relevant indicator to follow, but

lacks the forward looking benefit of permits.

Municipal Bond Issuance. Municipal bond flotation is a key driver of capital spending for local

government, particularly in the case of large-scale water projects. While the debate rages on whether or

not municipal bonds should continue to offer tax-free interest to investors (which is the asset class‘s most

attractive feature) it continues to be an enormous source of funding for munis. Key benefits of following

municipal issuance include (a) the forward-looking aspect of the data (capital raised in the municipal

bond market is typically deployed 1-2 years after issuance) and (b) the readily accessible nature of real-

time data.

Local Tax Receipts. Local tax revenues are the chief source of funding for municipalities, with stronger

tax receipts customarily translating into budget increases, which determine the level of both capital

investment and, to a lesser extent, operational expenditures in local water infrastructure. While water rates

make up the dominant share of water utility funding (~60% of municipal water utilities are structured as

financially independent ―enterprise funds‖), tax revenue is still a critical driver of spending trends over

the course of the economic cycle.

Municipal Water & Wastewater Pricing. The source of income directly attributable to water and

wastewater infrastructure investment is the charge for water and wastewater services. Many water

utilities continue to charge below cost for their service, yet increases in pricing move the industry toward

a more sustainable ―full cost‖ pricing model that will catalyze infrastructure investment in the

intermediate-term. In recent years, prices have been increasing at multiples of inflation in the broader

economy.

- 11 -


Municipal Demand Channel: Economic Indicators – Continued

0

500

1,000

1,500

2,000

2,500

U.S. Residential Permits (000s)

After reaching record heights in 2005 (permits are a leading indicator of the housing cycle), U.S.

Residential permits experienced an extended slump from 2006 to mid 2009. The recovery in permit

activity (though still well below 2005 levels) bodes well for water infrastructure companies that sell into

the residential construction industry.

Source: US Census Bureau

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

$500,000

$550,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E

U.S. Municipal Bond Issuancein Millions

Source: Bloomberg; JMS Estimates

Municipal bond issuance worked its way higher during the recession as local governments scrambled for funding amid lower tax receipts. This trend took a breather in 2011, but the "above average" borrowing resumed in 2012 as record-low interest rates enticed municipalities.

Lending has since normalized as economic conditions improve and interest rates work their way up. Overall, we view the increased funding from tax receipts as a preferred method of funding for munis.

- 12 -


Municipal Demand Channel: Economic Indicators – Continued

3%

4%

5%

6%

7%

Feb

-04

Jul-

04

De

c-04

May

-05

Oct

-05

Mar

-06

Au

g-06

Jan

-07

Jun

-07

No

v-07

Ap

r-08

Sep

-08

Feb

-09

Jul-

09

De

c-09

May

-10

Oct

-10

Mar

-11

Au

g-11

Jan

-12

Jun

-12

No

v-12

Ap

r-13

Sep

-13

Municipal Water & Wastewater Pricing (Year/Year Rate of Change)

Source: U.S. Bureau of Labor

Water pricing has been outpacing broader measures of inflation for years. While downward pressure on interest rates has the ability to

pressure water pricing, tariff growth still runs well above inflation levels even in such an environment, as utilities use rate increases as a method

for financing infrastructure and water sourcing needs.

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Local Tax Collections(in millions)

Local Taxes

Property Taxes

Source: United States Census Bureau

Local tax collections have expanded over 150% in the past two decades, and although local tax revenue declined from 2009 to 2011,

collections have since rebounded to reach record levels in 2013.

- 13 -


Municipal Demand Channel: Sub-sectors & Key Players

The products and services offered in the municipal sector represent vital components at each stage of the

water treatment and distribution process, creating a set of complementary goods (as opposed to

substitutes per se). The supply of potable water is first made possible through engineering and

construction, during which firms like Stantec (TSX:STN–NR) work with municipalities in developing

water plants that treat and distribute raw source water to service the needs of the community. Water

treatment (filtration, purification, etc.) is involved in this process as well, as water utilities are required to

treat water to meet the potable standards outlined by the EPA in the Safe Water Drinking Act. With point-

of-use filtration and wastewater treatment becoming more mainstream, these products are also used at the

back end of the water distribution cycle. Mueller Water (MWA-Neutral) and its privately held peers

provide the distribution vehicle, as piping is laid underground for water mains and ancillary systems.

While pipes provide the vehicle for distributing water, pumps represent the engine, creating water

pressure to transport the water, with valves managing the flow. A multitude of companies operate in this

area, ranging from Gorman-Rupp (GRC-BUY) and Xylem (XYL-BUY) who service high-volume pump

needs to Watts (WTS-BUY) who extends its value offerings to those beyond the municipal system.

Water metering is where the transaction between the consumer and the utility is recognized, and it is

essential for the service provider to properly account for customer usage. There are numerous types of

meters available (PD, impeller, magnetic), but the area that is getting much notoriety and investment is in

the data transmission space, where there are two distinct groups: manual-read and automated (AMR).

AMR technology allows for accurate and timely consumption monitoring, as transmitters communicate

meter readings to the water utility through either walk-by or drive-by sensors, effectively eliminating the

need for manual meter checking. AMI transmission systems take this one step further, leveraging fixed-

communications systems that enable the utility to gather consumption data in house. The evolution of

AMI involves two-way communication (both to the utility and back to the customer), which allows

consumers to adjust their consumption through water-efficient ―best practices‖.

Product Description Companies

Transmission &

Distribution

Underground distribution systems that facilitate

water transportation. Storage primarily involves

reservoir construction.

FSTR, MWA,

NES, NWPX

Pumps/Valves

Primarily flow control devices that promote water

quality, conservation, and safety and are integral

components to water systems of any size or type.

GRC, FLS, IEX,

MWA, PNR, XYL

Engineering &

Construction

Provides consulting, engineering, program

management, construction management, and

technical services for water, natural resources,

environment, infrastructure and energy sectors.

AEC, LAYN, STN,

TTEK, URS

Metering

Flow measurement and control devices that apply

to various applications servicing commercial,

industrial and residential customers.

BMI, Elster*, ITRI,

MWA, ROP, SSNI

Infrastructure

Diagnostics

Services aging infrastructure in the form of water

systems for leak detection, water inefficiencies,

and pressure abnormalities.

MWA, PUR (TSX)

Filtration

Offers filtration materials, systems, and consumer

products that service water, air, food and beverage,

and industrial process streams.

AOS, CCC, PLL,

XYL

*Privately Held

Products & Services Offered to Municipal Customers

- 14 -


Focus Issue #3: The Role of Water Metering in Driving Conservation

A strong driver for water efficiency in addition to

minimizing treatment costs for utilities is water

metering. Currently, over a quarter of the water that

is used worldwide is non-revenue water, or the

difference between the water put into a distribution

system and the volume that is billed to customers.

The three types of non-revenue water are: physical

losses, commercial losses, and unbilled authorized

consumption. Physical losses represent the leakage

from all parts of the system and overflows at the

utility‘s storage tanks, typically derived from poor

management of plant operations. Commercial

losses are drawn from customers with meters under

registration, with losses resulting from meter errors or water theft. Unbilled authorized consumption is

water that is used for public goods (i.e. firefighting).

According to the World Bank, nearly 50 billion cubic meters of non-revenue water is used each year,

representing a $14.6 billion annual loss of treated water. While full scale introduction of water metering

would not capture the majority of this revenue, it would ultimately improve the efficiency of water

distribution by identifying systems with water loss in order to more acutely focus infrastructure

improvements. This translates into fewer costs borne by utilities (less non-rev water) for the purchase and

treatment of water and subsequently, lower rates for consumers who would no longer compensate utilities

for non-revenue water. Companies have been noticing the benefits of metering especially, with automated

meter reading technology growing from close to zero a decade ago to 33% today. This significant

improvement highlights the popularity of water metering solutions, but also shows that despite public

presumption of metering installations flattening out, there is still ample opportunity.

12%

21% 21%3%

9%14%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Developed Countries Eurasia Developing

Countries

Global Non-Revenue Water Breakdown*

Physical Losses NRW Commercial Losses NRW

15%

30%

35%

*Percent of Water System Input Source: WHO, World Bank, Janney Captail Markets

- 15 -


Municipal Demand Channel: Key Players Comparable Analysis

Ticker PriceMarket

CapSales Ent. Value Fwd P/E

EV/

EBITDA

JMS

Analyst

Water

Exposure

Sourcing & Distribution

LB Foster Co. FSTR $43.75 $451.9 $582.2 $355.9 15.2x 6.8x NR Low

Northwest Pipe Co. NWPX $37.40 $353.4 $496.5 $431.8 24.9x 8.8x NR High

Nuverra Environmental Solutions, Inc. NES $1.46 $379.5 $600.8 $904.7 NM 13.2x NR Medium

Average 20.1x 9.6x

Pumps & Valves

Gorman-Rupp Co. GRC $39.43 $828.1 $388.7 $803.3 23.7x 15.3x Connors High

IDEX Corporation IEX $69.74 $5,657.2 $1,994.3 $6,041.9 21.2x 12.9x Knight Medium

Mueller Water Products, Inc. MWA $8.80 $1,392.5 $1,120.8 $1,869.7 26.5x 11.8x Connors High

Pentair Ltd. PNR $68.05 $13,564.7 $7,313.9 $16,020.2 17.9x 18.6x NR High

Watts Water Technologies, Inc. WTS $58.61 $2,068.9 $1,470.2 $2,150.0 21.3x 11.7x Connors High

Xylem Inc. XYL $33.94 $6,261.5 $3,773.0 $7,069.5 18.3x 12.4x Connors High

Average 21.5x 13.8x

Engineering & Construction

AECOM Technology Corporation ACM $28.96 $2,919.3 $8,153.5 $3,616.5 12.1x 7.7x NR Low

Layne Christensen Company LAYN $15.25 $299.2 $974.3 $393.9 NM 15.7x NR High

Stantec Inc. STN $67.26 $3,120.9 $1,773.8 $3,286.2 18.9x 12.8x NR Medium

Tetra Tech Inc. TTEK $26.42 $1,704.0 $2,029.5 $1,771.0 16.9x 14.3x NR High

Tutor Perini Corporation TPC $21.36 $1,027.7 $4,190.6 $1,675.2 9.3x 6.7x NR Low

Average 14.3x 11.4x

Metering

Arad Ltd. TASE:ARD $26.17 $647.2 $139.0 $649.8 0.0x 9.0x NR High

Badger Meter Inc. BMI $51.76 $744.2 $327.4 $804.7 24.0x 15.8x Connors High

Itron, Inc. ITRI $43.50 $1,703.0 $1,948.5 $2,002.6 15.6x 11.9x Connors Medium


Roper Industries Inc. ROP $125.63 $12,476.3 $3,158.9 $14,622.2 20.8x 14.6x NR Medium

Silver Spring Networks, Inc. SSNI $19.42 $915.3 $279.8 $773.6 28.0x NM NR Medium

Average 19.1x 12.6x

Infrastructure Diagnostics


Pure Technologies Ltd. TSX:PUR $6.42 $328.0 $59.1 $288.3 32.1x 24.7x NR High

Average 29.8x 18.3x

Filtration/Treatment

Calgon Carbon Corporation CCC $20.48 $1,118.3 $556.6 $1,136.9 21.1x 11.6x NR High

Pall Corporation PLL $81.87 $9,068.7 $2,648.1 $8,769.6 24.0x 15.3x Knight Low



Average 21.2x 12.7x

*Company Descriptions Located in Appendix Source: CapIQ, Company Documents

Municipal Demand Channel: Publicly Traded Company Comp Sheet

- 16 -


Industrial Demand Channel: An Overview

Expected to grow at an annual compounded rate of 6% through 2016, the industrial water equipment

market is expanding due in large part to two secular trends: water scarcity and water quality. With

tightened regulations and a renewed focus on water efficiency, companies are taking a proactive approach

to ensure compliance with increasingly stringent regulations governing both water usage and effluent

quality. Indeed, secular drivers provide a longer-term tailwind, yet investment in water products is largely

determined by the investment cycle of each relevant industry. The industrial demand channel exhibits a

relatively high degree of correlation with the broader industrial economy, and as a result, trends in

capacity utilization, industrial production, and industrial capital investment exert a significant influence

on the trajectory of demand for relevant water products.

Improving fundamentals in the U.S. manufacturing sector are augmenting the secular drivers by creating a

cyclical tailwind, with expanding industries such as hydraulic fracturing providing incremental demand

for water transmission and treatment equipment. With this noted, there can be significant shifts in the end

market conditions of the industrial sector, which makes it prudent to continually monitor the economic

trends emerging in the sector. The forward looking indicators that we follow include: the Architecture

Billings Index (ABI), U.S. Capacity Utilization and U.S. Industrial Production Index. The industrial

indicators provide insight into the investment trends in many of the largely cyclical and water dependent

industrial sectors, including the pulp and paper and mining industries. In addition, as the oil and gas

industry‘s water consumption expands (expected 24% 5-yr CAGR vs. 6% for all industrial markets), U.S.

construction spending on Energy and Manufacturing has become a vital metric to follow in projecting

demand for water equipment and technology.

Industrial Water Equipment Market Dynamics

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

Industrial Water & Wastewater Equipment Market

CAGR: 6%

Numbers in Milliions

Municipal WW

Treatment

Plants87%

Industrial Effluent

Discharge

13%

Wastewater Violations

Source: Public Interest Research Group; GWI/AWI

- 17 -


Industrial Demand Channel: The Market Opportunity

Agriculture consumes 70% of the world‘s water (with

the industrial sector using 22% globally), yet when

considering strictly high-income countries the

industrial sector leapfrogs into pole position,

comprising 59% of total water usage. With

globalization driving significant investment in

manufacturing capacity for developing economies, the

industrial sector is arguably the most important leg of

the water equipment growth story in the coming

decades. Indeed, since the United States already stands

as a high-income country it may seem that the market

opportunity for water equipment products is relatively

muted compared to its developing counterparts,

particularly considering its ―service-oriented‖

economy. However, the infusion of cheap energy has

reawakened the United States manufacturing sector,

opening up opportunities in the next few decades as

certain industries refocus on domestic production. In

addition, the country‘s stature as a developed country

enables it to focus on water quality and consumption

improvements amid this uptick, furthering its position

as a leader in driving improved water quality standards

in the industrial sector.

The $2.8 billion

industrial water

equipment market‘s

primary consumer is

the Pharmaceutical

industry ($520 million),

which finds water

particularly useful for a

number of applications

because of its unique

chemical properties.

While pharmaceutical

is expected to remain

the primary demand

channel for water

equipment in the industrial market, over the next five years certain industries are expected to eclipse

pharma‘s CAGR of 6%, including Oil & Gas (24%), Power (7%), and Chemicals (8%).

304

266

136

43

31

22

6

4

1

0 200 400

Russia

India

China

Global Average

USA

France

Germany

Japan

UK

Water Footprint per Unit Value Added(m

3/1,000 USD)

Source: Waterfootprint.com

Source: GWI/AWI

Industrial Water & Wastewater Treatment End Market: 2007 vs. 2016E

18%

14%

13%

11%7%

6%

5%

26%

2016E

Size: $3.8 bln

16%3%

12%

12%

11%9%

6%

31%

2007

Pharmaceutical

Oil & Gas

Food & Bev.

Power

Pulp/Paper

Electronics

Mining

Other

Size: $2.7 bln

- 18 -


Focus Issue #4: “Virtual Water” – A Holistic Measure of Water Consumption

The concept of ―Virtual Water‖ measures the volume of water required to produce goods and services,

with the term ―virtual‖ reflecting the fact that finished products contain little of the ―actual‖ water used in

its production. Much of the water efficiency discussion focuses on personal consumption (43,000

gallons/year), but this is minor relative to the nearly 700,000 gallons/year per capita required to enable

modern lifestyles. While academic literature on the concept of virtual water focuses on farming, which

accounts for about 70% of water consumption, the concept is also highly relevant for many industrial

companies, particularly as industry becomes a larger consumer of water. Indeed, many companies not

associated with the so-called ―water industry,‖ such as Dow Chemical (DOW-NR), International Paper

(IP-NR), Intel Corp. (INTC-NR) and U.S. Steel (X-NR), among others, rely upon trillions of gallons of

freshwater annually as a critical component of their everyday processes. With water scarcity and water

quality issues of growing concern worldwide, the business of helping companies minimize their virtual

water footprint should see consistent growth for many years to come.

Though discussions on water usage and conservation efforts often focus on residential consumption, the

concept of virtual water helps to illustrate the actual water usage patterns of modern society. Products

seemingly unrelated to the water industry in actuality are core to the rationale for investing in the water

sector, as the massive use of water highlights the criticality of enhancing water efficiency in these

everyday applications. In particular, companies whose products and services help farmers and industrial

customers use water as efficiently as possible (and to optimize their effluent water quality) should

continue to see a strong secular tailwind in the years ahead. This applies to a wide range of companies,

including those providing efficient irrigation systems (Lindsay Corporation-LNN, Valmont Industries-

VMI) and those working with industrial customers to optimize water usage patterns (Xylem-XYL). This

issue of water conservation is a vital component to the discussion going on today about a budding, water-

intensive activity to be discussed later: hydraulic fracturing.

ProductVirtual

Water Comments Product

Virtual

Water Comments

Egg 35 gall. Chicken feed production. Coffee (8 oz) 37 gall. 1,100 cups of water per cup.

Cotton T-Shirt 530 Cotton farming, processing. Hamburger 650 Raising livestock water intensive.

Bottle of Beer 20 Barley production, brewing. Loaf of Bread 170 10 gallons of water per slice.

Plastic (1 lb) 240Among most water intense

industries in water/sales dollar.Car 38,600 Metal, rubber, vinyl production.

Glass of Wine 32 Vineyards water intensive. Cheese (1 lb) 2,970 2.5 gall. of milk per lb of cheese.

Bag of Potato

Chips 50 Potato production. Milk (1 gal) 1,000 Dairy farming, processing.

Leather Shoes 2,100 Cattle ranching. Microchip 32 Many plants in arid regions.

Source: Hoekstra, Waterfootprint.org, Janney Montgomery Scott LLC Note: All virtual water content figures in gallons.

Virtual Water Content: Water Required to Produce Everyday Products

- 19 -


Focus Issue #4: “Virtual Water” – A Holistic Measure of Water Consumption – Cont’d

.

0.5

2

9

27

93

110

354

474

827

1,082

0 200 400 600 800 1,000 1,200

INTC

GM

XOM

NKE

EXC

X

BUD

IP

WLK

MCD

Water & the Income Statement: Gallons per Dollar of Sales

Source: Company Reports, waterfootprint.org

With a tremendous amount of "virtual water" embedded in

everyday items, water efficiency is increasingly relevant to

companies not typically associated with the "Water Sector."

McDonald's uses a whopping

1,082 gallons of virtual water to

generate $1 in revenue.

0

2,000

4,000

6,000

8,000

10,000

12,000

Japan China USA Brazil Australia Russia Italy

Average Virtual Water Content of Selected Products (yd3/ton)

Corn Wheat Soybeans Beef

Global

Average

The virtual water content of products varies greatly from place to place

as a result of differences in climate, farming techniques and land

quality. Due to the large amounts of time and feed required to raise

cattle, beef production requires relatively massive amounts of water.

14,410

27,700

27,500

22,400

22,200

20,275

17,25016,430

Source: waterfootprint.org

- 20 -


Industrial Demand Channel: Growth Dynamics

As mentioned above, the industrial

water sector has both secular and

cyclical catalysts that shape demand for

treatment and transmission products.

Environmental. The Clean Water Act,

amended and implemented by the EPA

in 1972, regulates both the discharge of

pollutants into the waters of the US and

the quality of surface water through the

setting of water and wastewater quality

standards for industry, making it

unlawful to discharge polluted industrial

effluent from a point source (i.e. pipes,

collecting ponds) into navigable waters (unless a permit is obtained). Accompanying the Clean Water

Act, the National Primary Drinking Water Regulations (NPDWRs) were introduced in 1976 under the

Safe Drinking Water Act, identifying 22 various ―contaminants‖ to be regulated in the U.S. Water

Supply. With the basket of regulated contaminants vastly expanding (over 90 now, though 71 were

subject to the 2010 review), the EPA established a cycle of 6 years for the agency to conduct reviews of

the appropriateness of each water regulation promulgated. In addition, the Agency also maintains a

Contaminant Candidate List (CCL) that is not covered by the six-year review, in which it must

periodically determine to regulate at least five or more contaminants on the list. The continually evolving

regulation of water contaminants requires equally progressive adoption of water treatment technologies

and instruments by the industrial sector to ensure compliance.

N.A/U.S. Manufacturing Resurgence. The U.S. is experiencing a manufacturing renaissance due to the

emergence and/or recognition of certain benefits of domestic production that were either overlooked in

the past or did not exist. For one, the cost of labor gap is closing as developing economies continue to

expand per capita income. While it is still estimated to be 20% more expensive to produce goods in the

U.S. compared to historically cheaper overseas markets, this gap has been closed in recent years as the

United States has began to leverage its fuel capacity primarily through the extraction of gas via hydraulic

fracturing (natural gas is now four times more

expensive in Asia as the U.S.). Advantages to

domestic production also exist outside of cost

convergence, with companies benefitting from the

reduction in supply chain complexities as well as

gaining a greater handle on quality control since

many that outsource manufacturing have limited

communication into the assembly line. The

residual effect of an uptick in manufacturing

activity is not only a net positive for the broad

U.S. economy, but specifically for the water

products market as the majority of water

consumption in the U.S. is for industrial purposes.

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

300,000,000

U.S. Nat. Gas Market Production

Source: U.S. EIA*Janney Estimate based on extrapolation of 2010-2012

in Millions of Cubic Feet

$0

$100

$200

$300

$400

$500

$600

$700

2007 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E

Industrial Water & Wastewater Treatment Equipment

by End Market

Oil & Gas Power Food & Bev. Pharmaceutical

Source: GWI/AWI*Numbers in Millions

- 21 -


Focus Issue #5: The Water/Energy Nexus

Water and energy have a codependent relationship, with the water industry needing energy to treat and

distribute water, and the energy industry needing water for everything from discovery to production and

refining. Representing 15% of the world‘s total water consumption (second only to the Agriculture

industry which requires an astounding 70%), the energy industry uses water for fuel extraction, refining

and processing, transporting and power generation, harboring a massive water equipment end market.

Energy Market Opportunity. The U.S. has long boasted the most formidable energy industry in the

world, yet the mass introduction of revolutionary drilling techniques to release ―trapped‖ oil and gas in

shale rock formations (i.e. horizontal drilling) that started in the late 1990s has taken it to new levels, with

the IEA projecting the U.S. to pass Saudi

Arabia as the largest oil producer by 2020

and become entirely energy self-reliant by

2035 (The U.S. is still the world‘s largest oil

consumer, after all). At the helm of this

transformation is America‘s transition to

natural gas, as the country‘s natural gas

potential has been estimated by the Potential

Gas Committee to be 2,384 trillion cubic feet,

which is double the estimate from ten years

ago and represents enough fuel to sustain the

U.S. economy for 110 years by itself.

As the principal fuel recovered from

hydraulic fracturing, natural gas now represents 26% of total gas consumption (vs. 17% in 1950),

representing 30% of electricity generation (vs. 18% in 1950).2 This presents an incremental opportunity

to water equipment companies as the U.S. energy industry

continues build out, and although the process water

requirement for shale gas is not massive, there is a need to

handle significant water flow as drilling brings about

produced water that must be treated (an expensive process).

In addition to the natural gas revolution is the move towards

ethanol, which is the second most water-intensive fuel type

without considering the amount of water required to produce

the underlying grains (the inclusion makes it larger than the

previously most consumptive fuel type by a factor of 10).3

With mandates set in place by the Federal government that

require 15 billion gallons of grain-based fuel per year, ethanol

production could expand even further behind efforts to raise

the 10% ethanol blends fuel requirement to 15%. Whether or

not Federal policies remain conducive to ethanol production is

yet to be seen, and while we concede that continued ethanol

production would signify sustained opportunity for water

2 "Annual Energy Review 2011." EIA.gov. U.S. Energy Information Administration, n.d. Web. 19 June 2013.

<www.eia.gov/totalenergy/data/annual/pd 3 Water Market USA 2011. Oxford, United Kingdom: American Water Intelligence, 2011. Print.

0

50

100

150

200

250

300

Water Consumption by Fuel Type(Gallons of Water/Million BTU)

Source: GWI/AWI

- 22 -


equipment, the benefit of U.S. energy independence alone remains indisputable and should provide

incremental opportunity to water treatment and distribution products regardless of the fuel composition.

Power Market Opportunity. The United States

consumes more electricity than the entire European

Union over the course of a year, or if you prefer, uses

more power than Russia, India, Japan, Canada and

Brazil combined.4 Thermoelectric power plants produce

89% of the United States‘ total energy, distinguishing

them as the primary users of water in the power market.

The industry‘s water footprint makes up 39% of U.S.

water withdrawals, though this only translates to 3.3%

of the U.S.‘s water consumption since much of that

water is returned to the water system from which it is

drawn. In determining the water consumption of

thermoelectric power generation, it is important to

consider the type of cooling technology implemented

since water efficiencies vary dramatically. An open-

loop cooling tower, or once-through, is sent through the system to condense the steam from the turbine

once, then returned to the original source of water about 20 degrees warmer.5 Despite net consumption

being low, the large water intake presents potential bottlenecks during drought conditions, while the

discharge of markedly warmer water carries negative environmental effects as well. Closed-loop cooling

has become the method of choice for recently constructed power plants as a result of these side effects.

The technology more efficiently uses the withdrawn water, which, although significantly increases a

plant‘s water consumption, translates into a smaller withdrawal footprint due to the recycling of cooling

water. Another alternative, although less popular, is dry cooling towers, which use air and turbines as the

cooling mechanism. While effectively eliminating water consumption, it does reduce plant efficiency due

to its reliance on ambient weather conditions (including humidity and temperature).6

4 "Central Intelligence Agency." The World Factbook. N.p., n.d. Web. 8 Nov. 2013.

<https://www.cia.gov/library/publications/the-world-factbook/rankorder/2233rank.html>. 5-6

Mielke, Erik, Laura Diaz Anadon, and Venkatesh Narayanamurti. "Water Consumption of Energy Resource

Extraction, Process and Conversion." Belfer Center for Science and International Affairs [Harvard Kennedy School]

Oct. 2010.

Tower TechnologySteam Turbine (coal,

gas,biomass)

Steam Turbine

(Nuclear)

Combined-

Cycle Turbine

IGCC

(coal)

Capital Cost of

Cooling Tech

Once-through 35,030 42,530 13,780 $19/kW

Closed-loop 480 830 260 389 $28/kW

Dry 30 30 30 $182/kW

Tower TechnologySteam Turbine (Coal,

Gas, Biomass)

Steam Turbine

(Nuclear)

Combined-

Cycle Turbine

IGCC

(coal)

Capital Cost of

Cooling Tech

Once-through 315 415 115 $19/kW

Closed-loop 405 575 195 369 $28/kW

Dry 15 15 15 $182/kW

Source: Electric Power Research Institute, Energy Technology Innovation Policy Research Group

Consumption (gal/MWh)

Withdrawals (gal/MWh)

Power Plant Cooling Towers Water Footprint

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Annual Electricity ConsumptionBillions of MWH

Source: CIA World Factbook

- 23 -


Is Fracking Water Footprint Gradually Becoming a Thumbprint?

A combination of an abundant domestic supply and an increasing focus on low-emissions energy has

driven the EIA to project natural gas to comprise 50% of the total U.S. Gas supply by 2035. Hydraulic

fracturing technology is a popular method of extraction, unlocking natural gas through fracturing dense

shale rock formations. The fracturing of the shale rock is traditionally done with pressurized fluids

composed of at least 90% water. This provides significant opportunity for both local utilities and flow

control companies as one horizontal well in a shale formation requires 2-5 million gallons of water. After

the water is used it is then treated to remove contaminants, providing significant commercial

opportunities for water treatment companies at the end of the process as well. Indeed, fracking presents

significant opportunity for water utilities, such as Aqua America (WTR – Neutral) and American Water

(AWK – BUY), which both are engaged in frack-related water supply initiatives, but opponents fear

fracking will compromise water quality in neighboring communities. While the general concern for long-

term water quality is valid, some view its concern in fracking as exaggerated as commissioned studies

continue to represent inconclusive evidence as to the impacts of fracking on groundwater quality.

Post-fracking, millions of gallons of flowback (typically 20-50% of total water used) carries chemicals

used and collected in the fracking process that must be disposed of properly to avoid groundwater

contamination. Companies such as Nuverra (NUV-NR) provide services for the treatment and disposal of

this waste; however the popular method of dumping it in disposal wells has been linked to earthquakes in

Ohio. Waterless alternatives are gaining momentum as public outcries against the water footprint of

fracking grow louder (though hydrofracking remains by far the most prevalent method). Alternative

methods provide environmental benefits as well as economic, whereas Liquefied Propane Gas (LPG)

gel‘s unique advantage—developed by GASFRAC Energy Services (GFS-NR)—is that it reverts to vapor

while underground, which allows for 1) the propane‘s return to the surface in a recoverable form and 2)

the elimination of toxic flowback water. Nitrogen-based fracking fluids, such as Baker Hughes‘s

VaporFrac (BHI-NR), provide similar environmental benefits as nitrogen is simply released into the air

after the process, vastly reducing the cleanup of toxic flowback. Another method developed by Chimera

(CHMR-NR) uses helium, eliminating the need for heat or steam. While these techniques can carry a 50%

premium to conventional hyrdrofracking, those costs are mitigated by the savings from 75% reduced

truck traffic and highly reduced clean up costs. In addition, the alternative methods could skirt

moratoriums on fracking in states like New York who have blocked hydrofracking.

- 24 -


Industrial Demand Channel: Key Macro Indicators

Architecture Billings Index (ABI). The Architecture Billings Index is derived from a survey of

architectural firm principals and partners by the American Institute of Architects that tracks business

conditions the participants are facing (referred to as ―Work-on-the-boards‖). The ABI itself is a diffusion

index from this survey that uses a reading of ‗50‘ as neutral (i.e. neither expansion nor contraction).

While its predictive track record is debatable, the reading remains widely viewed as a leading economic

indicator of non-residential construction by about 9-12 months.

U.S. Capacity Utilization. The United States Federal Reserve publishes a monthly reading of the

industrial capacity utilization in the economy, expressed in a percent form. The reading indicates how

much ―slack‖ there is in the U.S. productive landscape, i.e. how much room there is for manufacturing

expansion without having to deploy capital expenditures to increase production. The reading is extremely

high-level, but does provide some indication of impending cap-ex cycles, which can drive demand for

water-related industrial infrastructure products.

U.S. Industrial Production Index. The Industrial Production Index is an economic indicator published

monthly by the Federal Reserve that measures the real output of manufacturing, mining, electric and gas

industries located within the United States. The index measures production relative to 2007, with the

average reading in 2007 assigned a ―100‖ value, and is constructed by over 300 individual series that are

comprised of market groups (products and materials) and industry groups (durable and nondurable

manufacturing, mining, etc.). Similar to capacity utilization, industrial production provides a gauge of

manufacturing activity that ultimately drives investment in industrial facilities.

U.S. Construction Spending on Power and Manufacturing. U.S. Construction Put in Place is a

monthly measure in millions of USD calculated by the U.S. Census Bureau aggregating both private and

public spending. The U.S. Private construction for Power and Manufacturing is of particular interest

given the industries‘ water dependency. The data sets‘ greatest flaw is that it is a lagging economic

indicator, but it does add to the mosaic of information on the critical industrial demand channel.

- 25 -


Industrial Demand Channel: Key Macro Indicators – Continued

25

30

35

40

45

50

55

60

65

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Architectural Billings Index (ABI)

Source: The American Institute of Architects (AIA)

Contraction ↓


Expansion ↑

Commercial construction fell off dramatically during the recession, and the ABI reflected that,

posting 31 consecutive months of negative readings. While commercial construction has yet

to return to the U.S. in the fashion residential construction has, incrementally positive readings

bode well for non-residential markets.

65.0%

67.0%

69.0%

71.0%

73.0%

75.0%

77.0%

79.0%

81.0%

83.0%

Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13

Capacity Utilization

Source: U.S. Federal Reserve

Capacity Utilization fell off dramatically during the recession as a sharp reduction in demand left

companies operating well below their productive capacities. The U.S. has since rebounded off its July

2009 trough and continues to approach the 80% level that often spurs investment in new capacity.

- 26 -


Industrial Demand Channel: Key Macro Indicators – Continued

80

85

90

95

100

105

9/1/

2000

3/1

/20

01

9/1/

2001

3/1/

2002

9/1

/20

02

3/1/

2003

9/1/

2003

3/1

/20

04

9/1/

2004

3/1/

2005

9/1

/20

05

3/1/

2006

9/1/

2006

3/1

/20

07

9/1/

2007

3/1/

2008

9/1

/20

08

3/1/

2009

9/1/

2009

3/1

/20

10

9/1/

2010

3/1/

2011

9/1

/20

11

3/1

/20

12

9/1/

2012

3/1

/20

13

9/1

/20

13

Industrial Production (Indexed to 2007)

IndustrialProduction fell off dramatically due to the financial downturn in 2008-2009. Activity has

rebounded significantly since, reaching pre-recession levels as manufacturing strength has helped to drive

the U.S. economy back to prosperity.

Source: U.S. Federal Reserve

0

20,000

40,000

60,000

80,000

100,000

120,000

Ap

r-03

Au

g-03

De

c-03

Ap

r-04

Au

g-04

De

c-04

Ap

r-05

Au

g-05

De

c-05

Ap

r-06

Au

g-06

De

c-06

Ap

r-07

Au

g-07

De

c-07

Ap

r-08

Au

g-08

De

c-08

Ap

r-09

Au

g-09

De

c-09

Ap

r-10

Au

g-10

De

c-10

Ap

r-11

Au

g-11

De

c-11

Ap

r-12

Au

g-12

De

c-12

Ap

r-13

Au

g-13

U.S. Private Construction: Power & Manufacturing(in Millions of Dollars, Seasonally Adjusted Annual Rate)

Power (inc. Gas and Oil) Manufacturing

Construction in the Power and Manufacturing industries is a major

driver for water product sales, and the intermittent growth of these end-markets has challenged many OEMs. With power and

manufacturing comprising ~42% of the non-residential construction market, strength in these sectors will be a key component to

growth in water infrastructure product sales in the years ahead.


- 27 -


Industrial Demand Channel: Subsectors and Key Players in Each

Water is a vital ingredient in the production process for various

industries, including pharmaceuticals, food & beverage,

energy/power, mining, and pulp and paper. Water‘s versatility

renders it useful across all levels of production, serving as

anything from a raw material to a transportation method,

depending on which industry it is applied in. While the range of

uses varies dramatically, the categories of product offerings are

relatively fixed within most industries: valves and pumps to direct

the water flow, piping to transport the necessary water, water

treatment equipment (filters) to process the input and/or output

water, chemicals to assist in the treatment procedure, and water

heating and cooling equipment depending on the process needs.

The market opportunity in the water treatment market is massive,

as UNESCO estimates 300-500 million tons of heavy metals,

solvents, toxic sludge, and other wastes accumulate each year

from industry. In developing countries, this leads to 70% of

industrial wastes being dumped (untreated) into waters that

pollutes and reduces the usable water supply. This phenomenon,

combined with an industrial water productivity level well below

the international average and the sheer size of industry in the

United States supplies an attractive market opportunity for

efficient and reliable water equipment. 3

4

4

4

7

9

10

14

14

18

20

20

23

25

26

27

27

32

34

47

51

60

61

114

120

139

0 50 100 150

Russia

Hungary

Poland

Belarus

Canada

Armenia

USA

Czech Republic

France

Turkmenistan

Latvia

Italy

Germany

Netherlands

Finland

Estonia

Portugal

Spain

Norway

Ukraine

Sweden

Lithuania

Austria

Greece

Japan

Denmark

Industrial Water Productivity(Industrial Value Added/

Industrial Water Use)

Source: World Water Development Report 2, UNESCO 2006

Brief Description Key Players

Valves/

Pumps

Just as in the municipal market, the scale of water use requires reliable and durable

valves and pumps to direct the flow of water towards its required location.

Conbraco, GRC,

FELE, IEX, MWA,

PNR, RXN, Toto,

Watson-Marlow,

WTS, XYL

Piping/

Storage

Pipes allow the flow of water to and from its designated process point. With the water

dependency of industries like oil extraction and coal production, pipelines are often built

solely for the respective plants. Storage tanks are also used for water, often for heating

purposes in order to have larger amounts of hot water on demand.

FSTR, Griffin,

McWane, NES,

NWPX, U.S. Pipe

Water

Treatment

Water treatment activities are executed in a vast range of industrial activities. Whether it

is pretreatment of water for pharmaceutical purposes, or more commonly, treatment of

excess water via productive activities, the EPA enforces strict water quality requirements

that demand companies to properly treat their produced water.

CLC, DCI, GE, ECL,

NES, PLL, XYL

Water

Heating/

Cooling

The scale of industrial operations requires specifically engineered water heating (water

heaters & boilers) for both factory heating and production as well as cooling equipment

(particulary in power production) to remove excess heat emitted from production

activities, most notably in nuclear power plants.

AOS, Bradford

White, HSC,

Rheem, SPW, WTS,

XYL

Water

Treatment

Chemicals/

Disposal

While UV Disinfection continues to gain in popularity, many water treatment processes

still require water disinfectants such as chlorine, ozone, carbon, etc. In addition, many

companies offer services for safe and legal disposal of byproducts from water treatment.

CCC, CBT, TSX:CUS,

CWST, ECL, GE,

HWKN,

Products

Industrial Water Products Market

- 28 -


Focus Issue #6: Water Treatment Stokes Conservation

While treatment of process water represents a significant opportunity,

the treatment of produced water (resulting from processes) has become

a major focus in the initiative to decrease the water footprint of

industries. Water used from production is increasing in many

applications, particularly in the oil and gas industry as traditional

sources of energy are exhausted. Expanding alternative sources, such

as fracking and enhanced oil recovery, require enormous water

consumption and produce greater amounts of water as well, leading

companies like Shell to forecast an increase from a 2.7x water/oil

extraction ratio in 2007 to 5x by 2025. With this said, other

applications are becoming more water-efficient, particularly in power

plants, the industry‘s largest consumer of water, as the transition of

coal and oil-fired plants to gas plants reduces their water footprint, with

gas being less water-intensive than other power generation alternatives.

Mining and ballast water also require high amounts of water filtration,

with many industrial companies ―pre-treating‖ water in-house and

recycling in order to combat rising water and treatment costs. Indeed,

many types of water filtration are available, but certain technologies

have experienced growth that is outpacing the market, as zero liquid

discharge (ZLD) systems lead the way with a 27% CAGR from 2007

through 2016, easily beating the market‘s rate of 4.1%. ZLD as well as

ion exchange systems are growing in popularity because they leave

little waste after the water is treated via evaporation technology or

alteration of its chemical composition. The latest technology offered by

companies like Xylem provides an opportunity for firms to both

enhance their environmental performance and reduce costs.

Although a company‘s reuse of treated

wastewater for additional industrial

processes is the preferred method, many

countries are moving towards more

expansive methods of recycling, such as

irrigation and drinking water. Despite the

so-called ―yuck factor‖, the reality is that

over 1 billion people do not have access to

safe drinking water worldwide, and the

greater acceptance of this proven

technology would increase the prospects of

a sustainable water supply, and improve the

possibility of meeting basic needs in

poverty-stricken regions.

0

50

100

150

200

250

300

350

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

High Growth Water & WW Treatment Equipment

UF/MF Membranes (CAGR: 16.5%) Reverse Osmosis/NF (17.2%)

Ion Exchange / EDI (11.1%) Zero Liquid Discharge (27%)

*In Millions Source: GWI, JCM

70%

3%

86%

60%

10%

100%

30%

16%

9%

100%

50%

71%

78%

100%

100%

61%

87%

23%

63%

58%

61%

115%

40%

75%

10%

23%

7%

1%

15%

131%

35%

79%

41%

3%

0% 100% 200%

Vietnam

USA

UAE

Turkey

Tunisia

Syria

Sd. Arabia

Nicaragua

Mexico

Libya

Lebanon

Kazakhstan

Jordan

Japan

Egypt

China

Argentina

Global Wastewater Profile:

Treatment & Use

Treated WW (% of Produced)

Used WW (% of Treated)

Source: FAO Aquastat, JCM

- 29 -


Industrial Demand Channel: Key Players Comparable Analysis

Ticker PriceMarket


EV/

EBITDA

JMS

Analyst

Water

Exposure

Valves/Pumps


Franklin Electric Co., Inc. FELE $39.84 $1,898.2 $941.0 $1,978.5 20.7x 12.7x NR High




Rexnord Corporation RXN $23.40 $2,287.9 $2,035.2 $4,066.9 14.8x 10.6x Connors High



Average 20.5x 13.2x


LB Foster Co. FSTR $43.75 $451.9 $582.2 $355.9 15.2x 6.8x NR Low


Northwest Pipe Co. NWPX $37.40 $353.4 $496.5 $431.8 24.9x 8.8x NR Medium

Average 20.1x 9.6x

Water Treatment

CLARCOR Inc. CLC $58.97 $2,953.1 $1,125.9 $2,765.7 22.2x 13.0x NR Low

Ecolab Inc. ECL $106.43 $32,067.3 $12,739.7 $38,992.9 26.0x 15.7x NR Low


General Electric Company GE $27.05 $273,674.8 $144,912.0 $657,920.8 15.5x 22.8x NR Low

Pall Corporation PLL $81.87 $9,068.7 $2,648.1 $8,769.6 24.0x 15.3x Knight Low


Average 21.2x 15.4x

Water Heating/Cooling

AO Smith Corp. AOS $53.20 $4,853.1 $2,119.2 $4,604.1 24.5x 15.1x Connors High

Harsco Corporation HSC $27.13 $2,188.5 $2,981.5 $3,213.3 22.5x 7.5x NR Low

SPX Corporation SPW $94.13 $4,269.2 $5,033.4 $5,479.4 19.5x 10.6x Baliotti Low



Average 21.2x 11.4x

Water Treatment Chemicals/Disposal

Calgon Carbon Corporation CCC $20.48 $1,118.3 $556.6 $1,136.9 21.1x 11.6x NR High

Canexus Corporation TSX:CUS $6.18 $939.4 $558.9 $1,347.0 NM 12.2x NR High

Casella Waste Systems Inc. CWST $5.65 $225.6 $466.3 $726.1 NM 9.7x NR Low

Ecolab Inc. ECL $106.43 $32,067.3 $12,739.7 $38,992.9 26.0x 15.7x NR Low


Hawkins Inc. HWKN $35.85 $380.2 $354.5 $336.0 18.5x 7.8x NR High

Average 20.2x 13.3x

Source: CapIQ, Company Documents

Industrial Demand Channel: Publicly-Traded Company Comp Sheet

- 30 -


Construction Demand Channel: An Overview

According to the Bureau of Economic Analysis, the construction industry represented 3.6% of GDP on a

value-added basis in 2012. While materially smaller than the contribution from manufacturing (12%), this

$640 billion industry is substantially larger than

utilities, agriculture, or mining (other key water

product end-markets). The market opportunity for

water products in this space is massive, with each

building constructed requiring significant

plumbing infrastructure. Furthermore, a robust

repair and replacement opportunity exists due to

delayed capital investments by homeowners

during the economic downturn, which companies

such as Rexnord (RXN-Neutral) have exploited

recently with its Zurn brand. Although margins are

somewhat deflated in the aftermarket, remodeling

is an attractive demand channel for water

equipment during down cycles in new

construction activity, and one that has been rapidly

growing as of late (Leading Indicator of Remodeling is running at +9% YoY, fastest rate since 2006).

In contrast to the ―megatrend‖ growth stories in the industrial, agriculture, and municipal end markets, the

construction market for water products is more cyclical than its secular counterparts. Driven

predominately by macroeconomic factors, including financing availability, income levels and general

consumer outlook, the construction

market is split between two segments:

residential and nonresidential. Indeed,

every structure includes some degree

of water infrastructure, but there are

certain key structures that are highly

water intensive. For instance, the full

service nature of a household provides

a swift tailwind for plumbing

products, as do commercial structures

such as lodging and hospitals. These

buildings amplify many of the

residential uses for water to mass

scale, resulting in extremely water

intensive operations that require

complex and reliable systems.

To monitor the state of the construction demand channel, we follow a series of economic indicators,

including: residential housing permits and starts, the Architectural Billings Index, the Leading Index of

Remodeling Activity (LIRA) and Private Construction Put-in-Place. These readings help provide insight

into the demand environment for products sold into the construction market, including pumps and valves,

HVAC, fire protection, point of view systems and water filtration.

209 gal. per

room

231 gal. per

staffed bed

441 gal. per

HH

0

50

100

150

200

250

300

350

400

450

500

Lodging Hospitals Residential

Daily Water Usage

Sources: FDEP, AWWA and Practice Greenhealth

45%

5%

60%

9% 10%

55%

30% 29%

13%

23%

0%

10%

20%

30%

40%

50%

60%

70%

Watts (WTS) Mueller (MWA) AO Smith

(AOS)*

Xylem (XYL) Rexnord (RXN)

Revenue Breakdown: End Market Exposure

Residential Commercial

*Janney Estimate Source: Company Documents

- 31 -


Construction Demand Channel: Market Opportunity

As noted previously, the scale of the construction market in the United States is enormous, and in order to

properly examine the opportunity for water infrastructure companies, the analysis is divided into two

distinct sub-markets: residential and nonresidential.

Residential. U.S. Residential Construction was up 21% in August 2013 to $340 billion (annualized),

representing 53% of total private construction in the past twelve months within the United States (with

27% of private construction comprised of single-family homes alone). The market opportunity for water

products within this market is

significant, as the average cost of

plumbing in a new home totals

$11,000. With the 769,000 homes

completed in the twelve months ended

August 2013, this totals roughly $8.5

billion spent on plumbing in the past

year, and while a good portion of that

is attributed to labor, it nonetheless

illustrates a substantial source of

demand for water product companies.

Remodeling is a sizeable market as

well, projected by Harvard Joint

Center for Housing to reach $150

billion annually by the end of 2013, or

~44% of residential construction.

Nonresidential. Private non-residential construction in the United States totaled just over $300 billion in

2013, with power, manufacturing, office buildings, health care, and lodging (to a lesser extent) posing as

large contributors. In addition to the energy and manufacturing industries, commercial construction is also

a significant driver of water product

demand. Office buildings ($29B),

health care ($29B), and lodging

($12B) are acutely relevant as these

structures require extensive water

infrastructure to ensure the

compliance with stringent plumbing

codes and standards, such as the

soon to take effect ―lead-free‖

regulations. This regulated dynamic

provides barriers to entry for

competing firms, allowing

companies like Watts (WTS-

Neutral) to adopt premium pricing

with limited threat of market entry

from low-cost manufacturers.

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

$450,000

Non-Residential Construction vs. Watts & Mueller TTM Revenue

Non-Rez Construction TTM (L. Axis) WTS TTM Rev (R. Axis) MWA TTM Rev (R. Axis)

Source: U.S. Census Bureau, CapIQ* Numbers in Millions

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

$2,200

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

Residential Construction vs. Watts & Rexnord Annualized Revenue

Residential Construction LTM (L. Axis) WTS Rev LTM (R. Axis) RXN Rev LTM (R. Axis)

Source: U.S. Census Bureau, CapIQ*Numbers in Millions

- 32 -


Construction Demand Channel: Residential Growth Dynamics

Record low interest rates spawned a significant

resurgence in the housing market in 2011-2013,

and the renewed construction activity has been

touted by many as instrumental to the U.S.

turning the page from the ―great recession‖. Yet,

residential housing only contributed 2.7% of GDP

in 1Q2013, which at first blush suggests that

perhaps its contribution to economic activity is

more perception than reality. However, the reason

for the sector‘s vital importance to the economy is

the same argument for its importance to the water

products industry: the spillover effect. As homes

and developments are built, they must be outfitted

with water distribution systems and the

accompanying appliances and infrastructure

within the structure.

This point has been well illustrated, as companies like Mueller Water Products (MWA-Neutral) have

clawed back to profitability on the back of an improved housing market. With this noted, a largely unsung

contributor to the water products industry has been the residential remodeling market, which came alive

in the second half of 2012 and buoyed demand for household products such as faucets, valves, drains and

PEX piping while the housing market decided which way to turn. With 44% of the housing stock in

America constructed before the 1970s, and much in the way of home repairs and remodeling abandoned

in recent years due to the challenging economic conditions, this supplementary demand channel will

provide a long-term (and generally less cyclical) driver for water products as the remodeling and repair

market is expected to accelerate its upward trajectory to a run rate of ~$150 billion by the end of 2013,

expanding 16% over 2012.

Source: U.S. Census Bureau, Industry Sources

Replacement Market Dynamics

68.7

88.4

102.3

119.6124.5 128.2 130.1 132.2

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

1980 1985 1990 1995 2000 2005 2010 2011

U.S. Housing Stock(Millions of Units)

2000s12%

1990s12%

1980s13%

1970s19%

1960s12%

Before 1960s

32%

U.S. Housing Stock by Decade of Construction

3.24

2.89 2.932.82

2.72.52

2.272.42 2.43

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

1995 1997 1999 2001 2003 2005 2007 2009 2011

Housing InadequacyOwner-Occupied Homes Deemed Moderately or

Severely Inadequate (Millions)

After drifting downward for a number of years, housing inadequacy has begun shifting upward off the trough of the housing market as owners delay necessary improvements.

Source: JCHS

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

1980 1985 1990 1995 2000 2005 2010

U.S. Housing Stock(Millions of Units)

Occupied Vacant

- 33 -


Construction Demand Channel: Nonresidential Growth Dynamics

While residential construction is indeed a

strong driver for water product demand, many

companies cite the commercial construction

market as a larger portion of their end market

exposure. Commercial structures require

analogous functionality to residential

structures, with buildings such as hospitals

requiring similarly functional products

(faucets, valves, drainage, water filtration,

etc.) yet on a larger scale. The amplified size

of each application would perceivably allow

for healthier margins, yet the large project

bias of nonresidential construction can lend to

pricing pressure from companies attempting

to win the contract. In the years since 2008,

challenging economic conditions have caused commercial construction demand to be a headwind to

profitability for companies serving the end-market. The tide is looking to turn however, as investment has

stabilized over the past two years and is expected to post incremental growth from 2013 throughout 2016.

Commercial construction‘s evolution into a tailwind should spawn healthy growth for water equipment

companies over the balance of the next few years, as firms are able to exploit both rebounding

commercial demand and resurgent residential construction activity.

0

10,000

20,000

30,000

40,000

50,000

60,000

Private Construction: Water Intensive Structures

Lodging Hospitals Office

Source: U.S. Census Bureau*2013 as of August data

$288 $287 $281$291

$327$337

$287

$236$223 $223

$214$225

$237$247

0

50

100

150

200

250

300

350

400

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E

Non-Residential Building Construction(Real USD in Billions)

Source: IHS, Industry Sources

- 34 -


Construction Demand Channel: Key Indicators

Housing Permits. Housing permits are a leading indicator of housing construction in the United States.

The U.S. Census Bureau conducts a monthly recording of the housing permits that have been awarded in

the twelve months up until the end date reported. The purpose of the index is to get an early read on

trends in new home construction in the coming months.

Housing Starts. Released by the U.S. Census Bureau, housing starts measures new residential

construction projects that have begun during the twelve months leading up to the end date reported. Water

product sales see a direct benefit from increased housing starts, but there is usually 1-2 quarter lag from a

significant change in housing starts to when the benefit/detriment is recognized by companies like Watts

and Rexnord.

Architecture Billings Index. The ABI is a monthly survey of principals and partners at architecture firms

in the United States that serves as an indicator of commercial construction. The survey, conducted by the

American Institute of Architects, leads nonresidential construction activity by about 9-12 months, with

readings over the ‗50‘ mark indicating billings increasing in the month, and vise versa.

Leading Index of Remodeling Activity (LIRA). The Leading Index of Remodeling Activity is a

quarterly study conducted by the Joint Center for Housing Studies of Harvard University that estimates

national homeowner spending on improvements for the current quarter and subsequent three quarters.

Measured as both an absolute dollar value and annual rate of change, the indicator helps identify

inflection points in the business cycle of home improvement through supplying a short-term outlook on

homeowner remodeling activity.

Private Construction Put in Place. Private Construction Put-in-Place is a survey conducted by the

United States Census Bureau that estimates the total dollar value of construction work done in the private

sector within the U.S. in the twelve months up until the reporting date. The measure includes the cost of

architectural/engineering work, labor and materials, overhead, interest and taxes, and contractor profits.

- 35 -


Construction Demand Channel: Key Indicators - Continued

0

500

1,000

1,500

2,000

2,500

U.S. Residential Permits (000s)

After reaching record heights in 2005 (permits are a leading indicator of the housing cycle), U.S.

Residential permits experienced an extended slump from 2006 to mid 2009. The recovery in permit activity (though still below 2005 levels)

bodes well for water infrastructure companies that sell into the residential construction industry.

Source: US Census Bureau

0

500

1,000

1,500

2,000

2,500

U.S. Housing Starts (000s)

U.S. housing starts have rebounded from the trough experienced in 2009, and the percolation in residential construction has been a boon to the U.S. economic recovery. Nonetheless, activity in the housing market still remains well below the

levels experienced from 2000 through 2006.

Source: United States Census BureauSource: United States Census Bureau

- 36 -


Construction Demand Channel: Key Indicators - Continued

25

30

35

40

45

50

55

60

65

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Architectural Billings Index (ABI)


Contraction ↓


Expansion ↑

Commercial construction fell off dramatically during the recession, and the ABI reflected that,

posting 31 consecutive months of negative readings. While commercial construction has yet

to return to the U.S. in the fashion residential construction has, incrementally positive readings

bode well for non-residential markets.

$60

$70

$80

$90

$100

$110

$120

$130

$140

$150

$160

2Q-2

000

4Q-2

000

2Q-2

001

4Q-2

001

2Q-2

002

4Q-2

002

2Q-2

003

4Q-2

003

2Q-2

004

4Q-2

004

2Q-2

005

4Q-2

005

2Q-2

006

4Q-2

006

2Q-2

007

4Q-2

007

2Q-2

008

4Q-2

008

2Q-2

009

4Q-2

009

2Q-2

010

4Q-2

010

2Q-2

011

4Q-2

011

2Q-2

012

4Q-2

012E

2Q-2

013E

4Q-2

013E

2Q-2

014E

Leading Index of Remodeling ActivityHomeowner Improvements (Four-Quarter Moving Total $Billions)

Source: Harvard University Joint Center for Housing Studies

Demand in the remodeling market is expected to tick up notably over the next quarter (and years, in our view) for a number of reasons. 44% of

homes in the United States were constructed during or before the 1970s, and with many homeowners delaying housing improvements during the recession, activity is now percolating as investors pursue delayed repairs.

- 37 -


$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000Fe

b-0

0

Au

g-0

0

Feb

-01

Au

g-0

1

Feb

-02

Au

g-0

2

Feb

-03

Au

g-0

3

Feb

-04

Au

g-0

4

Feb

-05

Au

g-0

5

Feb

-06

Au

g-0

6

Feb

-07

Au

g-0

7

Feb

-08

Au

g-0

8

Feb

-09

Au

g-0

9

Feb

-10

Au

g-1

0

Feb

-11

Au

g-1

1

Feb

-12

Au

g-1

2

Feb

-13

Au

g-1

3

U.S. Private Construction Put-in-Place(in Millions of Dollars, Seasonally Adjusted Annual Rate)

Residential Construction Non-Residential Construction Total Private Construction

U.S. Private Construction bottomed out in early 2011 and has struggled to regain a level on par with pre-recession levels since.

With this said, private construction activity has exhibited an decidedly upward trajectory in the past 18 months due initially

to a resurgence in residential construction, with commercial construction adding gains also adding gains more recently.


- 38 -


Commercial Demand Channel: Subsectors and Key Players in Residential Market

The water infrastructure industry provides countless products to residential construction, equipment that

enables everyday living through ensuring running water and warm homes. The vast majority of these are

―behind-the-wall‖ products whose primary purpose is plumbing, like Watts Water‘s (WTS-BUY) shutoff

valves or water hammer arrestors. These products allow for the functionality of decorative products, like

toilets and sinks by Zurn (owned by RXN-Neutral) or water heaters via General Electric (GE-NR) and

A.O. Smith (AOS-BUY). Within the decorative classification there are a vast array of functions, with

Watts boasting a number of offerings that enable it to satisfy numerous plumbing needs. Other firms in

the industry choose to offer a more focused product to exploit their expertise, such as Conbraco (Private)

who focuses on valves or A.O. Smith, whose focus on the water heating industry has allowed it to achieve

leading market share in both the U.S. and China. Xylem (XYL-BUY) falls somewhere in the middle,

providing many water infrastructure products while choosing not to participate in the decorative products

category.

Although these products are sold to similar end markets, their functions are complimentary and most

applications are non-discretionary for homes and businesses, preventing cannibalization or product

substitution that municipal markets may face if, for instance, a city chose to invest in water meters rather

than infrastructure diagnostics. To illustrate, when a house is constructed it requires valves to monitor the

flow of water; water heating units for showers, cooking and cleaning; drainage systems for showers; and

decorative products such as faucets and showerheads. Luxuries like radiant under-floor heating and

environmentally friendly and energy efficient products such as tankless or solar charging water heaters

are gaining larger popularity in homes as well. Internationally, water heater sales are also experiencing

significant opportunity due in large part to the expansion of the middle class in emerging markets.

Alternative Energy

•Solar Water Heating Systems

•Solar Control Packages•Geothermal ControlPackages

Laundry Room

•Washing Machine Shutoff Valves•Water Hammer Arrestors•Gas/Water Connectors

Water Heater / Boiler

•Conventional/TanklessWater Heaters

•Gas/Electric Boilers

•Temp/Pressure Release Valves•Backflow Preventers

Xylem•Heating & Hot Water SystemPumps

•Steam and Boiler Controls

Bathroom

•Decorative Products•Tempering/Stop Valves•Electric Tile Warming•Waste Drains•Hot Water RecirculationSystems

Kitchen

•Mixing/Stop Valves•Metal/Plastic Tubular products•Electric Tile Warming

•Point-of-Use RO Water Filtration Systems

Radiant Heat Products

•Radiant Underfloor HeatingSystems

•Electronic TemperatureControls

Water Products - Residential

Source: Janney Capital Markets

- 39 -


Construction Demand Channel: Subsectors and Key Players in Nonresidential Market

Many products needed in commercial applications are comparable to those used in residential

applications, including: water heaters, backflow preventers and point-of-view products like toilets.

However, the amount of water processed in commercial applications leads to the need for additional

products, i.e. centrifugal pumps and reverse osmosis filtration systems. In particular, commercial

applications in the kitchen require numerous advancements to ensure the safety, sanitation, and

functionality of the kitchen. While some establishments may invest in products like beverage dispensing

and chilling pumps, most commercial kitchens will have grease interceptors, drainage systems, and water

filtration systems for beverages. Fire protection is another instance where the commercial scale creates

additional product categories and drives incremental demand, opening up the market for Gorman-Rupp

(GRC-BUY) and other fire protection system companies who offer fire sprinkler piping, with valves and

sprinkler heads supplied by Watts.

Considering the operations of a commercial property, wastewater drainage will be integral in achieving

efficient and safe operations. While there must be roof and floor drains throughout any building, effluent

drainage systems are of vital importance to ensure the proper and safe disposal of waste byproducts.

Indeed, as the price of water treatment and water itself become more expensive, opportunities exist for

firms to enhance their operational efficiency while also reducing costs through either ―pre-treatment‖ of

water in-house or recycling of used water. Another option is to leverage resources independent of

operations, with offerings such as solar-powered rain barrel pump systems being used to harvest

otherwise underutilized rainfall and solar energy for irrigation purposes.

HVAC

•Water heaters & boilers

G •Various Pumps

•Radiant under floor heating•Expansion valves

Kitchen

•Gas and Water Shutoff Valves•Metal/Plastic Tubular products•Point-of-view products•Steel piping and drains•Grease interceptors•Water Filtration Systems

Xylem•Beverage Dispensing/Chilling Pumps•Water Filtration Systems

Alternative Energy

•Solar Control Packages

•Solar-powered rain barrel pump system

Fire Protection

•Centrifugal Pumps & Systems

•Piping Systems•Valves, couplings, fittings, etc.

•Backflow Preventers•Transition Risers•RF PEX Tubing & Sprinkler Fittings

•Fire Pumps & Systems

Irrigation

•Backflow Preventers/Enclosures•Auto Control/Pressure Reducing Valves•Shutoff/Butterfly/Release Valves

•Water Lift & Booster Pump Station & Controls•Self Priming Centrifugal Pumps

Water Products - Commercial

Filtration/Potable Water

•Gas Connectors/ Various Valves•PEX Plumbing Systems•Backflow Preventers•RO Filtration Systems

•RO Filtration Systems•NF membrane systems•Filter Cartridges and housings•Rapid Gravity Media filtration

Wastewater Drainage

•Roof/Floor Drains•Trench Drains•Acid Waste Systems•Cleanouts•Interceptors•Fixture Carriers

•Sump, effluent and sewage wastewater removal and drainage products

•Electronic temp. controls, manifolds•Steam traps, strainers•Feed water regulators

•Circulator Pumps•Heating/Hot Water pumps•Steam/Boiler controls

Source: Janney Capital Markets

- 40 -


Construction Demand Channel: Key Players Comparable Analysis

Ticker PriceMarket


EV/

EBITDA

JMS

Analyst

Water

Exposure

HVAC





Regal Beloit Corporation RBC $73.31 $3,303.9 $3,084.0 $3,672.1 15.7x 8.7x Burke Low

Average 19.0x 14.1x

Fire Protection






Average 22.2x 12.8x

Irrigation



Toro Co. TTC $58.31 $3,332.8 $1,998.4 $3,395.1 20.4x 11.8x NR Medium



Average 20.9x 12.8x

"Decorative" Plumbing Products

Fortune Brands Home & Security, Inc. FBHS $40.58 $6,745.0 $4,003.4 $6,947.1 21.7x 17.1x NR High


Masco Corporation MAS $20.46 $7,304.0 $8,256.0 $9,654.0 19.1x 12.3x NR High



Average 18.5x 14.9x

Valves & Pumps

Colfax Corporation CFX $57.84 $5,894.1 $4,063.2 $7,002.9 24.9x 13.6x Burke Low

CIRCOR International, Inc. CIR $76.80 $1,351.0 $845.4 $1,314.5 21.5x 14.4x NR Low



Flowserve Corp. FLS $70.19 $9,789.3 $4,893.4 $10,790.2 18.6x 12.5x NR High


Masco Corporation MAS $20.46 $7,304.0 $8,256.0 $9,654.0 19.1x 12.3x NR High




SPX Corporation SPW $94.13 $4,269.2 $5,033.4 $5,479.4 19.5x 10.6x Baliotti Low



Average 20.6x 13.0x

Water Filtration


CLARCOR Inc. CLC $58.97 $2,953.1 $1,125.9 $2,765.7 22.2x 13.0x NR Low

Crane Co. CR $62.98 $3,662.3 $2,543.6 $3,592.8 14.5x 9.1x NR Medium



Average 20.2x 12.2x


Construction Demand Channel: Publicly Traded Company Comp Sheet

- 41 -


Agriculture Demand Channel: Irrigation Overview

The United States has nearly 200 million farmed acres, and

of that amount 55 million acres are irrigated, or

approximately 28%. While in 1998 flood and gravity

irrigation represented 50% of irrigation systems in the U.S.,

by 2008 that had shrunk to 39%, with center pivots

expanding 11 percentage points to comprise 46% of

irrigation systems today. The move towards more advanced

methods of irrigation stems from a concentration of

intermittent drought conditions and farmers‘ increased

concern over rising water and energy costs. The upward

trajectory of input costs will likely continue to drive

demand for more efficient products, however the influence

of weather on the adoption trends for center pivot systems

results in volatile swings in annual demand.

Given the significant price point of center pivots at just

above $80,000 fully installed, fluctuations in net farm

income can have a material influence on demand in the

short run as farmers, on the margin, are less likely to

pursue such a large capital investment in challenging

economic conditions. Net farm income largely moves with soft commodity prices (most notably corn),

and although the adoption of crop insurance has helped

smooth out farmers‘ income statements, commodity

prices still largely govern farming profits. While

challenging farming weather conditions are generally

dismayed by the agriculture machinery industry, times

of drought actually translate into boom years for

irrigation companies (seen in 2012), while wet

conditions typically pressure sales.

The most influential (and direct) water end-market in

agriculture undoubtedly belongs to irrigation, yet the

application of precision agriculture and new, more

efficient farm machinery also aids in the movement to

reduce water consumption. In order to anticipate

demand trends in these markets, we follow a number of

different metrics that amalgamate to convey a general

direction of the ag demand channel: net farm income,

farmland values, corn prices, and farm debt. Shifts in

the market conditions typically constitute

commensurate shifts in the performance of the ag

companies, though certain conditions may supply

different conclusions for each product offering.

40%

5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Flood/Furrow

Irrigation

Center Pivot

Irrigation

Irrigation Water Wastage

Factors by Method

Source: OECD; UNEP; JMS

35%

50%

15%

46%

39%

15%

0%

10%

20%

30%

40%

50%

60%

Pivots Gravity Other

Farm and Ranch Irrigation Survey:

System Type

1998 2008

Source: USDA

- 42 -


Agriculture Demand Channel: Irrigation Market Opportunity

The long-term drivers in the

agriculture industry are among the

most compelling in any of the

demand channels we have

discussed. With global arable acres

per capita steadily declining,

population and subsequent food

consumption increasing, and gross

water consumption steadily on the

rise, the need for greater

productivity in the farm sector will

be a driver for the decades to come.

Indeed, increased output is the

obvious advantage of center pivot

adoption, yet pivot and lateral systems also have an edge over competing irrigation techniques because

they: a) offer a speedy payback period due to water and energy cost reductions, b) reduce contamination

of local water supplies resulting from fertilizer and chemical runoff, and c) are less susceptible to damage

during harvest.

Center pivot systems are predominately used for ―row crops‖, which represent 70% of center-pivot

irrigated acres, or, 83.7 million hectares harvested annually. An installed base of 240,000 center pivots in

North America services these crops (among others), which gives companies like Lindsay and Valmont a

sizeable and consistent replacement demand channel.

In the long-term, public companies like Lindsay and Valmont and private competitors Reinke and T-L

Irrigation will likely continue to see strong demand, and although we believe the pace of adoption is

likely to moderate in the U.S., opportunity exists abroad with much lower penetration rates of efficient

irrigation practices in emerging farm economies such as Brazil and China. For this reason, OEMs are

investing heavily to expand capacity abroad.

9.38.4

7.46.8

5.5

4.3

2.92.1

1.7 1.5

0

1

2

3

4

5

6

7

8

9

10

1860 1880 1900 1920 1940 1960 1980 2000 2020E 2040E

Global Arable Acres per Capita

Source: United Nations

Standard Center Pivot Irrigation System:

Standard Pivot Device: $50,000

Equipment & Installation: up to $60,000

Total Investment Required: up to $120,000

7-Tower

Standard Pivot Length: 1,300 feet

Standard Irrigation Capacity: 160 acres

Minimum Irrigation Capacity: 25 acres

Maximum Irrigation Capacity: 600+ acres

Additional/Optional Functionality:

Pivot Control Systems:

Remote Monitoring Systems:

Enables farmer to operate pivot remotely; Web-based options available

Enables accumulation of data; Aids in maximizing pivot irrigation benefits

Center Pivot System Overview

- 43 -


Focus Issue #7: Precision Ag Adoption in Early Stages (Even in Developed Countries)

GPS applications have come a long way from indentifying and displaying the quickest routes from point

A to point B to transforming the way a farm is managed. Companies like Trimble Navigation, a pioneer in

global positioning, are finding new applications for traditional GPS technology in the agriculture sector

with a line of high-tech products, including automated steering systems for tractors and other equipment,

precise positioning systems and related software for use in land leveling and irrigation design, and

systems optimizing chemical and water application to ensure minimal waste and maximum yield. Indeed,

the use of traditional precision agriculture hardware has picked up in the North America, but the

penetration rate remains low in emerging economies, and even customers in the U.S. haven‘t fully utilized

the benefits offered by comprehensive implementation. In 2000, roughly 40% of farmers in the U.S.

planting corn used some type of precision technology, by 2010 that ballooned to over 70%. While GPS

hardware usage gained popularity, the number of farmers utilizing the technology to create yield maps

that tracks performance on a foot by foot basis remains below 40%. This adoption rate drops even lower

down the value chain of data analytics, which in our opinion represents the largest opportunity today in

precision agriculture. The expanding adoption of technology on the farmstead has allowed farmers to

collect invaluable data that up to this point has in most cases been grossly underutilized. With the help of

increasingly popular technologies such as UAVs, this data pile will grow even larger, and companies like

Trimble are just scratching the surface of the possibilities associated with the harvest of this information.

- 44 -


Agriculture Demand Channel: Growth Dynamics

The growth opportunity in the irrigation market lays in the adoption of technology that facilitates the

efficient use of water. With a large percentage of the country currently using water-inefficient gravity

irrigation techniques (39%), a substantial total

addressable market still exists for center pivots.

Cyclical. The agriculture demand channel has

endured its share of boom and bust cycles over

the past century, with the busts primarily coming

off of periods of jumps in food demand

(wartimes in 1910s and 1940s) and low interest

rates. Today, these same market currents have

sustained a thriving ag market in the U.S., with

food demand growing due to record exports and

an increased focus on biofuels, and farmland

values increasing amid dovish monetary policy

by the Federal Reserve. Many (including us)

have signaled a likely moderation in ag

equipment demand in the intermediate-term,

citing an expected mean regression for corn prices due to unfavorable supply/demand metrics and pace of

growth in farmland values, which have only seen one quarterly contraction in the past 13 years (with the

latest 8 quarters each exhibiting over 20% year-over-year growth). We do however believe it is unlikely

for a moderation in the demand metrics to be on par with that of the 1980s due to the significantly lower

level of average debt carried by farmers now. Even if farmers do see a downturn in crop prices and an

uptick in interest rates, their low level of leverage should grant them the ability to borrow. This access to

capital should prevent a drastic reduction in capital spending that was experienced in prior downturns.

Secular. In addition to the low-debt ―back-stop‖ built in for agricultural demand, the secular trends of

expanding food demand and water consumption on top of a fixed amount of arable acres give the

irrigation market healthy demand drivers for the long-term. Of the earth‘s 37 billion acres of land, only

one third (about 13 billion acres) are arable – meaning suitable for agricultural production of human food.

Lack of water is by far the most common reason for land being deemed non-arable (others include being

excessively cold and overly rocky soil), making access

to water a key long-term constraint on expansion of

agricultural production. With the global population

recently crossing the 7 billion mark, arable acres per

capita currently stands at 1.9 – down from 4.3 fifty years

ago. By 2040, some believe arable acres per capita could

approach 1. This issue is even more acute considering

that changing dietary patterns in emerging markets

require per capita agricultural production to increase as

well. The outsized growth of bushels produced relative

to acres planted in the past 20 years shows that farmers

have recognized this circumstance, and the need to

maximize yields is likely to grow in importance in both

the U.S. and emerging economies in the years ahead.

0%

10%

20%

30%

40%

50%

60%

0

5,000

10,000

15,000

20,000

25,000

30,000

1979 1984 1988 1994 1998 2003 2008

U.S. Center Pivot Acresin Millions

Center Pivot Acres Center Pivot % of Irrigated

Source: USDA Farm & Ranch Survey

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

0

20

40

60

80

100

120

1930 1940 1950 1960 1970 1980 1990 2000 2010

Corn: Planted Acreage vs. Production (Data in Millions)

Bushels Produced (R-Axis) Planted Acres (L-Axis)

Source: USDA

- 45 -


Focus Issue # 8: Influence of Net Farm Income on Demand

Strong demand for agricultural machinery in North America is being supported by record net farm

income in the U.S. The high price of agricultural commodities is putting more cash in growers‘ pockets

and is motivating prospective farmers to make the necessary investments to set up an operation. The dual

effect has created a boom in agricultural equipment demand in the U.S. and emerging farm economies

such as China, Russia and Brazil. While the U.S. has a history of government programs aimed at spurring

investment in the agriculture sector, many developing countries are just beginning to enact or expand

programs that will assist farmers in making the investments needed to compete globally. Indeed, weather

events like the severe drought of 2012 may create fluctuations in demand on a yearly basis. However, the

mass adoption of crop insurance in the U.S. Corn Belt combined with a rise in commodity prices resulted

in record 2012 net farm income and stimulated investment globally. As OEMs respond to the increased

demand by creating more efficient and productive machinery, farmers will be able to produce more while

reducing input consumption. While the connection between machinery and water conservation isn‘t

apparent at first blush, more efficient machinery enhances all aspects of the agricultural production

process, ultimately lessening global stress on water resources for agriculture usage.

- 46 -


Agriculture Demand Channel: Key Indicators

Many of the economic indicators in the agriculture channel are intertwined with one another, and while

weather drives a substantial portion of the market dynamic, there are measurable metrics that allow for

some insight into the direction of the United States agriculture sector.

Net Farm Income. U.S. Net Farm Income records the profits or losses incurred by the entire farming

sector in the United States throughout a calendar year. This metric is oft cited as a main driver of capital

expenditure for farmers. While true, it is important to note that net farm income is actually what is left in

the farmers‘ pockets after all expenditures for the year are recorded, including capital committed to new

machinery. The USDA forecasts U.S. net farm income for the prospective year, updating estimates three

times each year. The metric provides insight into the economic health of the U.S. farmer, telegraphing the

likely level of capital spending.

Corn Prices. The fluctuation in corn prices heavily influences the profitability of farmers and, as a result,

largely determines investment trends for farm machinery and equipment. While low grain prices are

perceptibly bad for farmers, it is good for livestock and grain storage equipment channels, as farmers are

likely to over-purchase to lock in lower feed costs for the next year and/or store a larger portion of a

strong harvest during low pricing environments.

Farmland Values. Our metric for measuring farmland values is derived from the Kansas City Federal

Reserve, measured in quarterly percent changes over the same period in the prior year. Farmland is each

farmer‘s most important asset, and with the price of corn jumping from $2 per bushel to upwards of $7 at

one point within the past decade, it is no surprise that the price of farmland has enjoyed a concurrent rise.

With this noted, farmland has long term drivers that makes it a bit less susceptible to economic swings as

commercial and residential properties do, with the reduction in arable acres per capita and growing food

demand providing long term trends that should provide some stability to farmland values.

Farm Debt-to-Equity. Farmer debt to equity measures the financial leverage of the U.S. farming sector,

which plays a heavy role in determining the farm sector‘s ability to weather a downturn. As debt-to-

equity levels remain low today compared to the historical level, farmers have the ability to access capital

if in need of financing for an investment during a bad year, potentially smoothing out capital spending.

- 47 -


Agriculture Demand Channels: Key Indicators - Continued

$39.1

$61.0

$87.4

$78.8

$57.4

$70.0

$83.7

$60.4

$78.0

$118.0$113.8

$120.6

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

$140

$150

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E

U.S. Net Farm Income (In Nominal $ - Billions)

Source: USDA

Net Farm Income has been in rarified air the last several years as elevated commodity prices drove strong price realization for row crop

farmers. This has resulted in a greater adoption of many "best-practices" within the agriculture sector, benefitting companies that

supply technologies to improve efficiency on the farmstead.

$0

$1

$2

$3

$4

$5

$6

$7

$8

$9

4/1

/20

01

9/1

/20

01

2/1

/20

02

7/1

/20

02

12

/1/2

00

2

5/1

/20

03

10

/1/2

00

3

3/1

/20

04

8/1

/20

04

1/1

/20

05

6/1

/20

05

11

/1/2

00

5

4/1

/20

06

9/1

/20

06

2/1

/20

07

7/1

/20

07

12

/1/2

00

7

5/1

/20

08

10

/1/2

00

8

3/1

/20

09

8/1

/20

09

1/1

/20

10

6/1

/20

10

11

/1/2

01

0

4/1

/20

11

9/1

/20

11

2/1

/20

12

7/1

/20

12

12

/1/2

01

2

5/1

/20

13

10

/1/2

01

3

Corn Price (USD per bushel)

Corn Price Trailing 6 mo. Avg. Price

Increased food demands and a higher focus on biofuels has resulted in a 150+% increase in corn prices over the past decade. While debate rages on where the "new norm" is for corn prices,

the elevated state compared to the early 2000s has allowed farmers to achieve record earnings in recent years, a notable

positive for Ag machinery companies.

Source: UW; USDA

- 48 -


Agriculture Demand Channel: Key Indicators – Continued

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

Farmland Values - Percent Change (Year-over-Year)

NonIrrigated Irrigated

Source: Kansas City Federal Reserve

A farmer's principal asset is his or her land, and with crop prices exploding over the past decade and interest

rates kept at record lows, farmland values have experienced a tremendous rise. This increase has

resulted in record net farm income and, as a result, increased spending on capital equipment.

0.0

5.0

10.0

15.0

20.0

25.0

30.0

U.S. Farm Debt Metrics (%)

Debt/Equity Debt/Assets

Current debt levels have remained relatively low compared to historical periods of other booms in the agriculture sector. This level of discipline

enhances farmers' ability to weather a downturn in commodity prices, such as the one seen in 2013. Of note however, this low-level of debt is not

homogenous across in the entire sector, as larger farms remain much more

levered than the smaller, more reticent proprietors.

Source: USDA & KC Fed

- 49 -


Agriculture Demand Channel: Irrigation Key Players and Product Offerings

The center pivot irrigation market is dominated by

public companies Valmont (VMI-Neutral) and

Lindsay (LNN-Neutral), who together represent 73%

of the global market share of pivot and lateral

systems, though privately held companies Reinke and

T&L are formidable rivals. Center pivot systems and

lateral systems are grouped together for all intensive

purposes, and while center pivots represent the vast

majority of the group, it is worth distinguishing

between the two. Center pivots move about in a

circular pattern, with the hub connected to a well at

the center point of the circle, pumping water down

the line to deploy throughout its different sprinklers.

Lateral pivots employ the same distribution method

but the application method is used in square or

rectangular fields and sweeps across the crop from one endpoint to the other (whole system moves side to

side) while drawing water from a large diameter hose or ditch that runs parallel to the field.

Alternatives to center pivots are mainly used out of budgetary reasons, with flood and drip irrigation

representing cheaper (and less efficient) methods of supplying water to crops. Flood, or surface, irrigation

uses gravity to distribute the necessary water to soil as water is filled in ditches at the top of the field (the

highest point) and flows down to the bottom. This method has been virtually unchanged for thousands of

years, which illustrates why many are moving towards a more technologically advanced method. Another

alternative that applies slightly more technology is the drip method, which runs perforated PVC pipe

underneath the crops to distribute water to the roots, removing it from potentially harming weather

conditions. While the method is less expensive than a center pivot system, the maintenance on the system

can be both costly and time consuming for farmers, especially in an age of reduced farm labor.

Valmont

43%

Lindsay

30%

Reinke 9%

T&L 4%

Other 14%

Pivot & Lateral Systems: Global Market Share

Breakdown

Source: Company ReportsSource: Company Reports

Irrigation Practices

Other

Hose Reel Travelers: Large scale hose carrier mounted

with sprinkler unfurls hose to distribute water. Relatively

labor intensive.

Ctr

Pivot

Large scale wheel-mounted water delivery systems.

Confer substantial productivity and water efficiency

benefits, but relatively expensive.

Flood

Oldest and still widely adopted method, involves

diverting natural water source onto crops. Low cost

drives popularity, but makes inefficient use of water

resources.

Drip

Perforated plastic pipe runs underground, dispensing

water at the root level. Uses water more efficiently than

flood irrigation, but maintenance can be costly.

Pivot/Lateral

System

Flood

Irrigation

- 50 -


Agriculture Demand Channel: Key Players Comparable Analysis

Ticker PriceMarket


EV/

EBITDA

JMS

Analyst

Water

Exposure

Agriculture Machinery

AGCO Corporation AGCO $58.20 $5,566.0 $10,630.6 $6,272.1 9.6x 5.4x Connors Low

Caterpillar Inc. CAT $83.85 $53,549.4 $57,329.0 $89,039.4 15.2x 10.9x NR Low

CNH Industrial N.V. CNHI $8.38 $12,088.7 $25,858.0 $29,928.7 0.0x 10.4x NR Low

Deere & Company DE $82.12 $31,339.8 $38,136.5 $61,231.9 10.1x 9.7x Connors Low

Average 8.7x 9.1x

Irrigation

Lindsay Corporation LNN $77.93 $1,013.5 $690.8 $861.6 17.3x 7.2x Connors High

Valmont Industries, Inc. VMI $143.48 $3,818.2 $3,291.4 $3,818.2 13.2x 6.8x Connors Medium

Toro Co. TTC $58.31 $3,336.2 $1,998.4 $3,398.5 20.4x 11.8x NR Medium

Average 17.0x 8.6x

Precision Agriculture

Trimble Navigation Limited TRMB $32.15 $8,222.6 $2,204.4 $8,929.7 19.1x 19.9x Connors Low

Raven Industries Inc. RAVN $34.18 $1,236.1 $383.7 $1,180.4 25.3x 14.8x NR Low

Deere & Company DE $82.12 $31,339.8 $38,136.5 $61,231.9 10.1x 9.7x Connors Low

Average 18.2x 14.8x

Seed & Fertilizer

Bunge Limited BG $82.23 $11,990.2 $62,012.0 $17,433.2 10.7x 11.5x NR Low

CF Industries Holdings, Inc. CF $218.32 $12,637.5 $5,629.8 $13,805.4 11.9x 4.8x NR Low

BASF SE DB:BAS $75.94 $69,752.0 $73,805.0 $83,716.0 12.6x 8.2x NR Low

Bayer AG DB:BAYN $93.21 $77,079.8 $40,148.0 $84,741.8 14.8x 9.5x NR Low

E. I. du Pont de Nemours and Company DD $62.05 $57,501.7 $35,547.0 $65,648.7 14.3x 11.6x NR Low

Monsanto Company MON $108.48 $56,001.7 $14,861.0 $54,500.7 20.3x 13.0x NR Low

The Mosaic Company MOS $48.02 $20,502.4 $9,974.1 $18,209.1 18.9x 6.2x NR Low

The Port of Tauranga Limited POT $13.45 $1,803.9 $244.0 $2,002.2 22.8x 15.0x NR Low

Origin Agritech Limited SEED $1.68 $41.0 $419.7 $54.3 NM 12.7x NR Low

Software AG SOW $28.07 $2,328.0 $977.9 $2,438.8 13.6x 9.8x NR Low

Syngenta AG SWX:SYNN $360.50 $33,091.4 $14,327.0 $35,868.2 17.5x 12.8x NR Low

Agrium Inc. TSX:AGU $95.13 $13,747.7 $16,620.0 $17,455.3 12.2x 7.0x NR Low

Average 15.4x 10.2x


Agriculture Demand Channel: Publicly Traded Company Comp Sheet

- 51 -


Regulated Water Utilities: An Overview

The publicly traded regulated water utility industry is composed of 9

companies that each operate in distinct geographic markets throughout

the United States, with the largest markets being California and

Pennsylvania. Revenue is principally generated through regulated

operations, which are governed by distinct utilities commissions in

each respective state the companies operate in. The regulated revenue

stream is derived from commission-approved volumetric rate

structures applied to residential customers. Investor-Owned Utilities

operate in a strict regulatory environment given the naturally

monopolistic nature of the water distribution industry, as its capital

intensive nature precludes dual systems, eliminating the prospect of

competition. As a result, the role of each state‘s utility commission

has a prominent effect on the ability of each utility to capture an

attractive return on its investment.

The size of the publicly traded water utility market is relatively small,

with the combined sales of the 9 companies totaling $5.2 billion in

2012. Given the regulated nature of the market, there is rather limited

volatility on the top-line for water utilities, with the group possessing

a standard deviation of 4.6% on its revenue growth over the past

decade. With this noted, the top-line growth of 6.8% (CAGR) for

utilities is fairly competitive, owing to a handful of growth drivers prevalent in the industry.

Per capita water consumption is declining in the United States, leaving utilities to grow their regulated

revenue base two ways: rate expansion and customer growth. Both have contributed to the industry‘s

sustained revenue growth, as the water utilities continue to consolidate and work toward full-cost pricing

models. The primary function of growing a company‘s rate base is to invest in capital projects, with

amount of money a company deploys to upgrade or install water infrastructure determining its rate award.

The respective utilities commissions grant a specified return on equity for each company‘s investment,

with typical ROE awards hovering around 10%. The ROE rate is just one mechanism for determining the

return generated by utilities however, and with other rate-related policies having a substantial impact on

the ROE actually realized in practice.

Investor

Owned

16%

Public &

Other

84%

U.S. Drinking Water Systems

Investor

Owned

2%

Public &

Other

98%

U.S. Wastewater Systems

Source: AWK, EPA

CA CT DE GA HI IL IN IA KY MD ME MO NJ NM NY NC OH PA TN TX VA WA WV

American States Water Company 100%

American Water Works Company, Inc. 8% <5% 10% 8% <5% <5% 11% 25% <5% 22% <5% <5% 5%

Aqua America Inc. 7% <6% <6% 6% 11% 56% 9% <6%

Artesian Resources Corp.* 97% <3% <3%

California Water Service Group 94% 3% 1% 2%

Connecticut Water Service Inc.* 74% 26%

Middlesex Water Co. 27% ~72% <1%

SJW Corp.* 97% 3%

The York Water Company 100%

*Percent of Customer base

Water Utility Universe: Regulated Operations Revenue Distribution by State

- 52 -


Regulated Water Utilities: Market Opportunity

As investor-owned water utilities are rewarded for committing capital

to infrastructure upgrades, a vast market opportunity exists due to the

decidedly poor condition of aging U.S. water infrastructure (as noted

previously). The majority of water systems were built before the

1950s during the rapid expansion of U.S. infrastructure. A

consequence of this is the need to replace a vast amount of

infrastructure as it approaches the end of its useful life. The EPA

estimates that while in 2000 just 23% of U.S. pipe infrastructure was

rated ―Poor‖ to ―Life Elapsed‖, by 2020 that is expected to swell to

45% without renewal or replacement of existing systems.

Once the capital is invested, the company either recoups its

investment immediately through an automatic reimbursement

mechanism, such as a DSIC (Distribution System Improvement

Charge) or through the eventual filing of a general rate case, which

requests permission for customer rate increases to both a) combat

declining water consumption trends and, most importantly, b) earn a

fair rate of return on the company‘s capital expenditures.

The turnaround for a decision by Commissions, along with other key

metrics, varies based on the conduciveness of each state‘s regulatory

body. The importance of regulatory exposure is evident in the

valuation of companies, with progressive systems awarding water

utilities like Aqua America (WTR-Neutral) a premium to the peer

group due to its primary operations being based in Pennsylvania (our

#1 ranked market), while haircutting the valuation multiple for IOUs that operate in less favorable

regulatory environments like California, seen in California Water Service (CWT-Neutral).

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

200

400

600

800

1,000

1,200

1,400

1,600

New Jersey American Water's Pipes by Decade

Miles of Pipe (L. Axis) % of Pipe Installed (R. Axis)

Source: AWK

Excellent

42%

Good

17%

Fair

18%

Poor

14%

Very Poor

2%

Life

Elapsed

7%

2000

Excellent

32%

Good

11%Fair

12%

Poor

13%

Very Poor

23%

Life

Elapsed

9%

2020

U.S. Pipes by Classification

Source: EPA

- 53 -


Regulated Water Utilities: Growth Dynamics

The ability of the investor-owned water utility industry to achieve 11% compounded EBT growth

annually while possessing a 5-year Beta of 0.4 provides investors a hedge against the market while not

sacrificing earnings expansion as a result. The recent pressure on interest rates has resulted in declining

ROEs awarded by regulatory commissions however, which should pressure earnings expansion by

utilities in the short-term as disinflationary market conditions remain prevalent. With this said, the secular

demand drivers for water utilities are fully intact as IOUs continue to invest in aging infrastructure for the

benefit of its customers, the community, and shareholders of the company. Furthermore, as the trajectory

of interest rates reverses water utilities will begin to enjoy an upward bias on awarded ROEs, a key

benefit to IOUs that is typically underweighted by investors who worry that income-oriented equities such

as utilities will suffer from rotation of asset flows towards increasingly attractive alternatives during

periods of rising interest rates. On the surface, this makes sense, but the historical data indicates that water

utility stocks have not only held up in rising interest rate environments, but actually posted some of their

best performance in the last period of sustained increases in interest rates (2003-2006).

Certain developments and supplements to regulated water delivery operations are worth discussing as

well. Principally, the expansion of unregulated operations in certain water utilities as companies pursue

opportunistic and complementary ventures. Many utilities are now providing insurance-like services to

customers to limit individuals‘ exposure to pipeline damage on his or her property, while others have

pursued projects ranging from the construction of a water pipeline to fracking companies in the Marcellus

Shale region (Aqua America) to Military base water system operations (American States Water).

On the accounting side, while not necessarily a growth driver, the recent adoption of flow-through repair

tax accounting is worth noting as well as it renders growth metrics centered on revenue less meaningful.

The method essentially forgoes rate increases in the near term in exchange for tax deductions for certain

infrastructure investments, shifting earnings power from the top line to the income tax line. While this is

not currently the widely accepted standard of accounting, Aqua America (WTR-Neutral), the country‘s

second largest water utility, adopted the method in Pennsylvania recently and has received a favorable

response from both investors and the Pennsylvania Public Utilities Commission.

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$5,000

$5,500

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Publicly Owned Water Utility Market

Revenue (L. Axis) CapEx (R. Axis)

Source: CapIQ; JMSGroup Includes: WTR, AWK, ARTN.A, AWR, CWT, CTWS, MSEX, SJW, YORW

- 54 -


Regulated Water Utilities: Regulatory Climate Indicator

Regulatory climate is the single most important factor driving shareholder returns for water utilities, and a

clear scoring system on this key issue substantially demystifies the investment decision making process.

Our Janney Regulatory Climate Indicator (RCI) assigns a numerical score to each state of relevance based

upon key factors such as Return on Equity and the adoption of key progressive regulatory mechanisms.

While we recognize that no such system is perfect and any attempt to tackle the issue will be controversial

(hence the Street's historical reticence to do so), our system is transparent, easily understandable, and

approximates the relative attractiveness of various regulatory jurisdictions. While the Janney RCI

methodology is explained in full on page 56, the shorthand is that possible scores range from -5.5 (really

bad) to +5.75 (really good).

Key Takeaways:

Record-low interest rates continued to pressure awarded ROEs in 2013, with the average ROE

falling 20 bps from 2012. The lower ROEs caused the average RCI score to fall for the second

consecutive year, as RCI scores fell 0.4 points on average.

Pennsylvania remained the #1 regulatory jurisdiction in 2013 despite its fall in absolute terms from

3.4 in 2012 to 3.1 in 2013. The fall was attributed to lower awarded ROEs (seen in most states), yet

the state‘s numerous progressive mechanisms still supply companies operating within the

jurisdiction with the best chance at actually hitting ROE targets, and thus remains the gold standard.

New Jersey followed its huge jump in 2012 by holding its position in the #5 spot, as the company

continues to evolve into a top flight of progressive regulatory state.

DE and IL round out the top 3 despite so-so ROEs. This shows that despite the importance of

ROEs, key regulatory mechanisms that limit regulatory lag can overcome lackluster approved rates.

3.4

2.3

1.81.6

0.8 0.80.9

0.7

2.0

-0.5

0.03

-1.8

-2.5

3.1

1.3 1.2 1.20.9

0.5 0.5 0.4

-0.3-0.3

-0.8-1.0

-1.3-1.5 -1.5

-1.8

-3.5-3.8

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

PA DE IL KY NJ OH MO CT WA IN ME NY TX HI VA NC TN NM MD WV CA IA

Janney RCI Scores for Key Investor-Owned Utility States: 2012 vs. 20132012 Values Include Adjustment for New Calculation Methodology

2012 2013

2.3 1.00.4 Flat 1.0 Flat NewNew New NewFlat0.30.40.5 Flat0.3

Flat 0.1 Flat

Key Points:

-Pennsylvania remains the top-ranked U.S. regulatory jurisdiction in absolute terms, though it fell 0.3 point from 2012.

-Ohio was the only jurisdiction to show improvement in 2013, up 0.1 point due to a marginal expansion in awarded ROE.

-New York saw the largest decline, falling to position #11 from #3 a year ago, as the state abandoned its use of the DSIC mechanism.

- 55 -


2013 Janney RCI: Summary of Methodology

In designing a system for quantifying the relative attractiveness of various state regulatory systems, we

adhere to the maxim that ―less is more‖ and deliberately favor elegance over complexity. Although a

more intricate approach would have benefits, we believe a simple, transparent system sacrifices little in

the way of accuracy while possessing the key advantage of being easily understandable.

Step-by-Step RCI Calculation:

1. Starting Point. All states are created equal, beginning the process with a baseline score of 0.

2. Allowed Return on Equity Adjustment. The first, and most significant, adjustment to the

baseline score of 0 is the ROE adjustor. Using an average of recent awarded ROEs in the state,

the baseline score is adjusted to reflect the attractiveness of returns on capital. States with ROEs

of 9.5% and below have 1.5 points subtracted from the baseline, while states with ROEs of 11%

and above have 1.5 points added to their baseline score. States with ROEs in between 9.5% and

11% receive a pro-rated adjustment according to their position in this range, with any state

exactly at the midpoint of 10.25% receiving no adjustment to the starting point.

3. Regulatory Mechanism Adjustments. The next set of adjustments takes into account whether a

state has in place key regulatory mechanisms that we believe reduce regulatory lag or otherwise

improve the investment climate. These simple +1/–1 adjustments are as follows:

+1 point if a Future Test Year is used, –1 if Historical (0 for Historical/Updated).

+1 if rate cases must be processed in 9 months or less, –1 if 12 months or more.

+1 if a state has in place single tariff rate structures, –1 if not.

-1 if a state does not have a DSIC, if it does:

i. Formula: 1 + [(% Granted – 7.5%)*100]

ii. i.e. Since the average DSIC percentage is 7.5%, it is awarded a ―+1‖ value, with

all other DSIC percentages adjusted on prorated basis

Summation = Final RCI Score. After all adjustments have been made to the initial starting point of 0,

the end result is the Janney RCI score. The highest possible RCI score is +5.75 (0 + 1.5 for an 11% ROE

+ 1.25 for DSIC + 1 for Future Test Year + 1 for <9 month rate case processing + 1 for Single Tariff =

5.75). Conversely, the lowest possible score is –5.50. Interpreting RCI scores is easy: higher scores

denote states with more capital-friendly regulatory environments.

Starting Point = 0ROE Adjustor – Sliding Scale:

•9.5% and lower: -1.5•11% and higher: +1.5•9.5% - 11%: Prorated Adjustment

Regulatory Mechanism Adjustors:•Test Year: +1 for Future, -1 for Historical•Processing: +1 for <9 mos., -1 for >12 mos.•Single Tariff Structure: +1 if yes, -1 if no•DSIC Like Mechanism:

•-1 if No DSIC•If yes: +0.75 for 5%, +1 for 7.5%, +1.25 for 10%•Other Percentages Prorated

Final RCI Score:•Highest Possible: +5.75•Lowest Possible: -5.5

12

3

4

Simplicity and transparency are key attributes of the RCI scoring system.

The Janney Regulatory Climate Indicator: Methodology

- 56 -


2013 Janney RCI: Data Breakdown

REG. ELEMENT GRANTED ROE (PREV) TEST YEAR PROCESSING DSICSINGLE

TARIFF

Sliding Scale Future = +1 <9 mos. = +1 Sliding Scale

9.5% & Below = -1.5 Hist./Updtd = 0 9-12 mos. = 0 No = -1, Yes: 7.5% = +1

11% & Above = +1.5 Historical = -1 >12 mos. = -1 = 1 + [X% - 7.5%)*100]

PENNSYLVANIAWTR,AWK,

YORW10.3% (10.4%) Future: +1 9-12 months: 0 7.5%: + 1 Yes: + 1 3.13 1 (1)

DELAWAREARTNA,

MSEX9.9% (9.9%) Hist./Updtd: 0 <9 months: +1 7.5%: + 1 Yes: + 1 2.33 2 (2)

ILLINOIS WTR,AWK 9.4% (9.8%) Future: +1 9-12 months: 0 5%: + 0.75 Yes: + 1 1.25 3 (4)

KENTUCKY AWK 9.9% (9.9%) Future: +1 <9 months: +1 No: -1 Yes: + 1 1.20 4 (6)

NEW JERSEYWTR,AWK,

MSEX10.0% (10.2%) Hist./Updtd: 0 9-12 months: 0 5%: + 0.75 Yes: + 1 1.15 5 (5)

OHIO WTR 9.6% (9.6%) Hist./Updtd: 0 9-12 months: 0 9%: + 1.15 Yes: + 1 0.90 6 (8)

MISSOURI AWK 10.0% (10.0%) Historical: -1 9-12 months: 0 10%: + 1.25 Yes: + 1 0.75 7 (9)

CONNECTICUT CTWS 9.3% (9.7%) Historical: -1 <9 months: +1 7.5%: + 1 Yes: + 1 0.50 T-8 (7)

WASHINGTON CWT 12.0% Historical: -1 9-12 months: 0 No: -1 Yes: + 1 0.50 T-8 (New)

INDIANA AWK,WTR 10.1% (10.2%) Historical: -1 9-12 months: 0 5%: + 0.75 Yes: + 1 0.38 10 (10)

MAINE CTWS 10.0% (10.0%) Historical: -1 <9 months: +1 10%: + 1.25 No: -1 -0.25 T-11 (12)

NEW YORK AWK 9.6% (9.8%) Hist./Updtd: 0 9-12 months: 0 No: -1 Yes: + 1 -0.25 T-11 (3)

TEXAS WTR,SJW 11.4% (12.0%) Historical: -1 >12 months: -1 No: -1 Yes: + 1 -0.50 13 (13)

HAWAII AWK, CWT 10.4% Future: +1 9-12 months: 0 No: -1 No: -1 -0.80 14 (New)

VIRGINIA WTR,AWK 9.8% (10.3%) Historical: -1 <9 months: +1 No: -1 Yes: + 1 -1.00 15 (11)

N. CAROLINA WTR 10.1% Historical: -1 9-12 months: 0 No: -1 Yes: + 1 -1.30 16 (New)

TENNESSEE AWK 10.0% Hist./Updtd: 0 <9 months: +1 No: -1 No: -1 -1.50 T-17 (New)

NEW MEXICO CWT 10.0% Future: +1 9-12 months: 0 No: -1 No: -1 -1.50 T-17 (New)

MARYLANDAWK,

ARTNA10.4% Historical: -1 <9 months: +1 No: -1 No: -1 -1.75 19 (New)

WEST VIRGINIA AWK 9.8% (10.0%) Historical: -1 9-12 months: 0 No: -1 Yes: + 1 -1.83 20 (14)

CALIFORNIAAWK,SJW,

AWR,CWT9.4% (10.2%) Future: +1 >12 months: -1 No: -1 No: -1 -3.50 21 (15)

IOWA AWK 9.85% Historical: -1 9-12 months: 0 No: -1 No: -1 -3.80 22 (New)

AVERAGE: NA 9.9% (10.1%) NA NA NA NA -0.3 NA

Source: Janney Capital Markets, Company Reports, State Regulatory Agencies

RCI

SCORE

RCI RANK

(PREV)RCI

PARAMETERS

Company

Exposure Yes = +1

No = -1

- 57 -


Regulated Water Utilities: Key Players

American Water Works (AWK-BUY) and Aqua America (WTR-Neutral) are far and away the largest

players in the water utility space, boasting market capitalizations of $7.3 billion and $4.4 billion,

respectively, with the American States Water (AWR-Neutral) and California Water (CWT-Neutral)

rounding out ―the big four‖. The size of American and Aqua allow the companies to enjoy geographic

diversification for purposes of both avoiding potentially adverse weather conditions as well as

challenging regulatory environments. Their magnitude also enables the companies to pursue tuck-in

acquisitions or portfolio shifting, such as the system swap that took place in 2012 where Aqua America

obtained American Ohio‘s properties for $101 million while selling American Water its New York

systems for $39 million in cash (without including debt assumptions in either case).

The remaining five publicly traded water utilities are all under $1 billion in market cap, with the average

size standing around $340 million. The majority of these companies have regulated operations that are

principally in one state or region, allowing the smaller companies to capitalize on existing company

infrastructure and established relationships with the Utilities Commissions.

3.38

2.312.14

1.751.36

0.60

-2.34 -2.43 -2.52

3.13

2.211.81

1.51

0.760.31

-3.31 -3.41 -3.50

-5.00

-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

YORW ARTNA WTR MSEX AWK CTWS CWT SJW AWR

Weighted Average Janney RCI Scores by Company: 2012 vs. 2013

2012 2013

0.30.30.10.3 1.00.2 0.6 1.01.0

Company Ticker PriceMkt. Cap

(mm)

Sales

(mm)

EV/

EBITDA

EV/

Sales

PEG

Ratio

Price/

Book

EV/ Rate

Base

Fwd

P/E

FY+2

PE

Historical

Fwd P/E

Investor-Owned Water Utilities

American States Water Company AWR $28.46 $1,101.9 $473.7 8.9x 3.0x 7.2x 2.3x 2.3x 20.3x 20.4x 20.3x

American Water Works Company, Inc. AWK $42.67 $7,607.0 $2,870.5 10.2x 4.6x 2.2x 1.6x 1.5x 18.0x 18.0x 18.0x

Aqua America Inc. WTR $25.04 $4,424.8 $767.5 14.0x 7.9x 2.8x 3.2x 2.3x 21.2x 20.9x 21.2x

Artesian Resources Corp. ARTN.A $21.97 $193.0 $69.1 10.8x 4.5x 3.9x 1.6x 1.4x 19.6x 18.0x 19.6x

California Water Service Group CWT $22.38 $1,068.4 $571.9 9.9x 2.6x 3.2x 1.8x 1.5x 21.1x 19.6x 21.1x

Connecticut Water Service Inc. CTWS $32.88 $356.6 $89.4 13.6x 6.0x 4.0x 1.9x 1.9x 21.1x 20.0x 21.1x

Middlesex Water Co. MSEX $21.36 $340.1 $114.5 12.2x 4.4x 4.2x 1.8x 3.1x 20.8x 20.5x 20.8x

SJW Corp. SJW $27.77 $559.9 $272.1 9.7x 3.3x 1.9x 1.8x 2.8x 22.4x 20.1x 22.4x

The York Water Company YORW $20.33 $263.1 $42.1 12.9x 8.1x 4.8x 2.7x 0.7x 24.1x 23.6x 24.1x

Sector Average 11.4x 4.9x 3.8x 2.1x 1.9x 21.0x 20.1x 21.0x


- 58 -


Appendix

Ticker Price Market Cap Business Description


LB Foster Co. FSTR $43.75 $451.9L.B. Foster Company engages in the manufacture, fabrication, and distribution of products

and services for the rail, construction, energy, and utility markets.

Northwest Pipe Co. NWPX $37.40 $353.4

Northwest Pipe Company manufactures and markets welded steel pipe and other products

in the United States, Canada, and Mexico. The company’s Water Transmission segment

offers large diameter, high pressure, engineered welded steel pipe products for use in water

infrastructure applications, primarily related to drinking water systems.

Nuverra Environmental Solutions, Inc. NES $1.46 $379.5

Nuverra Environmental Solutions, Inc., an environmental solutions company, provides full-

cycle environmental solutions to customers in energy and industrial end-markets in the

United States.

Pumps & Valves

Gorman-Rupp Co. GRC $39.43 $828.1 The Gorman-Rupp Company designs, manufactures, and sells pumps and pump systems.

IDEX Corporation IEX $69.74 $5,657.2IDEX Corporation manufactures and sells various pumps, flow meters, other fluidics

systems and components, and engineered products worldwide.

Mueller Water Products, Inc. MWA $8.80 $1,392.5

Mueller Water Products, Inc. engages in the manufacture and marketing of products and

services used in the transmission, distribution, and measurement of water primarily in the

United States and Canada.

Pentair Ltd. PNR $68.05 $13,564.7

Pentair Ltd. delivers products, services, and solutions for water and other fluids, thermal

management, and equipment protection in the United States, Europe, Asia, and other

regions.

Watts Water Technologies, Inc. WTS $58.61 $2,068.9

Watts Water Technologies, Inc. designs, manufactures, and sells various water safety and

flow control products for the water quality, water conservation, water safety, and water flow

control markets in the North America, Europe, the Middle East, Africa, and Asia.

Xylem Inc. XYL $33.94 $6,261.5Xylem Inc. engages in the design, manufacture, and application of engineered technologies

for water and wastewater applications.

Engineering & Construction

AECOM Technology Corporation ACM $28.96 $2,919.3

AECOM Technology Corporation, together with its subsidiaries, provides professional

technical and management support services for commercial and government clients

worldwide.

Layne Christensen Company LAYN $15.25 $299.2Layne Christensen Company provides water management, construction, and drilling

services in North America and internationally.

Stantec Inc. STN $67.26 $3,120.9

Stantec Inc. provides professional consulting services in planning, engineering, architecture,

interior design, landscape architecture, surveying, environmental sciences, project

management, and project economics for infrastructure and facilities projects in the North

America and internationally.

Tetra Tech Inc. TTEK $26.42 $1,704.0

Tetra Tech Inc., together with its subsidiaries, provides consulting, engineering, program

management, construction management, and technical services for water, environment,

energy, infrastructure, and natural resources sectors.

Tutor Perini Corporation TPC $21.36 $1,027.7Tutor Perini Corporation provides diversified general contracting, construction management,

and design-build services to private customers and public agencies worldwide.

Source: CapIQ , Company Documents

Municipal Demand Channel: Publicly Traded Company Comp Sheet - Business Descriptions

- 59 -



Metering

Arad Ltd. TASE:ARD $26.17 $647.2Arad Ltd. designs, develops, manufactures, sells, and supports water meters for residential,

bulk, irrigation, and water management companies worldwide.

Badger Meter Inc. BMI $51.76 $744.2Badger Meter, Inc. manufactures and markets flow measurement and control products to

water and gas utilities, municipalities, and industrial customers worldwide.

Itron, Inc. ITRI $43.50 $1,703.0Itron, Inc. provides metering solutions, meter data management software, and knowledge

application solutions to electric, natural gas, and water utilities worldwide.





Roper Industries Inc. ROP $125.63 $12,476.3

Roper Industries, Inc. designs, manufactures, and distributes radio frequency (RF) products

and services, industrial technology products, energy systems and controls, and medical and

scientific imaging products and software.

Silver Spring Networks, Inc. SSNI $19.42 $915.3Silver Spring Networks, Inc. provides networking platform and solutions that enable utilities

to transform the power grid infrastructure into the smart grid.

Infrastructure Diagnostics

(Invalid Identifier) EMTEK





Pure Technologies Ltd. TSX:PUR $6.42 $328.0

Pure Technologies Ltd., an asset management technology and services company, engages

in the development and application of patented technologies for inspection, monitoring, and

management of physical infrastructure worldwide.

Filtration/Treatment

Calgon Carbon Corporation CCC $20.48 $1,118.3

Calgon Carbon Corporation provides services and solutions for purifying water and air,

food, beverage, and industrial process streams primarily in the United States, Europe, and

Japan.

Pall Corporation PLL $81.87 $9,068.7Pall Corporation manufactures and markets filtration, separation, and purification products

and integrated systems solutions worldwide.








Municipal Demand Channel: Publicly Traded Company Comp Sheet - Business Descriptions

- 60 -



Valves/Pumps


Franklin Electric Co., Inc. FELE $39.84 $1,898.2Franklin Electric Co., Inc., together with its subsidiaries, designs, manufactures, and

distributes water and fuel pumping systems worldwide.







Pentair Ltd. PNR $68.05 $13,564.7



regions.

Rexnord Corporation RXN $23.40 $2,287.9Rexnord Corporation designs, manufactures, markets, and services process and motion

control, and water management products worldwide.








LB Foster Co. FSTR $43.75 $451.9L.B. Foster Company engages in the manufacture, fabrication, and distribution of products

and services for the rail, construction, energy, and utility markets.




United States.

Northwest Pipe Co. NWPX $37.40 $353.4

Northwest Pipe Company manufactures and markets welded steel pipe and other products

in the United States, Canada, and Mexico. The company’s Water Transmission segment

offers large diameter, high pressure, engineered welded steel pipe products for use in water

infrastructure applications, primarily related to drinking water systems.

Water Treatment

CLARCOR Inc. CLC $58.97 $2,953.1CLARCOR Inc. provides filtration products, filtration systems and services, and consumer

and industrial packaging products worldwide.

Ecolab Inc. ECL $106.43 $32,067.3Ecolab Inc. develops and markets programs, products, and services for hospitality,

foodservice, healthcare, industrial, and energy markets worldwide.




United States.

General Electric Company GE $27.05 $273,674.8General Electric Company operates as an infrastructure and financial services company

worldwide.

Pall Corporation PLL $81.87 $9,068.7Pall Corporation manufactures and markets filtration, separation, and purification products

and integrated systems solutions worldwide.



Water Heating/Cooling

AO Smith Corp. AOS $53.20 $4,853.1

A. O. Smith Corporation engages in the manufacture and sale of water heaters and boilers

to the residential and commercial markets primarily in the United States, Canada, Europe,

India, and China.

Harsco Corporation HSC $27.13 $2,188.5 Harsco Corporation provides industrial services and engineered products worldwide.

SPX Corporation SPW $94.13 $4,269.2 SPX Corporation provides specialized engineered solutions worldwide.







Water Treatment Chemicals/Disposal

Calgon Carbon Corporation CCC $20.48 $1,118.3

Calgon Carbon Corporation provides services and solutions for purifying water and air,

food, beverage, and industrial process streams primarily in the United States, Europe, and

Japan.

Canexus Corporation TSX:CUS $6.18 $939.4

Canexus Corporation, through its subsidiaries, engages in the production and sale of

sodium chlorate and chlor-alkali products primarily for the pulp and paper, and water

treatment industries in North and South America.

Casella Waste Systems Inc. CWST $5.65 $225.6

Casella Waste Systems, Inc., together with its subsidiaries, operates as a regional, vertically-

integrated solid waste, recycling, and resource management services company in the

northeastern United States.

Ecolab Inc. ECL $106.43 $32,067.3Ecolab Inc. develops and markets programs, products, and services for hospitality,

foodservice, healthcare, industrial, and energy markets worldwide.


worldwide.

Hawkins Inc. HWKN $35.85 $380.2Hawkins, Inc. distributes bulk chemicals, as well as blends, manufactures, and distributes

specialty chemicals.


Industrial Demand Channel: Publicly-Traded Company Comp Sheet - Business Descriptions

- 61 -



HVAC




India, and China.








worldwide.

Regal Beloit Corporation RBC $73.31 $3,303.9

Regal Beloit Corporation, together with its subsidiaries, manufactures and sells electric

motors and controls, electric generators and controls, and mechanical motion control

products in the United States, Asia, and internationally.

Fire Protection














Irrigation




Toro Co. TTC $58.31 $3,332.8The Toro Company designs, manufactures, and markets professional turf maintenance

equipment and services worldwide.







Point of View Plumbing Products

Fortune Brands Home & Security, Inc. FBHS $40.58 $6,745.0

Fortune Brands Home & Security, Inc. provides home and security products for use in

residential home repair, remodeling, new construction, and security and storage

applications.


worldwide.

Masco Corporation MAS $20.46 $7,304.0Masco Corporation engages in the manufacture, distribution, and installation of home

improvement and building products primarily in North America and Europe.








Construction Demand Channel: Publicly Traded Company Comp Sheet - Business Descriptions

- 62 -



Valves & Pumps

Colfax Corporation CFX $57.84 $5,894.1

Colfax Corporation, a diversified industrial manufacturing and engineering company,

provides gas- and fluid-handling and fabrication technology products and services to

commercial and governmental customers worldwide.

CIRCOR International, Inc. CIR $76.80 $1,351.0CIRCOR International, Inc. designs, manufactures, and markets valves and other engineered

products, and sub-systems worldwide.




Flowserve Corp. FLS $70.19 $9,789.3Flowserve Corporation engages in the design, manufacture, distribution, and service of

industrial flow management equipment.



Masco Corporation MAS $20.46 $7,304.0Masco Corporation engages in the manufacture, distribution, and installation of home

improvement and building products primarily in North America and Europe.





Pentair Ltd. PNR $68.05 $13,564.7



regions.



SPX Corporation SPW $94.13 $4,269.2 SPX Corporation provides specialized engineered solutions worldwide.







Water Filtration




India, and China.

CLARCOR Inc. CLC $58.97 $2,953.1CLARCOR Inc. provides filtration products, filtration systems and services, and consumer

and industrial packaging products worldwide.

Crane Co. CR $62.98 $3,662.3Crane Co. manufactures and sells engineered industrial products in the United States and

internationally.








Construction Demand Channel: Publicly Traded Company Comp Sheet - Business Descriptions

- 63 -



Agriculture Machinery

AGCO Corporation AGCO $58.20 $5,666.3AGCO Corporation manufactures and distributes agricultural equipment and related

replacement parts worldwide.

Caterpillar Inc. CAT $83.85 $53,358.5Caterpillar Inc. manufactures and sells construction and mining equipment, diesel and

natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide.

CNA Financial Corporation CNH $30.30 $0.0

CNA Financial Corporation, through its subsidiaries, provides a range of property and

casualty insurance products and services to small, middle market, and large businesses and

organizations in the United States and internationally.

Deere & Company DE $82.12 $31,439.3Deere & Company manufactures and distributes agriculture and turf equipment, and

construction and forestry equipment worldwide.

Irrigation

Lindsay Corporation LNN $77.93 $1,003.2

Lindsay Corporation designs, manufactures, and sells irrigation systems that are primarily

used in the agricultural industry to increase or stabilize crop production while conserving

water, energy, and labor in the United States and internationally.

Valmont Industries, Inc. VMI $143.51 $3,844.2Valmont Industries, Inc. produces and sells fabricated metal products in the United States,

Australia, China, France, and internationally.

Toro Co. TTC $58.31 $3,332.8The Toro Company designs, manufactures, and markets professional turf maintenance

equipment and services worldwide.

Precision Agriculture

Trimble Navigation Limited TRMB $32.15 $8,289.6

Trimble Navigation Limited designs and distributes positioning products and applications

enabled by global positioning system (GPS), optical, laser, and wireless communications

technology.

Raven Industries Inc. RAVN $34.18 $1,243.7

Raven Industries, Inc., together with its subsidiaries, provides various products for the

industrial, agricultural, energy, construction, and military/aerospace markets in the United

States and internationally.

Deere & Company DE $82.12 $31,439.3Deere & Company manufactures and distributes agriculture and turf equipment, and

construction and forestry equipment worldwide.

Seed & Fertilizer

Bunge Limited BG $82.24 $12,109.4Bunge Limited, through its subsidiaries, engages in agriculture and food business

worldwide.

CF Industries Holdings, Inc. CF $218.28 $12,510.3CF Industries Holdings, Inc. manufactures and distributes nitrogen and phosphate fertilizer

products worldwide.

BASF SE DB:BAS $75.94 $69,752.0 BASF SE operates as a chemical company worldwide.

Bayer AG DB:BAYN $93.21 $77,079.8Bayer Aktiengesellschaft develops, produces, and markets health care and agriculture

products, and high-tech materials worldwide.

E. I. du Pont de Nemours and Company DD $62.05 $57,464.7E. I. du Pont de Nemours and Company operates as a science and technology based

company worldwide.

Monsanto Company MON $108.51 $57,058.7Monsanto Company, together with its subsidiaries, provides agricultural products for

farmers worldwide.

The Mosaic Company MOS $48.02 $20,455.6The Mosaic Company produces and markets concentrated phosphate and potash crop

nutrients for the agriculture industry worldwide.

The Port of Tauranga Limited POT $13.45 $1,803.9 Port of Tauranga Limited operates and manages the Port of Tauranga in New Zealand.

Origin Agritech Limited SEED $1.68 $38.9Origin Agritech Limited, an agricultural biotechnology company, specializes in crop seed

breeding and genetic improvement activities in the People’s Republic of China.

Software AG SOW $28.07 $2,328.0Software Aktiengesellschaft provides business process management, data management,

and consulting services worldwide.

Syngenta AG SWX:SYNN $360.50 $33,091.4

Syngenta AG, an agribusiness company, engages in the discovery, development,

manufacture, and marketing of a range of products designed to enhance crop yields and

food quality worldwide.

Agrium Inc. TSX:AGU $95.13 $13,746.3 Agrium Inc. engages in the retail of agricultural products and services.


Agriculture Demand Channel: Publicly Traded Company Comp Sheet - Business Descriptions

- 64 -

IMPORTANT DISCLOSURES

Research Analyst CertificationI, Ryan M. Connors, the Primarily Responsible Analyst for this research report, hereby certify that all of the views expressed inthis research report accurately reflect my personal views about any and all of the subject securities or issuers. No part of mycompensation was, is, or will be, directly or indirectly, related to the specific recommendations or views I expressed in thisresearch report.

Janney Montgomery Scott LLC ("Janney") Equity Research Disclosure LegendIndividual disclosures for the companies mentioned in this report can be obtained by accessing our Firm’s Disclosure Site

Disclosure Site

Definition of RatingsBUY: Janney expects that the subject company will appreciate in value. Additionally, we expect that the subject company willoutperform comparable companies within its sector.

NEUTRAL: Janney believes that the subject company is fairly valued and will perform in line with comparable companieswithin its sector. Investors may add to current positions on short-term weakness and sell on strength as the valuations orfundamentals become more or less attractive.

SELL: Janney expects that the subject company will likely decline in value and will underperform comparable companieswithin its sector.

Janney Montgomery Scott Ratings Distribution as of 9/30/13

IB Serv./Past 12 Mos.

Rating Count Percent Count Percent

BUY [B] 244 51.80 38 15.60

NEUTRAL [N] 221 46.90 21 9.50

SELL [S] 6 1.30 0 0.00

*Percentages of each rating category where Janney has performed Investment Banking services over thepast 12 months.

Other DisclosuresJanney Montgomery Scott LLC, is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and amember of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor ProtectionCorp.

This report is for your information only and is not an offer to sell or a solicitation of an offer to buy the securities or instrumentsnamed or described in this report. Interested parties are advised to contact the entity with which they deal or the entity thatprovided this report to them, should they desire further information. The information in this report has been obtained or derivedfrom sources believed by Janney Montgomery Scott LLC, to be reliable. Janney Montgomery Scott LLC, however, does notrepresent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgmentof Janney Montgomery Scott LLC at this time and are subject to change without notice.

Investment opinions are based on each stock's 6-12 month return potential. Our ratings are not based on formal price targets,however, our analysts will discuss fair value and/or target price ranges in research reports. Decisions to buy or sell a stockshould be based on the investor's investment objectives and risk tolerance and should not rely solely on the rating. Investorsshould read carefully the entire research report, which provides a more complete discussion of the analyst's views. Supportinginformation related to the recommendation, if any, made in the research report is available upon request.

- 65 -

http://jms.bluematrix.com/sellside/Disclosures.action?encrypt=d5a9bb5a-57a8-4d10-a44b-008354befa8f

http://jms.bluematrix.com/sellside/Disclosures.action?encrypt=c3fe34d4-8ea9-4025-a4d4-cb6d6e1e0d61