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COMMENT
A story about an interruption to water supplies to parts of East London caught my eye yesterday. It was reported that thousands of homes in the area were without water because of a mishap to a mains pipe. Thames Water, which is owned by Germany's RWE, said it could not say for certain when normal service will be resumed. The unfortunate incident highlights our relentless demand for clean and uninterrupted supply of water, which in my view makes it one of the most stable commodities. Moreover, unlike other commodities, it is largely unaffected by cyclical influences. But how does water stack up as an investment? Recently, water companies have put in a red-hot performance. For instance, shares in Northumbrian Water Group (LSE: NWG) have improved 92% to 192p since its flotation at 100p in May 2003. Meanwhile, shares in East Surrey Holdings (LSE: ESH) have gushed from a low of 277p in 2003 to 531p today. However, this has been due in part to takeover talks with private equity company Terra Firma. Over the long-term, water companies have been extraordinarily robust too. In the last ten years, most have delivered annual double-digit returns after dividends have been reinvested. Kelda's (LSE: KEL) 15% total return is notable, roundly outperforming the overall market, which has returned around 8% per year. AWG (LSE: AWG), formerly Anglian Water, has been another stalwart of the water sector. It has delivered a total return of 13.9% per year sine 1995, with Pennon (LSE: PNN) close behind with a return of 13.7% per annum. Other standouts include Welsh water company Dee Valley (LSE: DVW), which has returned 12% per year, and Severn Trent (LSE: SVT) which has produced a return of 13% per year. United Utilities (LSE: UU.), the largest water company, has returned 11%. One of the main worries that investors have with utility companies is that they are heavily regulated. Indeed, regulation is a valid concern. However, regulators also appreciate that clean and cheap water is no longer something that we can take for granted. Consequently, utility companies need access to capital markets to ensure that potable water is consistently piped into our homes. Another bugbear is the high levels of debts at utility companies. However, high operating margins, which are generally in excess of 20%, ensure that interest payments are well covered. Naturally, high levels of gearing, which in the case of Bristol Water (LSE: BTW) is over 400%, can be worrying. But those interest payments are covered almost three times by operating profits. Interestingly, whilst water may appear plentiful right now, there is anxiety that demand in some areas may outstrip supply within a decade. The upshot of all this is that water companies looks a good bet for the long-term investor. The only word of advice is that dividends should always be re-invested to reap the full benefits of your investment. And what better way than through DriPs!