Xylem Inc. (XYL) Earnings Call Transcript

All right. We're going to get started with our next panel. And this one is on water, something very important to all of us and to the world, challenges and investment opportunities, in not just water but reliable clean water. Water remains a topical area from a number of different sustainability vantage points for the markets. Water lies at the cross-section of several industries and as such, in essential and often times overlooked, natural resource. That is a critical input, whether it's sustaining critical infrastructure, maintaining industrial production, it just checks a lot of boxes as we all know. At the same time, water though this fact is sometimes taken for granted in developed markets is very critical to providing a sustainable and safe living standard for communities across the globe. And thus, in this context, the ability to provide, as mentioned, reliable clean water is a key consideration in the sustainability spectrum. With all this in mind, we've established a diverse mix of water sector leaders and experts here before us, both from public equities as well as the private investment side of the markets. And we look forward to a wide-ranging discussion of critical topics in the area from technology to demand, to policy as well as broader outlooks for the sector. Our group of distinguished speakers in no particular order, in fact I'll start with the middle here. It includes Patrick Decker, President and CEO of Xylem, a bellwether, a $22 billion market cap, water equipment services and infrastructure supplier; Matthew Diserio, President of Water Asset Management, New York-based Global Investment Fund focused solely on companies and assets that ensure water quality and supply, and to round out our group; Susan Kennedy, Executive Chair of Cadiz, a water solutions innovator focused on providing clean water, safe, reliable, affordable in California. So welcome to each of you.

We are going to kick it right off with Q&A, because there's a lot to talk about. And Patrick, let's start with you. The challenge is to provide clean, reliable water globally, continue to become front and centered. Can you compare and contrast how you see the opportunity of said risks, ability to execute in the U.S. versus Western Europe versus emerging markets in which Xylem is looking to grow its business?

Sure. Well, thanks, Brian. Thanks to all for your interest in joining. I'll try to keep my comments brief, which is challenging because it's such a passionate topic for all of us, I'm sure, and we all have a lot to say about this. But I'd start with the 3 key challenges that we see as Xylem, and we operate in 150 countries around the world. Half of our -- 40% of our business is water utilities, 40% is on the industrial or the business users of water, and 10% are in what we call the Building Solutions and ag space. So we got a pretty good purview of what's going on around the world. Three key themes that are consistent. There are a few hundred watersheds around the world. Most people don't know that. And while each watershed is unique and different, they have pretty common challenges that are facing them. The first is scarcity of water, and when we talk about scarcity, most people immediately go to a household level. They think about poverty, they think about deserts, but that's one issue. But scarcity is also an issue for businesses that are operating in water-stressed environments more and more. And given climate change, that water stress is creating economic losses, where for a business the value of water is not what they pay per liter or gallon, it's when they don't have it, and they have to disrupt operations, and they lose revenue, and they lose margin and profitability. And when it happen on a sustained basis, they end up having to relocate their plan. And that impacts communities and jobs. So scarcity impacts all the society, and it's getting worse. I'm not going to throw stats of fear that are out there. I'm sure the crowd kind of knows many of those. Second is resilience of infrastructure to climate change. And when you think about the large majority of natural disasters, over the last 5 years have been water related. And it's had huge damage to water infrastructure that is -- there that impacts communities. And of course, then it has the ripple effects of society. The third though is, okay, we all know that. And then we hear these numbers like $22 trillion required. Ask somebody, the model would be $25 trillion or $15 trillion, everybody throws the numbers around. Well, I'm not sure where the $22 trillion is going to come from. Bottom line is we don't need $22 trillion, because the innovation, technologies exist today to solve these challenges at a fraction of that. They're typically involving digital enablement. Digital is not a strategy. It's a way to enable outcomes, helping a utility or an industrial customer, build infrastructure in a much more smart, efficient, affordable way versus the old school way, large engineering capital, big works. That's still needed, but not nearly what it was before. I can go to a litany of those technology. But to your question, Brian, about by region, what we see is the challenges are much the same. We hear more about them in developing markets. It plays to the narrative of poverty. But we see the same challenges here in the U.S. And secondly, what we find, at least within Xylem is there's a reason why emerging markets, developing markets for us, Asia, Middle East, Eastern Europe are growing at 2x the rate of developed markets is because they don't build new [ dumb ] infrastructure. Whenever I lived in Thailand many years ago, they didn't build land lines for a phone, they went right to cellphone. It's the same thing happening around water infrastructure. So they're leapfrogging the technology, whereas I would say here in the U.S. and parts of Europe, we are still dealing with aged infrastructure, and you got to remodel, refurbish. And so there are some challenges associated with that. But again, technology has a big role to play in addressing that. Sorry for the long-winded answer.

No, that's great. And the leap-frogging infrastructure point is a really interesting one. And it probably applies to more than just water in some ways as well. Susan, similar question to you, but for California. What do you think California needs to do to improve water reliability and availability? And what role do you see Cadiz playing in providing that solution?

I'm going to say, I agree with 99.9% of everything Patrick just said. Going to take issue with 2 things. One is we don't have a water scarcity problem. We have as much water on the planet today as we've had for 4 billion years. Water does not leave the planet. We have a water access problem, and it's because of infrastructure, 100% because of infrastructure. And if you look at California -- and this is a global problem. If you look at California, our water -- drinkable water for the human race was designed by the Romans and the Egyptians and the Chinese about 4,000 years ago. It's snow melt, the melt goes down into the -- and it gets into the river. It gets held in reservoirs that we build and then it percolates into the ground, and that's how humans access clean water, potable water. Problem is we're losing our snow melt, right? The snowpack in [indiscernible] California is ground 0 in the U.S. of Southwest. Basically, the Sierra Nevada is the major source of our drinking water. Over the last -- since 1950s, the snowpack in Sierra Nevada has decreased by 23%, steady trajectory. It is not going to reverse. Scientists are saying that the snowpack in Sierra Nevada's be gone in 25 years, gone. Same is true for the Rocky's in Colorado, 20% reduction over the last 7,500 years. It is not going to change. It's going in that direction. You lose the snowpack, that means you won't -- and the snow melt is happening, not where it was designed. Snow is now melting in the southern Sierras, where we don't have our reservoirs built. The atmospheric rivers we're experiencing are happening on the coast, not happening in the mountains. So we have a massive amount of water and no place to store it. And water is the most destructive force on earth. What's happening with the violence of our -- the changing climate is that Katrina and Louisiana was the calling card for what's now happening around the globe. What happened in Libya just now were two dams failed. Our system was designed with rock, cement, rebar and dirt. We've got 400 miles of canals in California Aqueduct, 200-foot section of it was destroyed few years ago. That would have been the source of water for all of Los Angeles. The California Aqueduct is -- that was the LA Aqueduct. California Aqueduct, 400 miles of dirt and cement. 1,000 miles of dirt levies up north. The entire water source for Southern California is now one storm away from losing its source of drinking water. So this solution, I agree with everything Patrick said about the solution is -- Yes. First of all, we have a 2 tri- we're going to spend $1 trillion in the next 20 years in North -- in America alone in terms of water infrastructure. And it's spent by public utilities and it's spend by -- they are funded through rate payers, right? And then we -- there's a $2 trillion gap over the next 20 years. And while we were -- everyone knows our infrastructure is aging, and we haven't had to invest in it because they just deal with the leaks. We lost $7 billion in water in leaks alone in the U.S. in 2019. We can't do that anymore. And now what's happening with the violence and the weather, when you have rivers through the subways of New York is your -- the systems that were designed for storms that are long gone, now crumbling. So you're going to see that $1 trillion spent, and you're going to see another $1 trillion probably spent in emergency funding. And so it's -- what needs to happen is storage, storage, storage and being able to move water in a way where we're not losing it. And we control it, because all of our flood control systems were designed to move water away from cities and farms and out to the ocean. We're losing it to the ocean. So it's an infrastructure problem that can and should be solved by storage and by the technologies to be able to manage our groundwater.

Great. Thank you. Let's get the investor perspective here. Matt, tell us how Water Asset Management is positioned in public and private opportunities. And how do you see the opportunity set risk, returns, whether it's California, the U.S. or elsewhere?

We started Water Asset Management 2 decades ago. We invest exclusively in company's assets, equities globally that ensure water quality and water supply. The core belief is that scarce, clean, reliable water is the resource defining this century, much like oil defined the last century. And while these problems are absolutely being described in an accurate manner, all water problems that we've seen on earth regardless of size, are solvable. It made -- it's a very interesting characteristic to this very colossal set of problems. The solutions depend on where you are and what the problem is. But ultimately, it boils down to capital, water industry confidence and then most importantly, the will to act. And what we do is we allocate capital to companies that are basically providing all 3 of those key factors and doing it through companies that are either investor-owned water utility, wastewater utilities around the world, companies that make the pipes, the pumps, the meters, the things that [indiscernible] or shareholders [indiscernible]. Companies that are involved in all different kinds of water-related technologies. And then we've got a very well-developed practice on our private equity side, separate team that does water resource development, and we do that in the Southwest. We're actually an investor and own a piece of the Cadiz project and -- but what we do is directly is we own tens of thousands of acres of farmland, where the best water rights are typically flood irrigating forage crops. We implement very large-scale water conservation programs with that -- those assets through rotational [ following ], more efficient irrigation and now we've launched a large crop switching. So we're going from high water consumptive crops to low water consumptive crops, conserving significant amounts of that water, and then we're in a position to -- through compensated voluntary water conservation programs to re-lease or even sell that water to what is sometimes referred to as higher beneficial consumptive users. So we've generated very solid non-correlated market-beating returns with a lot less risk, a lot less correlation in all of our strategies. And again, we're here for sustainability purposes with very clear, simple to understand, definable, positive metrics, a positive impact. Xylem, for example, does a great job reporting their data in terms of positive impacts, and I don't have it all on the top of my head, but it's billions of gallons of water treated. It's billions of gallons of water conserved through leak detection and repair. And so we were talking last night, it was a great session last night. I don't know if everyone was there. But just about the complexity of ESG reporting and all of the myriad acronyms that are being required for -- water investing is impact investing, period. And the metrics, the KPIs that the companies deliver are very straightforward. We gather them as best we can from all of our portfolio companies. We report them to our shareholders. And we don't have to -- by being a water investor, we don't have to get lost in the complexity, ambiguity, challenges around all the myriad reporting. Although we do it because we've got a usage spun that is requires our reporting, but it's not -- the strategy is not driven by that. It's driven by very simple KPIs. And I would just -- one last thing I'll make before I hand it off, is -- I know that we're here talking about climate-related issues. The conversation around climate historically has been focused primarily on emissions, on carbon, obviously, very important. Transitioning to a low-carbon economy is very, very important. However, I mean the recent climate change is bad, 2 words, [ intensificate ] drought and flood. I mean the intensification of drought and flood. That's why climate change is bad. That's why we don't want temperatures below 2 degrees, we're trying to hold it at 1.5. Drought and flood are addressable by the companies in my portfolio and the companies that are sitting up here. And we need to expand the conversation to be more balanced to include water along with emissions, water along with carbon. All of the -- and when everybody talks about renewables, batteries, electric vehicles, I mean, this is all very important. It's all climate mitigation. Those are investments to mitigate climate for the future, okay? The climate adaptation is water. It's investing in companies that make pipes and pumps and meters, develops water supplies, technologies associated with monitoring, data and analytics. That's climate adaptation. We need climate adaptation as much as we need climate mitigation. And climate adaptation is now. And by the way, the businesses that are in climate adaptation, i.e. water, they've got more sustainable inflation-protected, non-correlated pricing power than companies in almost any other industry that I've ever looked at. So it's a great way to make great money while having a very positive impact. And our returns, we've been -- we have a very highly ranked return profile for almost 2 decades, and our stock picking is quite good, and I'm not going to get into that. But the main reason is because we're owning stocks in the water industry and avoiding stocks in other industries that are code ESG but that aren't necessarily as good a business as the water industry. I hope that...

That's great. And I was going to move right on to a technology question, but...

What Matt just said is super, super important. We -- this -- when you think about what's happening, I would just add fire to your other -- the example of one of the -- what climate change means today in terms of crisis. And water -- it's about climate adaptation. That is the immediate -- everyone talks about emissions in the long-term policy, but the immediacy is -- and that the trillions of dollars we're talking about, that's what's talking about the next 10 years of immediacy and again, climate adaptation is the key. And if you think about water and fire and flood, it underpins the entire housing industry. It underpins the entire insurance market. I mean there are so many multitrillion dollar impacts if you don't manage your water resources.

We've recently started a company with one of our companies that is -- it's called Wildfire Water Solutions. And it basically -- it's a company that delivers hundreds of thousands of gallons of water per hour over many miles and overland along with millions of gallons of storage with using very rapidly deployable, tactical water systems. And what we're able to provide is literally 30x the amount of water to the wildfire zone at 5% the cost per gallon. And the implications around wildfire suppression could be game changing. The implications around wildfire prevention and the wildland urban interface could be quite impactful. The allocations for the insurance industry that's fleeing the west in -- on mass because they don't want to underwrite that risk anymore. We may be able to have an impact on the industry's ability to assess risk and ultimately come back and underwrite. So again, all water, all the time.

I just appreciate the paid commercial advertisement. [indiscernible], I mean I think these intersections you're talking about is where technology comes into play, but also where having a platform not being a single point solution company comes into play, because customers and communities as they are coming to grips with the reality of their manifestation of water challenges for climate adaptation, they don't know where to go. And they don't want to deal with 25 different people to come in and solve the problem. And we, at Xylem, are not going to be everything, they're all people. But when you have a big platform, you kind of -- you kind of know the network and your neighbors. And if you're a company with a purpose that says it's not just about creating economic value, it's about social value. And your people want to do the right thing, they know to bring in. So we recently had a customer, a large refinery, I won't mention who it is or where it is had a major fire. And the whole thing was going to go down. And they were -- their solution because they couldn't get access to water, the water stress area was to use phone, which happen to have, of course, PFAS. Sure we'll talk about PFAS later. But with our capabilities with this recent acquisition we did, our teams came together within 24 hours, we laid 2.5 miles of pipe and brought in water from an area they didn't have access to before and put the fire out within 24 hours [ versus ] using phone. It's just a one -- I mean, a real-time example over the last month of people think -- I hate when people call it the water sector. There's a water sector. Water runs through society and economy in ways that we all kind of know here, but I think it's only recently that parts of the world are beginning to come to grips and understand that, that water is not one thing. It's part of everything.

I was going to ask you on technology, but I may rephrase the question to how you see Xylem's point of differentiation relative to other players in the space, either on technology and innovation or on implementation and execution.

I mean there are so many -- it's a great question there. There are so many innovative solutions that are out there already and being developed every day. And part of the reason we created what we call Xylem Innovation Labs; which is early stage kind of internal venture capital fund, which is not really about the money, it's about the knowledge and expertise; is to create a lighthouse effect. There are a lot of entrepreneurs and innovators that are out there around the world that believe they've come up. They have a passion to solve these issues, especially younger generation. They want to be part of the solution, but they don't know where to go. And we're not the only game in town by any means. But I think the larger the platform you have and the clear you are around what we believe the challenges are we're solving, it makes it easier for them to engage. We don't get all of them. We don't necessarily need to work with all of them, but we learned a lot through that process, and they learn a lot. A lot of these things aren't -- they won't be commercialized, they're not scalable. We can't have a portfolio of a whole bunch of myriad of bespoke solutions, not scalable. So -- but you find those ones that are, and you inspire, and you move them forward. So I think we have an advantage there to some extent in that people see that we're building a platform, which means scale globally. That's one. I think, two, I really believe, and I know every CEO will say this, but I think purpose -- I think culture and climate matters, really do. I think that people want to believe in something larger than themselves. And they want to know that the organization they work for is not just about the economic value. That has to happen. That's like my mom always said, "Son, you can eat your vegetables before you get dessert." You've got to deliver your numbers and generate a return, but it's how you go about doing it. It's the other things that you do while you're doing that. It's the community service. It's being involved in the Thai Cave Rescue years ago and not advertising it. Not talking about it while you're doing it, but afterwards. It's getting involved in disaster relief efforts around the world and building a capability. Those things matter at this point. In this crazy world, high-stressed, tight-strong world. People want to have a soul in something. We got great engineers, all companies have great engineers. We have great technologists, they'll smell up the bulls*** in terms of what works, doesn't work, what -- that's fine. Every company has that. But I think you want to be a [indiscernible]. You want to get the best number at bats of opportunities that are out there. And I feel very good about where we're positioned. And we don't do it ourselves. We have partnerships with academia, we have a couple of venture capital groups that we're invested in, that we get first look at. We have our eyes and ears open pretty much around the world, because most of the ideas don't always come out of the U.S., breaking news. There are many other countries around the world that are far more innovative, because water is a critical national resource, and it's a critical national security issue. So Singapore is really in the whole list of countries that tremendous, tremendous incubation opportunities going on and coming up with amazing stuff.

Susan, can you take us through the water conservation and storage project you're pursuing in the Mojave Desert and what you're waiting for, the key catalysts for implementation from a government approval front?