Muni Budgets May Not Be as Strong as Perceived

Overview:

• Overall municipal spending growth is expected to persist in the low single digit range, but we saw negative revisions to last year's outlook.
• Cash outlays negatively diverged versus last year's survey and are lagging capex budgets.
• PFAS water treatment is important, but implementation timelines could be challenging to achieve.
• Increasing market demand in data centers increases demand for water and could place strain on local resources.
• Survey participants expect reduced federal funding for future budgets as a result of incoming policy changes

Our 10th annual U.S. municipal spending survey tracked outlooks at municipalities across the country. We targeted approximately 50 municipalities. In addition to our survey results, we explored the use cases for water cooling technology for data center related markets.

The TD Cowen Insight

The results of our survey were surprising this year. Given federal money and a still-strong economy, we expected universally positive reads. However, budgets in 2024 coalesced at lower-than-expected growth versus 2023 forward expectations, and cash outlays materially lagged. This result calls into question 2025 growth that is already expected to moderate.

Surprisingly Low Growth Versus Expectations for 2024

Our survey last year was very positive, and given nothing had fundamentally changed regarding broad economic conditions or federal funding into the sector, we expected overwhelmingly positive results. That simply wasn't the result. Surprisingly, the actual 2024 growth came in below what was anticipated last year proving to be the largest negative gap versus expectations in the 10 years of our survey. The cash outlays versus budget also slipped substantially.

In 2023, 88% of respondents expected to spend >60% of their capex budget and 36% expected to spend 80-100%. This year almost all respondents were 60% or lower. This is a substantial negative divergence without an obvious catalyst. While respondents generally see low single digit to mid single digit budget growth into 2025, the amount expecting 5+% operating budget growth was nearly cut in half year on year. The negative revisions versus initial expectations for 2024 coupled with the weakness in actual outlays keeps us on alert for negative 2025 revisions.

Muni Spending and Growth on a Less Stable Foundation

In our 10th annual spending survey, we received budget outlooks directly from 50 U.S. municipalities both large and small. We collaborated with our colleagues, the TD Cowen Washington Research Group, on progress regarding policy decisions affecting the broader water space. Our work suggests that while spending in dollars remains healthy, the magnitude of recent growth came in below what was implied by our survey last year. Cash outlays – which were very strong last year relative to budget – have declined substantially on a relative basis. Growth is expected to continue into 2025 but seems to be on a less stable foundation than we would have thought.

Our takeaways from the recent Water Environment Federation's Technical Exhibition and Conference highlight the importance of Per-and polyfluoroalkyl substances (PFAS) treatment across the sector, though many expect current timelines to be overly ambitious given the technology currently available (largely on the testing and disposal side).

Our full report also contains a look at water considerations from the anticipated data center buildout. It is well known that increasingly powerful data centers require large quantities of water. However, the extent to which these facilities could place unmanageable strain on local resources will likely be a topic of rising importance over the coming years.

Financial and Industry Model Implications

Consensus forward growth for the water sector is on average over 5%. Order growth at the industry leader was negative in June before rebounding in September. We believe this has near-term downside risk and is a fair proxy for other players in the space. A broader cool down in water-related growth seems likely, and our survey results support that view. It also remains to be seen to what extent federal money is more of a state or local replacement of funds rather than purely additive.

Capital Spending Moves Higher but is Decelerating

Capital spending (based on publicly available data for water supply and sewage/waste disposal) has continued to move higher but is decelerating at high gross dollar levels. We will look to see if delays related to actual deployment of federal funds continues, and if year-on-year growth flips negative or drives another leg higher.

Participants will have to work through potential policy implications of an incoming Trump administration on existing and future U.S. Environmental Protection Agency regulation and federal funding disbursement. For the second straight year, all respondents expect to receive funds from the Infrastructure and Jobs Act – although this year, nearly all participants expect the contribution to be under 50% of the budget. This finding is a negative shift versus the prior year where approximately half of survey participants expected it to contribute over 50%. Perhaps this helps explain cash outlays lagging budget growth – something to monitor.