7 Small Cap Water Infrastructure Plays for the Stimulus Package

by: Jim Regan

One of the major themes of 2009 to this point has been investor speculation on global infrastructure. With the recent $787 U.S. stimulus package signed into law by President Barack Obama, analysts are at a crossroads in looking where to invest to get the best exposure to bailout money. But where exactly is the money going to be? After digging into the stimulus, it seems to me that all signs are pointing to the road and water infrastructure as leading areas of the package.

If you want the “pure play” on this plan, one needs to look beyond the larger companies and focus on the smaller market cap, more niche, investments in infrastructure. Having a look into the “water” space can yield some big winners as the global water shortage scare starts to take effect in the face of huge capital injections into deserving companies. Small market cap companies in the stock market could have big advantages as money starts to pour into the system.

The Problem with Large Cap Companies

When most investors consider stocks that will be “plays on the stimulus package,” they often mis-represent the relative exposure that is obtainable. In most recommendations, we find companies like Caterpillar (NYSE:CAT). Caterpillar is a fantastic construction giant… and they do indeed have exposure to highway infrastructure among other infrastructure building projects. The downside to investing in a larger company like Caterpillar is that you need to deal with all of the excessive business segments of the company… areas that build cranes and erect commercial buildings, for example. More than likely, if you are looking for a “pure play” stimulus stock you want to be able to focus on a specific niche area of the plan. Now I’m not saying that big construction companies like Caterpillar, or safer engineering and construction companies like Jacobs Engineering (NYSE:JEC) and Fluor (NYSE:FLR), aren’t worth your while. However, if you want to bet big, you better have a specialist!

Plays on Water Infrastructure

You may have heard recent “doomsday” forecasts of a global water shortage. The global demand for water has tripled over the past 50 years, and the U.S. government has projected that 36 states will run into water shortages in less than five years. Indeed, the way that we distribute water in the United States and around the globe leaves much to be desired. In fact, the amount of money that it would take to repair the U.S. piping infrastructure is actually less than the cost of leaving things as they are. Pipes break, and the water waste has already wreaked havoc on our agriculture and plumbing efficiency. Because problems will likely only accelerate, the stimulus package makes it a no-brainer… and a play on water infrastructure is a fantastic play on the stimulus.

Infrastructure and Fluidics

One of the top water infrastructure plays for the year comes from a leader in “fluidics” systems and components for everything from medical to fire & rescue. I’m talking, of course, about IDEX Corp. (NYSE:IEX). IDEX is a company with a solid 9% growth in orders over 2008, and one of the few not laden with bad news. They trade at a premium 13x multiple, but may be worth your while. Dipping down into the even smaller market cap companies, we find Layne Christensen (NASDAQ:LAYN), who produces water infrastructure as 75% of their business. One thing that is a net positive about Layne is that they have about 85% of their sales coming from the U.S., where stimulus packages are plentiful. The problem here is that Layne faces huge pressures from falling state and local budgets for water infrastructure in the face of the stimulus package that could weigh on earnings.

Fluid control has been an interesting niche area inside of water infrastructure. Since we waste so much of our water, companies specializing in pressure and control can really help us thwart a drought. Have a look at companies like Gorman-Rupp (NYSEMKT:GRC) and Mueller Water Products (NYSE:MWA) for a little taste of the control equipment business. This is a space where there have been significant headwinds thus far, as temporary plant shut downs and pay cuts at Mueller echo throughout the industry. If you have an appetite for risk, have a look in this niche.

Profits Buried in Your Backyard

One of the more positively viewed areas in water (in my opinion) is investing in the companies making the actual pipe. Northwest Pipe Co. (NASDAQ:NWPX) and Ameron (NYSE:AMN-OLD) have been solid performers for the year, and now command valuations sometimes 2x the industry P/E (in the case of Northwest Pipe). This high-pressured steel infrastructure can be used for many practical purposes, such as drinking water, and have high prospects with a dire need for a domestic re-haul. In fact, a new “trenchless replacement technology” may advance these names even higher. Essentially, we don’t need to dig up the actual pipe any longer. With trenchless replacement, you simply dig through to the start and finish of the pipe, and fit a smaller pipe inside of the old one for a seamless repair. Great ideas build great investments, so keep these companies on your watch list for a more attractive buying point if the valuations scare you.

Agriculture Irrigation

Lindsay Corporation (NYSE:LNN) puts through a self-propelled irrigation system infrastructure, primarily used in agriculture. Irrigation can be a big theme going forward, and I wouldn’t be surprised if the next scare is properly feeding our nation’s crops with water. Problems with the agriculture space include the commodity price collapse of late, but an increasing need for bio-fuels could send Lindsay higher with the ag. companies.

Bottom Line: The Barack Obama stimulus package has investors speculating like mad on companies even remotely tied to bailout spending. However, most analysts are missing the “big picture” in my opinion. What does this mean? You can capitalize on these small cap names if you can stomach the volatility because they are proportionally quite a bit more involved in all of the right spaces. At any rate, many of these water infrastructure plays make a serious case for premium P/E trading multiples.

-Jim Regan

Disclosure: None