Liquid Assets: Using Water to Add Life to Your Portfolio (Part II)

| About: Companhia de (SBS)

In part I of this series, I suggested that during times like these, with governments in turmoil, economies in question, and markets schizophrenic, it may just be that taking two aspirin with water, or at least a couple quality water stocks, can provide a calming effect. In that first article, I presented my favorite water management, desalination, purification, recycling, and reclamation company. Now let's look at some other interesting opportunities on the waterfront:

How About A Nice Quasi-Safe Water Utility – With a Growth Kicker?

I believe that one side-effect of the Great Recession is that more municipalities will be turning over their mom-bureaucrat-and-pop-bureaucrat water distribution systems to for-profit corporations that know how to manage payrolls and projects skills most municipalities have shown themselves to be woefully lacking in. I’ll try to cover them in a future article.

But there is one water utility I’d like to suggest for your due diligence right now. It is the Brazilian mouthful properly called Companhia de Saneamento Basico do Estado de Sao Paulo (NYSE:SBS). I mentioned a couple months back that Brazil was the only high “total available renewable water resource” country that makes it into my A ‘n’ B ‘n’ C club. Here’s a company that is in Brazil, is in water, and meets my own personal growth and fundamental value criteria. SBS has been growing at double-digit rates for several years, and is a one of the few in-country stocks I like enough to buy rather than buying an ETF or closed-end fund that spreads my risk.

The company provides clean water as well as environmental sanitation services like treating sewage and recycling gray water via its industrial waste treatment facilities. Founded in 1954, the company has grown with the Sao Paulo state of Brazil. The company treats sewage for 26 million people and also handles rainwater drainage and management. One thing all water utilities have are very wide moats. How does zero competitors sound as a moat? SBS’s growth depends upon the growth of the nation, not taking market share from a rival – or worrying about a rival taking theirs. And, unlike the US water utilities, growth in Brazil is extensive; SBS will continue to grow as Brazil grows. The company enjoys a high free cash flow of some $2 billion a year, as well as high growth.

Add to this already-good story the fact that the upcoming World Cup, hosted by Brazil, will have some games played in Sao Paulo. Wanting to project the best image to the rest of the world, I imagine Brazil will provide the funds for a significant boost to San Paolo’s (read: SBS’s) sanitation facilities. Future regional and world events will ensure that Brazil takes steps to improve water quality, sanitation, and many other infrastructure opportunities.

The company sells at one times revenue, a P/E of 7.9, and well below book value, which is over $100. Even skimming its high for the year, it yields just over 7%.

Still, before I personally would buy a lower-growth, politically-constrained US water utility, I’d take a hard look at SBS.

Hyflux (OTCPK:HYFXY) is my favorite company in the area of the business with what I believe has the biggest potential. And SBS is my favorite for income with mostly-steady growth. But there are companies working in the fresh-water world that will benefit mightily from their technologies and experience, as well. Pollution, chemical and oil spills, waste and fertilizers have exaggerated the health impact caused by the lack of clean drinking water. It’s the same all over the world.

And Here’s a Preliminary Look at Some Other Fine Companies

In the US, agricultural pesticides and herbicides account for more than 70% of water pollution. At least 70,000 different chemicals are used regularly throughout the world, and there are between 200 and 400 toxic chemicals that contaminate the world's waterways. This industrial waste, when coupled with agricultural runoff, further exacerbates the problem.

That’s why wastewater treatment is big business, processing millions of gallons of water while sending tons of the refuse taken from the water to landfills. However, in much of the world, this process is even more necessary and is just getting started. In many nations, 90% or more of all sewage and a close-to-it or equal percentage of all industrial waste are discharged into surface waters without any treatment whatsoever!

So companies that provide services to collect, treat, monitor, meter and analyze water and wastewater, or who provide the pipes, the pumps, the generators, and the flow control systems, efficient irrigation , recycling of gray water, and so much more, are all in demand. This last area is where I find 90% of the great investment opportunities. I can’t possibly do justice to all these fine companies in the little space remaining. But I can introduce you to them and invite you to research them in greater depth, as I have done.

Tetra-tech (NASDAQ:TTEK) does it all: consulting, engineering, program management, construction and technical services, all focused on resource management and infrastructure. It is involved in the Big three going forward: water, the environment, and alternative energy services. Pentair (NYSE:PNR) has two primary business segments: Water and Technical Products. The Water Group provides both products and systems used to move, store, and treat water. (The Technical Products Group is mostly about thermal management, designing standard and custom enclosures for electronics and electrical components.) ITT Corp (NYSE:ITT) is not a pure play but, rather, a conglomerate (sorry! “Multi-industry company”) that is in three primary areas, but their Fluid Technology includes water and wastewater treatment systems, the pumps that make it all work, and related technologies.

Then there is Lindsay Corp (NYSE:LNN). If you drive across America, or fly over it, you’ll see gigantic circular crop irrigators that spew water out like huge lawn sprinklers. Basically, these irrigation systems save the farmer money and save all of us water. Veolia Environnement SA (VE) is a big French water services firm, with a large and growing presence in a number of developing markets, where it competes directly with Hyflux. Suez Environnement SA (OTCPK:SZEVF) is another French company primarily engaged in the field of environmental services. The Company comprises two divisions: the Water Division, which is involved in the treatment and distribution of drinking water and the purification of domestic and industrial water; and the Waste Division, which is involved in waste collection, treatment of waste, recycling, and material, biological and energy recovery.

Layne Christensen (NASDAQ:LAYN) is an interesting drilling and construction company focused on water, mining and natural gas production. In the water arena, LAYN provides water well drilling services, water and sewer distribution remediation services, and waste water treatment services. As water management becomes more critical, LAYN’s services to repair in situ (in-the-ground) distribution pipes for both water and sewer become more important. Energy Recovery Inc. (NASDAQ:ERII) is a small-cap company that seeks to make desalination more affordable. ERII’s primary product is the PX Pressure Exchanger, a rotary positive displacement pump that recycles about 98% of the energy used in the pressure requirements of reverse osmosis, reducing overall project energy requirements by upwards of 60%.

Here are a few more for your consideration: Itron (NASDAQ:ITRI), Insituform (INSU), Gorman-Rupp Co. (NYSEMKT:GRC), Valmont Industries Inc. (NYSE:VMI), Badger Meter Inc. (NYSE:BMI), RWE (OTCPK:RWEOY), Idex (NYSE:IEX), Flowserve (NYSE:FLS), Ameron (NYSE:AMN-OLD), Pall Corp (NYSE:PLL), Dow Chemical (NYSE:DOW), Watts Water Technologies (NYSE:WTS), Siemens (SI), Basin Water (OTC:BWTRQ), Mueller Industries Inc. (NYSE:MLI), Mueller Water Products (NYSE:MWA), Danaher (NYSE:DHR), Calgon Carbon (NYSE:CCC), and Franklin Electronics (NASDAQ:FELE), Fluor (NYSE:FLR), and Nalco Holding (NYSE:NLC) – the largest global player in the industrial water treatment industry.

If you can’t find something you like about this industry from among all these choices, you simply aren’t looking hard enough!

Disclosure: We, and/or those clients for whom it is appropriate, are long SBS. We have many of the others listed above on our Watch List.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

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