Blue Gold Bargains: Water Utilities Targeting Emerging Markets Present Opportunities

by: Danny Furman

In May 2009 I wrote an article about a small-cap water utility stock. The company, Cascal, has operations in emerging Asia, South America and Africa as well as more developed Europe. Cascal, which traded under the ticker symbol HOO, has since been acquired by private equity firm Sembcorp Industries Limited. In August 2010, an offer of $6.75, representing more than a 100% gain from May 2009, was made for remaining shares of HOO before delisting from the NYSE.
More than two years later, the same logic that made Cascal a great investment makes water utility companies the most attractive sector in today's market. Here's an excerpt from the HOO article:

It appeals to me when a business operates in multiple countries. It appeals to me when a company innovates a way to make waste (cheap in any market) valuable. Dividends appeal to me.

I am a big believer in water utilities and don't doubt that investors (those who haven't yet) will realize that, in order for us to exist, so too do these companies. Drinking water is everyone's most precious resource and many governments, currently managing domestic water distribution and treatment, are expected to turn to the technology and efficiency of the private sector. You can't print water!

With real growth highly questionable in the United States, water utility companies with operations in emerging markets remain superior investment choices. Two such companies, both yielding over 3% and discounted heavily vs. their peers, are:

1. Veolia Environment (VE): Calling Veolia a water utility company is like calling General Electric (NYSE:GE) an electronics maker. The company began as a water distributor in mid-19th century France. Today it also provides waste management, transportation, energy and water treatment services throughout the country. Veolia has won contracts and established itself as an environmental management provider in dozens of countries spanning almost every continent. Though Veolia is a highly leveraged conglomerate, the company has remained profitable through recessionary times in Europe and elsewhere. Margins were slashed from 2007 to 2008 but have remained steady since. Veolia recently sold its Belgian division to Van Gansewinkel, a Dutch waste management company. The closing price of the sale has yet to be announced. At $27.84 per share, down 20% since early May, VE currently trades at a trailing earnings ratio near 16. North American water utilities mostly have trailing P/Es in the low 20s and annual sales less than their respective market caps. Veolia has a market cap below $15B and annual sales over $45B. Shares appear significantly undervalued, as North American utilities such as Waste Management (NYSE:WM) and American Water Works (NYSE:AWK) have taken smaller hits recently and garner richer valuations. With an annual dividend averaging $1.42 over the last four years, VE yields just under 5%.

2. Consolidated Water Company (NASDAQ:CWCO): Desalination, making saltwater potable, is an easy technology for water investors to get excited about. It does not, however, seem to be highly popular or applicable on a worldwide basis. CWCO and Energy Recovery Inc (NASDAQ:ERII) are two publicly traded desalination companies. ERII currently trades near all time lows, though the stock did close June 17 with a high volume 4% surge. Perhaps the thinly traded stock has finally bottomed following May 2010's "flash crash" and reporting a loss in FY2010. CWCO boasts a stronger operating history and focuses more on performing desalination than the design or manufacture of pertinent technology. It is also the lone dividend payer of the two, yielding 8 cents per share quarterly. Having traded as high as $35 per share in 2007, $19 in 2009 and $11.50 earlier in 2011, CWCO also trades at a deep historical discount. Revenues have declined slightly since 2008 along with profits, however a 50% owned reverse osmosis plant currently being developed in Northern Mexico will desalinate 100 million gallons of water per day. The stock closed June 17 at $8.58, bringing the annual yield up to 3.5%. Consolidated Water is seeking new projects worldwide and is well established in Central America with major operations in the Bahamas and Cayman Islands.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VE, CWCO, ERII over the next 72 hours.