Last night, Consolidated Water (NASDAQ:CWCO) reported first quarter earnings of $0.04 per share, down from $0.26 last year and a nickel below consensus estimates of $0.09. As a result, the stock closed at $11.17 today, down 10.50%.
Clearly, the decline in earnings was disappointing. Management attributed the decline (vs. last year results) to three factors: (1) lower earnings and profit sharing attributable to its affiliate OC-BVI, which operates in the British Virgin Islands; (2) higher project development expenditures incurred by its Mexican business venture and (3) lower earnings from its retail business segment.
The first two factors were disclosed by management well in advance and were almost certainly included in analysts' estimates. At OC-BVI, the shortfall vs. last year was attributable to the scheduled decline in court-ordered payments from the British Virgin Islands government related to the government's takeover of the Baughers Bay plant.
In Mexico, the company paid $1 million to an investor in its joint venture under an option agreement and also $0.35 million its EPC contractor for building and operating a pilot plant. (It decided not to renew its memorandum of understanding with this contractor when it expired in February.)
These expenses were previously disclosed in the company's 2013 10-K. In it, CWCO estimated that development expenses for the Mexican project would total $25.2 million in 2017. Besides this quarter's $1.35 million, the company has agreed to pay $17 million to acquire land. CWCO also anticipates $6.8 million in other development expenses during the course of the year. On the conference call, management said that its $25.2 million guidance for Mexican development costs in 2014 was unchanged.
In the retail business segment, sales were down 4% for the quarter. Management thinks the decline may be due mostly to much higher than average rainfall in the Caymans.
Gross profits in the retail segment declined by $340,000, more than the decline in sales, mostly due to the fixed cost nature of water plant operations. We believe that some of the costs of CWCO's start-up operations in Bali are also included in retail segment results.
General and administrative costs in retail were also higher, due to increases in salaries and higher professional expenses (associated with the company's effort to renew its retail operating license on Grand Cayman).
Taken together, these factors caused retail operating income to fall 68% to under $300,000. This translates into a $0.04 decline in EPS from $0.06 last year to $0.02 this year. Given that the first two factors discussed above were previously disclosed, most of the shortfall from consensus estimates was apparently due to the drop in retail profits.
It is true that besides the disappointment in the retail segment, investors could find other causes for concern here. Among them: Difficulty in signing up new customers in Bali, especially under long-term contracts; the potential difficulty and delay caused by the search for a new EPC contractor in Mexico and the sharp run-up in receivables due to payment delays by the Commonwealth of the Bahamas (which were settled in the 2014 second quarter).
Yet, it is not surprising that CWCO is experiencing some challenges which require adjustments to its plans in Bali and Mexico. We will undoubtedly see more of these in the quarters ahead.
Despite the adjustments and disappointments, the projects appear to be on track. We also assume that rainfall will return to normal in the Caymans and so should revenues and profits in the retail segment (albeit with some drag from start-up losses in Bali). On balance, therefore, while CWCO has embarked on a speculative development path, we view the recent sell-off as a buying opportunity.
Disclosure: I am long CWCO.