OK, fine, we borrowed that headline from a teaser ad and we can categorically state up front that you will not be able to retire on just this “one hot stock.” But that doesn’t mean it mightn’t be a useful part of your portfolio — so let’s try to separate the stock from the hype and figure out who it is, shall we?
The ad is from Mitchell Clark, a busy bee over at Lombardi Publishing who we’ve written about a few times — this time the ad is encouraging you to sign up for a subscription to his Micro-Cap Reporter, and if you pay to subscribe you’ll get your “free” copy of the special report called China’s Great Water Crisis Winner.
So who is it? To find out, let’s dig into his pitch a bit and sniff out the clues. Here’s how he gets us interested:
“Retire on this one hot stock!
“Already controls 17% of the $20.0-billion global water treatment market.
“Now ready to help the 980 million Chinese drinking polluted water…
“How a little-known 64-year-old American company is making China’s dirty water problems vanish for good
“This could be the longest-running blockbuster I’ve ever uncovered. Be advised to take immediate action!”
Sounds pretty intriguing, no? China absolutely has severe water problems due both to actual shortages (relative to population and agricultural demand) in the North, and to severe water pollution in the South and many of the major urban areas. The factoids are pretty widely known: essentially all of the rivers are heavily polluted, many cities process little more than half of their sewage before discharging it into waterways, extremely heavy fertilizer use impacts more rural areas, Chinese food security is at risk from desertification in the north as water is diverted to population centers … etc., etc. Throw in an occasional drought, an industrial accident that causes even more pollution, and some public demonstrations by local residents and farmers, and you can see how precarious the situation might be for this massive and rapidly urbanizing country.
So, the argument goes (and yes, this is an argument we’ve heard many times over the last five years — and one I agree with to some extent), there ought to be a lot of money made by the companies who can help China to clean up its water. That’s a pretty big picture argument, encompassing everything from new wastewater plants to better fertilizers to environmental cleanup to water distribution, pretty much everything you can think of in the business of finding, moving, using, cleaning, and reusing water.
Which stock, then, is Mitchell Clark pitching for his newsletter? Let’s get into the clues:
“In February 2011, it was revealed that China’s water crisis is twice as dire as previously reported. (Beijing’s 2007 report ‘forgot’ to account for agriculture waste water, even though 65% of China’s water is used for agriculture.)
“With that disturbing news igniting Beijing into aggressive action, I’m twice as excited about the profits I see headed our way from my top pick….
“And the innovative water-treatment company I’m going to tell you about is in line to see sales explode this year, next year, and for years to come…thanks to China’s monumental water crisis.”
Ooh, ooh! Tell me! Tell me!
“China’s Great Water Crisis Winner
“Surprise: It’s an American company! …
“A 50% pop in share price looks to be right around the corner and the main reason is: this company’s moneymaking opportunities in China are immense.
“Its business in China is exploding!
“You’re not investing in mere potential here. This little-known American dynamo has been in China for more than a quarter of a century! And the revenue it gets from China has, according to Barron’s, ‘… jumped by more than 25% a year in the past decade.’”
Sounds impressive, no? Especially if it’s an established American company, which means that hopefully we won’t have quite as much concern about accounting inconsistencies or fraud hitting the share price, as we have seen with the broad brush that has hit just about every Chinese small cap reverse merger stock (including water-related picks like Duoyuan Global Water (DGW), which has been in a trading halt for almost two months and seen mass board resignations — unfortunately not so rare these days, almost all of the trading halts at any given time are of Chinese small cap stocks).
Some more clues?
“The $130 million in revenue hauled in last year from its China operations is on track to rise about 30% this year. And management is targeting China revenue to reach half a billion dollars by 2015…
“The company went public in 1947 and has had a presence in China since the early 1980s. It already controls 17% of the $20.0-billion global market for water treatment, and 10% to 15% of China’s water-treatment efforts, leaving room for tremendous gains where it is most demanded.
“The stock has already climbed 44% since September. And, as I said, another 50% surge is at hand for investors who own this stock today.
“Now, the company has offices all over the country, including Hong Kong and, of course, Beijing.”
Sounds like enough, right? Well, we get a few more clues from Clark, just to be sure … he tells us that the key to “Winning in China” is that you have to have good networking connections, and this company apparently just improved their connections …
“… position just got stronger with the recent hiring of the former head of Asian operations for Eastman Kodak, who also happens to be a Beijing native, naturalized U.S. citizen and the one-time head of the U.S. embassy’s commercial-affairs department in Beijing.”
So … other than the hundreds of billions of dollars that China will need to spend to clean up water over the coming decade, that’s what we learn … who, then, is the company Mitch Clark is teasing?
I took all those clues, shoveled em into the hopper of the Thinkolator, and our answer came out clear as day: this is Nalco Holdings (NLC)
And yes, the investment thesis in this teaser from Clark appears to be lifted largely from the Barron’s article that he quotes — not that he actually plagiarized it, but that the argument and the background are very similar, even the focus on networking being critical and the impact that the former Eastman Kodak exec has had a big impact on Nalco’s China ambitions. You can see that full Barron’s article here if you’re interested, it ran in September of last year. The stock price, interestingly enough, is almost the same as it was then — NLC is right around $27 right now, right where it was last fall. The shares climbed to about $32 over the winter and have come back down fairly gradually.
But what Clark doesn’t quote from the Barron’s article is probably equally important — Nalco is definitely getting growth from China, and their China sales have slightly higher margins than their sales in more developed nations … but China is still a tiny part of their business. Here’s a fuller quote from the article:
“Nalco has operated in China for more than a quarter- century, and the revenue it generates there has jumped by more than 25% a year in the past decade. Last year, China accounted for about $130 million, or 3.5%, of total revenue of $3.7 billion, according to Eric G. Melin, Nalco’s executive vice president for Asia, based in Shanghai. This year, sales in China are on track to rise more than 30%, and management is targeting annual revenue of $500 million by 2015.”
Good stuff, to be sure, but even if they hit their targets and the rest of the company grows at the annual 15% clip that analysts expect (that’s a big “if,” of course, growth rates several years out are impossible to estimate very accurately), then Nalco’s overall revenues will be around $8 billion in 2015, and that $500 million in targeted Chinese revenue would make up about 6% of sales. So yes, China is growing in importance for the company, and that will probably continue, but it’s not just — or even primarily — a “China story.”
Nalco, incidentally, was a Warren Buffett story years before it became a China story — Berkshire Hathaway bought shares of the company in 2008, and reportedly had sold all of those shares as of Berkshire’s last 13F report (those are the quarterly filings that money managers and institutional investors have to file, listing their holdings). They did hold more than 5% of the company at one point, and the Buffett connection was certainly talked up quite a bit by investment newsletters and others, but since Buffett himself hasn’t talked much (if at all) about the company and it was a relatively small investment (it never reached the $500 million-$1 billion level that gets you individual attention in Berkshire’s annual report), it seems likely that Nalco was probably actually an investment handled by Lou Simpson at GEICO, a guess that is also supported by the fact that, as with several other Simpson investments (like Bank of America), it was cleared out of the portfolio when he retired. Just because Berkshire’s “favorite holding period is forever,” that doesn’t mean that they actually hold everything forever.
And as a tiny side note to that, the recent Berkshire Hathaway acquisition that’s gotten so much press, Lubrizol, is in a somewhat similar business and recently bought one of Nalco’s business lines.
So who is Nalco?
This is a company that is probably better understood as an industrial services firm than a water company, they sell processes and chemicals to help industrial users use water more effectively and efficiently, which is certainly a key issue for Chinese companies as well as industrial firms around the world. They have exposure to both some slower-growth areas (they do a lot of business with paper companies, for example), and to higher growth areas (like enhanced oil recovery technologies). This is how they describe themselves:
“Nalco Company is the world’s largest sustainability services company focused on industrial water, energy and air applications. We help our customers reduce energy, water and other natural resource consumption, minimizing environmental releases while boosting the bottom line. Through our sales, service, research and marketing team of more than 7,000 technically trained experts, we serve nearly 50,000 customer locations in over 150 countries.”
And their CFO actually gave a presentation at an investment conference this morning, so you can get their updated sense of themselves if you want to listen to the recording — it should be up later today.
The company has indeed been around for decades, but it fell into the hands of private equity in a leveraged buyout almost a decade ago and rejoined the public markets in the early 2000s with a bucket load of debt. They still carry a lot of debt, enough that it’s a substantial concern of many investors despite Nalco’s relatively steady and high-margin cash-generating business — they’ve been paying off debt gradually and pretty steadily over the last six or seven years since they re-IPO’d, and now their total debt is pretty close to their market cap and they seem to be able to cover interest expense handily with free cash flow … but they still have to pay a fairly high level of debt service (interest rates on their bonds are in the 6-8% range for expirations in just the next couple years), and they would probably be quite sensitive to another credit crisis if it cut off their ability to refinance at a bad time.
I have no idea why Mitchell Clark is pitching this special report specifically for his Micro-Cap Reporter, because, though he teases the idea aggressively and also pitches the huge gains that can be made from micro-cap stocks and low-priced stocks in the balance of the ad letter, Nalco is absolutely neither a micro-cap nor low-priced. Micro cap usually means stocks with a tiny capitalization, at least under $500 million and sometimes far smaller, under $250 milllion or even $50 million, depending on who you ask. Low-priced usually means stocks under $5 or $10, which institutions usually shy away from and which tend to be more volatile day-to-day.
Nalco would be considered a mid-cap stock by most folks, it has a market capitalization of just under $4 billion and debt of a little under $3 billion. And the share price itself is a perfectly ordinary $27 and change.
So it ain’t a micro-cap, it is a somewhat indebted company with a bit of exposure to the Chinese water problems (and a large global water business — it’s not just China that’s facing water shortages, crises, and pollution … even many US non-desert areas are in this camp, thanks largely to dilapidated urban water infrastructure), and with a pretty strong and steady cash-flow generating business around the world. It seems likely that their growth in the coming years will also be from their higher margin businesses, including their energy services and their emerging market water businesses, so things look at least decent for Nalco.
Nalco is probably not dirt cheap here, but the price looks quite fair — it trades at a price/earnings/growth (PEG) ratio of just over 1, with the PE ratio right around 14 and earnings growth expected to be right around the low teens going forward. They have paid a dividend for about four years, but it’s quite tiny — which makes sense for a company with this level of debt service. The payout ratio is less than 10% (meaning, they pay out less than 10% of their earnings as dividends), and current yield at this price is about 0.5%, so the dividend serves largely to remind investors that they’re, well, strong enough to pay a dividend.
From this limited look at the stock I’d say that it certainly looks reasonable, maybe even a bit inexpensive, but so then do many of the other water infrastructure and service companies, almost all of which are involved with China and other emerging markets.
Other stocks to possibly look at for this “story” are perennial industry leader Veolia (VE) or other big players like Severn Trent (SVT in London, SVTRF on the pink sheets), or stocks that are smaller and more levered to China like Hyflux (600 in Singapore, HYXFX on the pink sheets), Beijing Enterprises Water Group (0371 in Hong Kong, BJWTF on the pinks), or Kurita Water (6317 in Tokyo, KTWIF on the pinks). It’s a large sector that’s mostly occupied by utility operators, you can find relatively stable water company dividend payers as diverse as Aqua America (WTR), caribbean desalination firm Consolidated Water (CWCO) and Brazilian utility Sabesp (SBS). More convenient, if you’re focused on just the broad story, are the several water-focused ETFs, including PHO or PIO from PowerShares, (PHO includes a lot of irrigation and infrastructure consulting companies, PIO tries to have a global bent with more foreign-listed stocks) or CGW from Guggenheim/S&P, which has more utilities and industrial names — the three ETFs all clearly ride the same waves and usually have performance numbers within a few percentage points of each other, but trade leadership from time to time.
Oh, and despite the clear need for more water for a thirsty world, and for cleaner water for China in particular, all three of those ETFs are flat or down slightly over the last 4-5 years since they were introduced, and pretty much every individual company I mentioned above, with the exceptions of Beijing Enterprises Water and Sabesp, is also down substantially over that time. That’s an arbitrary time period and an arbitrary listing of the many available stocks that happened to come to your Gumshoe’s mind, I chose the timeframe just because that dates back to the first water investing hype-craze that I can remember, and the time that the water ETFs were launched en masse … but it serves as a reminder that supremely logical stories, and obvious needs like water, don’t always lead directly to immediate profits.
But it’s your money, what do you think? Would Nalco rise to the top of your favorite water investments, or do you have another you’re thirsting for? Let us know with a comment below.
Full disclosure: I hold shares in Berkshire Hathaway, but do not own any other stocks or investments mentioned above, and will not trade in any stock mentioned for at least three days.
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