“Motley Fool’s #1 Inevitable Mega-Trend Investment”

By Travis Johnson, Stock Gumshoe, September 25, 2008

The last time I looked in detail at some picks from the Motley Fool Income Investor, it was for their top “Peak Oil Picks,” all of which were at least interesting companies even if they’re all down by 10% or so following the decline in oil prices. (The latest version of that writeup is here, from late July, if you’re curious.)

Today, we’ve got a new one from the Fool, and their “inevitable mega trend” is about investing in water — I’ve seen teases about water stocks from the Motley Fool before, but that was for the Global Gains service, and for a different company. Back then, it was Bill Mann saying that the “water stock to buy if you’re buying only one” was SABESP (SBS) — you can see that article here if you like.

Here’s the yelling part of the ad that is supposed to get your attention:

“80 countries and 3 billion people are desperate for it right now!

“It’s more precious than oil. And potentially the biggest growth opportunity of the decade. Just ask Warren Buffett… and T. Boone Pickens… along with investment whizzes Chuck Royce… and Stanley Druckenmiller (to name a few)…”

And today, interestingly enough, this other Motley Fool newsletter uses some of the same language to promote a different water stock — again we hear about “The water stock to own if you’re buying only one.”

Only this one has a higher dividend, and a much larger business.

So — what are we dealing with here?

You probably don’t need me to tell you about the importance of water, but the Fool makes that case over several pages of frightening prognostication regarding the world’s supply of fresh water — including stark reminders of the amount of water that’s required to make a hamburger, or a cotton ball, and a map that illustrates the declining water supplies in much of the industrialized world, as well as in much of the globe that lies between the Tropics of Capricorn and Cancer. Plus, of course, Australia is now in what most describe as the sixth year of drought, which is not that unusual for the driest inhabited continent … but still a significant problem, particularly for agriculture.

They give a few examples of the scary things that have been happening recently …

“Great Lakes shrinking at alarming rate!
California drought stokes record forest fires!
New York reservoirs at record lows!
Georgia drought impacts millions!
Florida drought threatens future growth!”

So water is important, granted. How does one profit from that — and without seeming to be a water profiteer? There are lots of ways to profit from water, whether you want to buy actual water rights like T. Boone Pickens or PICO, or run a water utility, or build or sell pipes or water control equipment, or buy those big tanker ships that they use to bring Fiji spring water to American yuppies.

The Fool’s argument this time is that you should buy the dominant water services company, a firm that builds and runs water systems, desalinization plants, wastewater treatment, and all kinds of related equipment and services.

Here’s what we’re told about this specific company:

“History — has been in business for over a century!
“Expertise — #1 water and sewage provider on the planet… with a 96% renewal rate on its home market contracts!
“Financials — 80% of revenue comes from long-term contracts, often 20-30 years… and return on capital shot from 6.4% to 10.9% in 2007 alone!
“Dividend — required by law to pay you over half of what it earns every year… with a dividend that has grown over 20% annually over the past 3 years!”

OK … so not a huge stack of specific clues, but enough for the Gumshoe to tell you that this must be …

Veolia Environnement (VE)

Veolia probably is the one company to buy if you want to buy a water stock, if you’re of the mind that that Wal Mart is the one retail stock to buy, or Bank of America is the one financial stock to buy — it is a huge company that is a good proxy for water infrastructure investment and management.

And it has fallen very, very, very hard this year — Veolia was close to being a $50 billion company back in December and January, and you could pick up the whole thing today for less than $20 billion … if you ignore the $23 billion in net debt.

I’m not sure what French law says, but Veolia’s dividend policy continues to be that they aim to pay out between 50-60% of earnings as dividends. And the dividend has gone up dramatically in recent years, from 88 cents in 2005 to $1.87 this year (it’s already been paid and it only gets paid once per year, so you’ll be waiting until next May for 2009’s dividend). That means the effective dividend on shares for this year is about 4.5%, nothing to sneeze at — and if they’re able to continue growing income, as they have done quite well in recent years.

Veolia actually has several big lines of business — they are the major company, along with GE and Suez and a few others, that can be counted on to bid on many of the world’s big water infrastructure projects, whether it’s building a new water distribution network or a new desalinization plant or a few wastewater treatment plants. They both build and manage these projects, acting as a private utility for water around the world.

But that’s not all — they are also one of the major operators of mass transit systems in the world, including bus and rail. They provide some services to energy companies, too, and do a lot of industrial services related to the environment — essentially, you can outsource your factory’s environmental management to Veolia, including wastewater treatment, etc.

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Right now, Veolia is a worldwide firm but is heavily dependent on its home markets — they get close to half of their revenue from France, and about 75% from throughout Europe, but Asia is one of their bigger areas of growth potential and they also work in North America and elsewhere.

So … do you want to buy Veolia Environnement? Now that panic has hit the markets, VE is certainly much cheaper than it was earlier in the year (I wrote about it following a Roger Conrad ad that touted the same company back in April, when the shares were close to $75). Last Winter, the “theme” of water stocks was on everyone’s lips — that was probably the wrong time to buy any of these kinds of stocks. Today, most folks aren’t talking about water — but we still need it, and it’s undeniable that the need for new water plants and systems around the world is only growing.

It might be that funds will run short to build and operate new plants, or that sinking economies will nationalize or pressure water utilities, but in the end I expect that companies like this will probably end up being good long term investments. I haven’t researched Veolia specifically to see if there are company-specific reasons or hairballs on the books that account for the dramatic recent fall in the share price, but all else being equal I still think the money the world needs to spend on increasing the supply and distribution of clean water, and cleaning the dirty water, will probably bring profits for a number of companies. At these prices I’d probably also be tempted by GE with its water and energy businesses being depressed by their financial divisions (though they’re taking another hit this morning with their reduced guidance), but Veolia would certainly be one of the first companies to research for any investor interested in water stocks. Being big doesn’t mean they can’t fail, and they have quite a bit of debt to service if you’re worried about the future of credit, but they are profitable and have shown good growth, and they do share the wealth with shareholders.

Other water stocks have been covered from time to time in this space, if you’re curious — including Hyflux in Singapore, PICO in Nevada, SABESP in Brazil, and the little bouncer World Water and Solar. Even Navellier has been all over this, from the equipment side, with his touting of Fl