Water stocks
have strong
upside potential
by Stephen J. Hoffmann
Water Investment Newsletter
Given
the complexity of the economic and regulatory environments that shape the
water industry as well as the investment subtleties that may favor one water
stock selection over another, Water Investment Newsletter periodically highlights
selected water stocks from their Portfolio. These highlights are intended
for general discussion purposes only.To make the list beneficial to readers, it is composed of just five long-term selections that are believed to be timely, based both on current valuations and the state of the economics that may govern future growth. The overall investment theme is presented as a starting point for more detailed individual analysis.
The
selection representing the favored water chemicals business is Betz/Dearborn
(NYSE BTL) (formerly Betz Laboratories). Betz/Dearborn is a supplier of
engineered chemical treatments for influent water, cooling towers, wastewater,
and process systems. The company's Novus polymers are advanced, cost-effective
treatments for a wide variety of liquids/solids separations applications.While
chemical treatment faces increasing competition from biological and physical
treatment methods, there are a number of applications that have the potential
for continued growth. Corrosion and scale inhibitors are used extensively
in maintaining distribution system integrity, pH adjusters have a growing
impact in controlling disinfection by-products and in recycling industrial
water and enhanced coagulation aids in advanced filtration. The list of
issues mitigated by water treatment continues to expand: arsenic removal,
reduction of hazardous sludge, improved dewatering of sludges, and increased
effluent quality.It
is for these reasons that the so-called service chemicals business looks
promising. Betz is following the lead set by the large purification and
wastewater treatment systems suppliers in providing integrated solutions
that maximize performance and minimize costs. Betz recently completed its
purchase of Argo Scientific, a leading provider of highly specialized chemical
treatments, services and technology for membrane separation systems. This
acquisition positions the company in international desalination, RO and
other high growth middle market segments. Significant to the selection of
Betz/Dearborn is that the chemical business is shaping up as a platform
for growth in other areas of the water industry.Despite
lackluster performance, Osmonics (NYSE OSM) continues to be a favored selection.
The central theme is a technological focus on fluid purification and separation.
The company manufactures replaceable membranes and other filter media for
use in fluid separation and filtration. Its processing equipment employs
crossflow filtration (including RO, nano-, ultra-, and micro-filtration),
ion exchange, and ozonation. The company's fluid handling equipment includes
pumps, electronic controllers for water softeners, flow control, and measuring
devices and instrumentation.Recent
weakness in the stock is due to flat earnings caused by product mix and
price competition. Predatory pricing by Hydranautics (the US subsidiary
of a Japanese form) has impacted the margins on the membrane business, which
accounts for roughly 25% of Osmonics' sales. The weakness is believed to
be a long term opportunity as the company deliberately executes its growth
strategy. Most notable are the recent acquisitions that provide insight
into the strategic direction of the company. In July of 1996, Osmonics acquired
Desalination Systems which manufactures membranes for reverse osmosis, nanofiltration,
ultrafiltration, and microfiltration. In February 1997, AquaMatic, which
makes specialty valves and controllers for the water treatment market, was
purchased. Micron Separations, which makes membranes and filters primarily
for the diagnostic, laboratory and medical markets was acquired. And RO
membrane elements maker, Purification Products Corp. was acquired from Sybron.
In the area of instrumentation, Osmonics acquired product lines form ORS
Environmental Systems which measure volatile organics and disinfection by-products
on-site.Osmonics
is also a play in ozone technology. In addition to its existing ozone business,
the company entered into a partnership with Fuji Electric in October 1997
to manufacture high concentration ozone generators using proprietary Fuji
technology and components. The objective is to pursue large ozonation projects
worldwide giving Osmonics a strong entry to the municipal water treatment
market. Osmonics has a good mix of businesses and is selected as a basic
water industry stock with an extremely modest valuation.Another
basic water industry company is Watts Industries, Inc. (NYSE WTS). Watts
designs and produces a broad line of valves used in, among other areas,
plumbing, water quality, water flow control, and industrial applications.
The company's product lines include safety relief valves, pressure regulators,
thermostatic mixing valves, ball valves, and flow control valves for water
service primarily in residential and commercial environments. While Watts
is not a pure play in water, the company is one of the world's largest independent
valve companies and well-known for its backflow preventers that prevent
contamination of potable water caused by reverse flow within water supply
lines.The
investment theme is one of stability and leadership in the water infrastructure
and distribution segment. Growth rates are not spectacular, but as a solid
water company with the potential to be a takeover target long term, the
stock is an attractive selection.The
trend toward alternative disinfection technologies is another compelling
investment theme. Trojan Technologies Inc. (TSE TUV) is a Canadian-based
company that specializes in UV applications for disinfecting drinking water,
industrial and residential applications, and is the world's largest supplier
of ultraviolet (UV) municipal wastewater disinfection systems.The
potential of UV light to provide technological solutions to the environmental
problems of microbial and toxic pollution in air and water is promising.
In addition to UV as an alternative to chemical disinfection methods, it
has been extended to recirculated water and effluent disinfection, organics
reduction, and treatment of toxic chemicals. UV disinfection is also finding
applications in the treatment of combined sewer overflow, in process equipment
protection, in preventing contamination in cooling water, and in aquaculture.
New technologies have extended the use of UV light to treating greater water
flow, and effluent water with high levels of solids.Trojan
has developed a position of leadership in UV technology and is in a strong
growth phase. The company is actively seeking to broaden applications into
areas beyond those currently served, including removal and destruction of
toxic wastes in liquid streams, volatile organics in the gas phase, and
advanced oxidation products.The
final selection, Met-Pro Corporation (MPR), is a small cap company with
strategically diverse operations. Met-Pro manufactures and sells pollution
control and allied equipment for purification of air and liquids, and fluid
handling equipment for corrosive, abrasive, and high temperature liquids.
As a pure environmental company, Met-Pro offers a variety of positives.
The segments of the company are engaged in activities that, when aggregated,
comprise a fairly compelling investment picture.For
example, the Stiles-Kem Division is a leading manufacturer of specialty
chemicals for the control of lead and copper leaching, scale, and the discoloration
of drinking water caused by the presence of iron and manganese in the source
water. This segment benefits from the mandates of the Lead and Copper Rule
as well as the need for controlling water quality problems in distribution
systems.The
Systems Division is a leader in the supply of custom designed and manufactured
air and water pollution control systems. The water capabilities include
physical, chemical, and biological control systems for treating toxic leachate
from landfills and a wide variety of industrial wastewater applications.
The Keystone Filter Division includes industrial standard products, custom
products for air and liquid filtration, and standard home drinking water
products.The
company also has several divisions engaged in pumps; Sethco makes corrosion
resistant pumps, filter chambers, and filter systems used in wastewater
treatment systems; Dean Pumps manufactures high quality pumps that handle
a broad range of industrial applications; and Fybroc is a world leader in
fiberglass reinforced corrosion resistant pumps used in, among other applications,
industrial and municipal wastewater treatment.Despite
record sales and increased earnings, Met-Pro's stock trades at 13 times
estimated fiscal year ended January 31, 1998 earnings. The stock is believed
to have significant upside potential.Editor's Note: Copyrighted (c) 1998. Stephen J. Hoffmann is a contributing editor to Water Investment Newsletter, 230 Main St., Halstead, KS 67056, 1 year, 12 issues, $140. Mr. Hoffmann prepares the selections for the Model Portfolio. Water Investment Newsletter focuses on water stocks and investments. WIN researches publicly-held, water-related manufacturing, service, treatment, and utility companies. Featured are Company Profiles, Model Portfolio, Industry Reports, Water Stocks Table and more. Bull & Bear readers can receive a FREE copy of WIN by writing to the address above or by calling 1-800-251-0046.