Industrial uptick boosts equipment stocks
- From: Vol 11, Issue 1 (January 2010)
- Category: General
- Region: Americas
- Country: United States
- Related Companies: Calgon Carbon, Danaher, Energy Recovery Inc, GLV, H2O Innovation, Insituform, ITT, Layne Christensen, Millipore, Mueller Water Products, Nalco, Pall Corp, Pentair and Tetra Tech
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A combination of internal and external factors meant that nearly all the North American water equipment stocks in the GWI index grew in value in 2009. What are the prospects for 2010?
If the upturn in the market in 2009 was not so friendly to water utility stocks, the opposite has been true for water equipment suppliers, whose fate is more directly tied to economic resurgence.
When you fall fast and hard, there is frequently no place to go but up, and the majority of the North American equipment stocks tracked by GWI’s Global Water Index showed a strong improvement last year versus where they ended 2008.
The lesson learned from 2009 is that water equipment suppliers follow the industrial sector more closely than many had thought, and the rebound from industry has given them an additional boost. Within the equipment sector, however, stocks tied to repairing infrastructure have tended to do better than those relying on investment in high-tech equipment.
“I think that for the municipal water and maintenance sector, revenues will be a bit better than people expect, but for fancy new treatment plants it will still be slow,” said Debra Coy, an analyst with Janney Montgomery Scott. “The residential end markets and new construction projects will remain slow, but we think the industrial markets will get a bit better in 2010.”
The best performer by far was Illinois based Nalco, which specializes in water treatment products. Nalco’s stock closed at $25.52 on 31 December 2009, showing a remarkable 121% improvement over the course of the year.
“Nalco was one of those situations where it fell so sharply that it had a fairly significant rebound,” explained Ryan Connors, an analyst with Boenning & Scattergood. Connors explained that because Nalco’s customer base includes many industrial manufacturers, the company’s top and bottom lines both took a big hit in 2008 when many industrial clients shut down facilities. This economic pain was reflected in Nalco’s all-time low stock price of $8.95 in November 2008. As Connors explained, “even though we have had a dramatic run-up, we are still only getting back to prior levels.”
Nalco also received a boost at the end of 2008 when Warren Buffett’s Berkshire Hathaway bought 6% of the stock, sending a clear message to the market that the company was likely to offer good value from that point onwards. Buffett’s view that the water infrastructure market represents an enormous growth opportunity in the US and in China is borne out by the fact that Nalco plans to double both the number of people it employs in China and its sales in the country within the next five years. The company’s efforts to reduce its debt load over the course of 2009 also drew plaudits from sector analysts.
Pentair, a water treatment and storage products company, focused on cost-cutting as one of the chief strategies to confront sagging demand for its products. This policy appears to have borne fruit, as the stock ended 2009 up 36%. Pentair management was keen to stress that the company had focused on permanent costs rather than temporary costs, a move that analysts viewed as positive.
“If you are a well-run company like Pentair, when you trim unnecessary costs, there is a long-term benefit from that,” said Connors. “Now that it appears that the end markets are going to recover, people are recognizing that the prudent cost-cutting that took place will encourage more growth on the bottom line.”
2009 was a difficult year for Energy Recovery Inc., whose shares have shown a 9% decline over the course of the last twelve months. Desalination technology companies such as ERI got caught up in a certain amount of hype surrounding the perceived potential of the market, but ERI’s struggles in 2009 illustrate both the benefits and the problems this can generate. “Desalination will grow, but even fast-growing end markets are not invulnerable from the depth of the downturn,” said Connors. ERI also had to readjust its earnings expectations in response to economic conditions, which took its toll on the stock. At $6.88, the stock is a far cry from the $12.30 high recorded in July 2008, shortly after the IPO.
Calgon Carbon also had a tough year but the company is definitely on the rebound, and Michael Gaugler, an analyst with Brean Murray Carret, views it as one of his top picks for 2010.
CCC, which specialises in activated carbon, manufacturers a powdered carbon that is used in removing mercury emissions. Gaugler estimates that there will be a sharp increase in demand to meet state mercury removal regulations – one that Calgon will be uniquely positioned to meet.
“Activated carbon plants are not cheap to build,” said Gaugler. “You have to know what you are doing to make a buck at it. You have very few competitors and a lot of incremental demand coming online. Calgon has already sold forward a majority of its future production in multi-year contracts.” Gaugler also expects Calgon’s ultraviolet products to take off in a big way between now and 2013.
He emphasized that their strong financial position further positions them for future growth. “You look at their balance sheet – it doesn’t get any better,” he said. “They’ve got no debt and they still have tons of free cash.”