Zenon Environmental: Having it both ways

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How has the Canadian membrane specialist been able to capture the best of both worlds?

During the stock market run-up of the late 1990s, Canadian membrane firm Zenon Environmental gained a respectable 300%. In the three years since the bottom fell out of the tech market, Zenon has gained 120%. During the same period, the Dow has lost 30%.

Over the last decade, Zenon Environmental has behaved like a tech stock when tech is strong, and like a water stock when tech is down and the security of water is attractive.

Zenon’s core product is a hollow fibre membrane that requires less energy to operate than conventional membranes and can be used in relatively small footprint areas on various types of water and wastewater plants. Zenon is a technology leader in the filtration sector, and has stayed ahead by narrowly focusing its capital on membrane technology. So far, the company hasn’t expanded into the other areas that some of its competitors have.

Many water filtration companies do a large business in O&M for treatment plants, which Zenon does not, and at least one, Ionics, derives over 30% of its revenues from its ultra-pure water unit which services the scientific and medical community. Zenon’s commitment to investing in the best technology starts at the top – CEO Andrew Benedek has a PhD in chemical engineering and had a long academic career before founding Zenon.

In 2002, Zenon set records in revenue growth and order backlog. Zenon’s 2002 revenues rose 17% to $146 million, with a backlog up 34% to $164 million. The fourth quarter saw Zenon book another record of $80 million in new orders.

From an investor’s point of view, Zenon may be a victim of its own success – P/E ratio based on 2003’s projected earnings is 32. However, this is not out of line with US water filtration and tech companies traded on the NYSE.

Schwab Capital’s Debra Coy has reported that Zenon has been slow to show significant earnings as it has ramped up its product line and manufacturing capacity, but recently these capital investments have started to pay off and Zenon is beginning to enjoy increased profits and revenue growth. 2002 earnings per share (EPS) were $0.23, and analysts that follow the company forecast significantly increased EPS, $0.37 for 2003, and $0.54 in 2004.

Recent projects in Singapore, New Zealand and Germany, as well as continued expansion in North America, specifically a $20 million contract in Canada’s western province of British Columbia have contributed to the company’s success. Currently, the Asia Pacific region accounts for less than 6% of Zenon’s sales, but the company expects strong growth now that it has established a beachhead in Singapore.

Zenon is aggressively expanding into eastern Europe where it has opened a new membrane manufacturing facility in Hungary. As eastern European nations are phased into the EU, Soviet-era water infrastructure will probably not pass muster with the regulators in Brussels. The need to meet EU standards for water should create strong demand for Zenon’s filtration technology as the region begins to climb out of the environmental hole that is the product of 40 years’ water supply poisoning from a rickety and inefficient industrial complex.

Too good to dislike, Zenon is ranked as Canada’s top corporate citizen for its combination of socially and environmentally responsible business practices. There is strength gathering behind the responsible investing movement that has some real financial basis, despite the poor showing of indicators like the FTSE 4Good Index. Zenon could be the poster child for the long-term cost reductions and strong performance that social and environmental responsibility is billed as providing.