Water Works

10/23/2015 10:00 am EST

Focus: UTILITIES

Nick Hodge

Founder and President, Outsider Club

From broken pipes to drought to global infrastructure, the water sector presents significant opportunities according to Nick Hodge. Here, the editor of Like Minded People walks us through his water sector portfolio, highlighting the best ways for investors to gain exposure to their critical market.

Steven Halpern:  Our special guest today is Nick Hodge, editor of Like-Minded People.  How are you doing today, Nick?

Nick Hodge:  Very well, Steve.  Thanks for having me.

Steven Halpern:  In your newsletter, you compile a number of sector-based portfolios and one that has been particularly strong has been the water sector portfolio. Now, before we look at some individual holdings, can you give our listeners a general overview of the water sector and your thoughts on the long-term prospects here?

Nick Hodge:  Sure, so, the nutshell version is that only 2.5% of all the water on Earth is fresh water. The rest is salt water and 70% of that 2.5% is frozen.  It’s either in glaciers or permafrost, so we only have access to a very limited amount of it, most of which is stored in underground and ancient aquifers and we’ve been drawing down on those for centuries now.

And that’s resulted globally in nearly a billion people that don’t have access to safe, fresh water and a recent report says that number could double to two billion in the coming decades, so, not only are we using more water, but we’re using more water for other things, not just for drinking and sanitation but also to produce energy and to produce food.  

What I mean by that is it takes a lot of water to drill oil, to frack wells.  You have to shoot millions of gallons of water down wells, and to generate nuclear fuel, you have to use thousands of gallons or millions of gallons of water to cool a nuclear reactor.  Plus, it takes a lot of water to make food that we eat, right?  

Not only to grow the grains that we eat, but also to produce the meat.  One kilogram of meat requires about 20,000 liters of water and all of this means that trillions of dollars needs to be spent on the water sector globally in the coming years.  

China has dedicated $600 billion by 2020 and Bloomberg has said the market as a whole is worth about $450 billion annually and that’s growing at a 4% to 6% annual clip, so that’s a really good space to be in for investors.

Steven Halpern:  So this is a very long-term sector from your perspective, but there’s also short-term events—such as the drought in California—that raises awareness of this.  Is that bringing this sector to investor attention?

Nick Hodge:  You know, absolutely.  California is seemingly in perpetual drought for the past decade and every once in a while, we get stories coming out of there, whether it’s wildfires or the amount of water required to produce almonds, that certainly jog the investors’ memory and the memory of the public in general.  

Not just stories about drought, but think about how many stories you see on your local news programming about a busted water pipe or something like that, flowing into a street. They’re nearly every day, right?  

About 50% of the water that goes through city pipes are lost because those pipes are leaking and draining, so, certainly drought helps keep it fresh in the mind, but really it’s underground.  You don’t see we’re losing 50% of our water, and so, that’s a catalyst right there for investment, as well.

Steven Halpern:  Let’s turn to some of your favorite investment ideas in this sector and one idea that you consider a particularly intriguing buy right now is Layne Christensen (LAYN).  What’s the outlook here?

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Nick Hodge:  This is really one of my favorite companies, not just in the water space, but across the nexus of investments that I look at. It’s the number one driller of water wells in the US. It’s a top five US sewer repair and construction company.  

It’s the number two trenchless pipe rehabilitator in the country and it’s basically a drilling company, right?  It drills water wells, it drills oil wells, and it drills exploratory wells in the mineral sector, but it’s really been bogged down by some problems, right?

It derived a large portion of its revenue from that mineral sector—from its minerals division—and that sector globally is in a six-year bear market, so revenues from that division have fallen off sharply, which has led to losses.

But at the same time, its other divisions, mainly its water division and its inline pipe rehabilitation division—which relines pipes while they’re still underground—has been doing gangbusters, and so, really this is a turnaround story, right?  

Management either needs to sell the mineral division and the heavy civil division and focus on just the water division or it needs to pare down those divisions that are making losses to the bone.  

Other than that, the company is in really good shape.  It has, just in its heavy civil segments and mineral divisions, it has $260 million in assets.  That means it can sell those, pay off its $130 million in debt and still be left with $120, $125 million in cash.  

The company is going to do $700 million to $800 million in sales this year, but it’s only trading at $138 million market cap, a reflection of their recent losses from the minerals division, so I think once we take care of this minerals division thing and let the water division continue to ramp up, I think this is a heck of a turnaround story, especially down at around $7 or $8, this is certainly a $10 stock.  

Steven Halpern:  Now, you’re also bullish on a company called Lindsay Corp. (LNN).  What’s the attraction here?

Nick Hodge:  Lindsay is a very interesting company.  They primarily make large irrigation units.  These are the giant sprinklers you see in the middle of cornfields and soybean fields as you’re driving through the country, but they make them a little bit different than other companies.  These are very smart machines.  

They’re GPS-enabled, they’re connected to the Internet, they’re connected via Wi-Fi to centers in the ground, so they know exactly which crops need how much water, exactly which acre needs how much water, and so, they don’t waste a drop in that respect.  

They also don’t use much energy and they don’t require as much manpower because they can be moved around the fields remotely from the farmer’s barn or from his home, and so, they generally save water, and they save energy and manpower.

But the problem has been that the soft commodity prices over the past few years have meant that farmers haven’t spent as much on equipment as they typically do, so Lindsay’s revenues have been hurt in that regard.  Still, the company is profitable.  

It just reported four-year earnings this week. Had $26 million in profits—or $2.22 per share on $560 million in revenue—so it’s profitable. It’s been raising its dividends and it has said it plans to do that in the coming years as well, so right now it’s already paying 28 cents, I believe, per share quarterly.

And, you know, once the commodity sector—the agriculture sector—turns around and we can get higher prices for corn and beans, then farmers will start spending once again and Lindsay will be even more profitable than it already is during this downturn.

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Steven Halpern:  Now, your water sector portfolio also includes two funds that you recommend for their long-term value and as dividend-payers.  The first of those is Macquarie Infrastructure (MIC).  What does this company offer to investors?

Nick Hodge:  This is basically an infrastructure, sort of, a holding company, if you will, that trades like an MLP, but it’s not, it’s a company. And what it does is, it owns, operates, and invests in a portfolio of infrastructure businesses.

It owns an airport business that refuels planes on the tarmac and builds airports and hangars, it owns a 50% interest in the largest bulk liquid tunneling business in the US, it has a gas processing and distribution business and it also owns a portfolio of power and energy investments that include renewable generation facilities like solar and wind, and also, other utility businesses.

So it’s a soup-to-nuts infrastructure play, really, which is why I like it.  It’s big, it’s stable, it pays a nice dividend.  It’s a $6 billion market cap company that is generating a billion dollars a year in profits, so, you know, a nice low PE and multiple there and it’s also yielding 5.7% annually, so a nice solid play in a sector that is stable and not going anywhere.

Steven Halpern:  Now, finally, you recommend a direct play on the water sector and that’s the Guggenheim S&P Global Water ETF (CGW).  How can investors use this as a way to get diversified exposure to the sector?

Nick Hodge:  CGW is just a one-stop shop fund for the water sector globally, so, it was the first fund listed in the US that is a global water ETF.  Holds 50 water-related companies, and only 38% of them are from the US, so it’s truly a global fund.  

17% of the company is in the United Kingdom and the rest are spread out across the world, but it does a good job of diversifying between large stable utilities and the growth opportunities that include parts manufacturers like pipe manufacturers and pump manufacturers.

So you own really a basket of water companies, 50 of them across the world. Has a low expense ratio of .65% and you still get a tiny dividend of 1.5% that more than outspends that expense ratio.

If you don’t want to take a direct bet on an individual company like Lindsay or Layne, you can certainly buy the Guggenheim S&P Global Water ETF and get exposure to the entire sector.  

I will note that it does own Lindsay as one of its holdings but it does not own Layne, so if you want to buy one fund to get exposure to the entire water industry, CGW would be the way to do it.  

Steven Halpern:  Again, our guest is Nick Hodge of Like-Minded People.  I thank you for your time today.  It’s a very fascinating discussion.

Nick Hodge:  You’re most certainly welcome.  It was my pleasure.  

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