Investing in “Blue Gold”

03/24/2008 12:00 am EST

Focus: STOCKS

Nicholas Vardy

Editor, Bull Market Alert, The Alpha Investor Letter, and The Global Guru

Nicholas Vardy, editor of Global Stock Investor, says that as demand for water grows while supply remains fixed, water-treatment companies may be the way to play the trend.

For most of us, water is like oxygen: life sustaining, plentiful, but virtually free. Yet the smart money is betting that water may be the “oil of the 21st century.” And France’s Veolia Environnement (NYSE: VE) is my number one way to profit from this global megatrend.

By 2050, more than four billion people—nearly half the world’s population [then]—are expected to live in areas that are chronically short of water. Even as demand is exploding, supplies of water on a per-capita basis are diminishing rapidly.

Water’s unique characteristics mean that no other industry has a more compelling—or more sustainable—business model. Water by far is the most stable of all commodities and it remains virtually immune to business cycles. Economists say that demand for water is virtually inelastic—as prices rise, consumption does not decrease. Nor does water have a substitute.

Headquartered in Paris, Veolia is the largest provider of water and wastewater services in the world. The company now supplies drinking water and wastewater treatment services to nearly 117 million around the world in 59 countries.

Chief executive officer Henri Proglio has mapped out an impressive expansion strategy for his company. His aspiration? To double the size of the company in the next five years. In addition to an ambitious acquisition agenda, Veolia is pushing aggressively to secure new water and waste-management contracts. Veolia signs long-term contracts with its customers, some as long as 50 years. The contracts start generating positive cash flow after six or seven years. With contract-renewal rates hovering at 93%, the business is a model of stability that provides Veolia with reliable cash flows even in troubled times.

While investors throw money at any stocks remotely associated with China, investment in adequate water and sanitation facilities may be the safest and the most profitable way to play the rise of China. Indeed, China has more than 20% of the world’s population and only 7% of its water.

Veolia already has invested $800 million in ten water-treatment projects and two facilities that generate power with methane gas released from solid waste. Its management sees a lot of opportunities for its business in China, across the board, whether it’s water, energy, public transportation, or waste treatment—and expects its business there to grow by 20% to 25% per annum as far as the eye can see.

Annual revenue in 2007 was expected to rise nearly 40%, [while analysts are expecting earnings growth of over 50%. Trading at] a forward P/E of about 16x, its combination of double-digit percentage earnings growth and returns comfortably above average capital costs is sustainable for at least the next five years. (The ADSs closed Thursday above $66—Editor.)

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