The Next Boom Name in Fracking

06/05/2012 8:15 am EST

Focus: STOCKS

Patrick McKeough

Editor, Successful Investor

Oil and gas exploration and production stocks have been a hot sector for some time now, but the next wave will be in stocks that will help clean up these ongoing fracking operations, writes Pat McKeough of TSI Network.

Xylem (XYL) sells equipment and services related to managing water.

The company’s products help its clients collect, distribute, use, and return water to the environment. Xylem is a Greek-derived word that refers to vascular tissue that carries water and nutrients through plants. The company operates through two divisions:

  • The Water Infrastructure division sells a wide range of products, including water and waste-water pumps, controls and systems, as well as water-treatment and -testing equipment.
  • The Applied Water division focuses on residential, commercial, industrial and agricultural water users. Its main products include pumps, valves, heat exchangers, controls, and dispensing equipment.

Xylem was formed on October 31, 2011, after ITT (ITT)split up into three separate companies.

ITT shareholders received one Xylem share for each share of ITT they held, plus one share of defense and information technology spinoff Exelis (XLS), and one share of the new ITT. Xylem began trading on New York on November 1, 2011.

In the three months ended March 31, 2012, Xylem’s earnings fell 19.2%, to $63 million, or 34 cents a share, from $78 million, or 42 cents a share, a year earlier. Without unusual items, such as costs related to the spinoff from ITT, earnings per share would have risen 9.1%, to 36 cents from 33. Sales rose 3.9%, to $925 million from $890 million.

The company has clients in more than 150 countries. Europe provides 37% of Xylem’s sales, the US supplies 36%, and the Asia-Pacific region contributes 11%. Other parts of the world provide the remaining 16%. Without the negative impact of currency exchange rates, sales would have risen 5.5% in the latest quarter.

The company now holds cash of $347 million, or $1.87 a share. Its long-term debt of $1.2 billion is a reasonable 25% of its market cap. The shares yield 1.6%.

New acquisition brings clean water services for fracking

Xylem has expanded rapidly over the last two years, mainly by making $1.3 billion in acquisitions.

Its most recent purchase was on September 1, 2011, when it bought YSI Inc. for $309 million. YSI is a leading developer and maker of water-monitoring technology. This is a big growth area, especially in the US, where stricter environmental regulations require companies to continually monitor the effects of their operations on water quality. YSI contributed $34 million to Xylem’s sales in the latest quarter.

Right now, one of the most controversial areas of industrial water use is hydraulic fracturing, or fracking, of hydrocarbon-bearing shale. This process involves pumping a mix of water, chemicals and other materials into shale rock formations that contain oil or natural gas. This fractures the rock and releases the oil and gas.

Some environmentalists are bitterly opposed to fracking, due to fears that chemicals will leak into drinking water supplies. YSI’s systems monitor water conditions near fracking sites and provide an early warning if pollutants are released.

Vast amounts of oil and gas have been discovered in fields in North America that will require fracking, including the Marcellus Shale in Pennsylvania, the Barnett Shale and Eagle Ford Shale in Texas, and the Horn River Shale in BC. Increased use of fracking will push up demand for YSI’s services.

The stock has gained around 8% since it split from ITT. It now trades at 13.6 times the $1.89 a share that Xylem will probably earn in 2012.

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