Water is One of the Market’s Hottest Sectors

It may sound strange to talk about a global water crisis, especially from the perspective of a comfy Westerner who pays pennies per gallon for clean water. Then again, it probably sounded strange to talk about $60 oil when it cost little more $13 per barrel in 1999.

There is one big reason why you should pay attention to the emerging water crisis: You can make a boatload of money investing in the idea. Believe it or not, water-themed stocks were one of the stock market’s hottest sectors over the last six or seven months.

Let me share with you our results, and then give you two ideas that look good now.

The water pump company we recommended last July, Gorman-Rupp (AMEX: GRC) is up 111% since July. Nalco Holding (NYSE: NLC), the global water filtration company, is up 43%, while irrigation equipment maker Lindsay Corp. (NYSE: LNN) is up 24%. We also picked up a couple of Asian water companies, Kurita Water Industries of Japan and Hyflux Ltd. of Singapore, up 11% and 24%, respectively.

That’s not all. In my investment letter, Capital & Crisis, I recommended a water pipe company, Northwest Pipe (Nasdaq: NWPX), and a water utility SJW Corp. (NYSE: SJW) in July. They are up both up more than 50% since then.

These are pretty satisfying gains, especially for a holding period of only half a year. Also, there was not a single loser in the bunch. Though I met with much skepticism on the water crisis idea and I talked to many doubters about my investments in water, the market’s validation of these picks is undeniable.

The long list of profitable water investments I have just listed would probably seem like just one long “infomercial,” if not for my conviction that the long-term outlook for all of these companies is even better than when I first recommended them. The vast and urgent water challenges facing much of the world’s population are not going to go away anytime soon. Fixing them will require lots time and lots of money. The companies we hold are part of the solution and their businesses should all benefit as a result.

Even so, a couple of these ideas stand out as particularly timely buys right now.

I’d start with Lindsay Corp., the maker of irrigation equipment. The one basic fact I like to highlight is this one: Irrigated land makes up only 17% of the world’s farmed acreage, but yields 40% of its food supply. So in a world where freshwater sources are strained, irrigation is one way to dramatically increase the efficiency of water use. Irrigation use is lower overseas, where Lindsay gets more than 30% of its sales. As a result, it is a rapidly growing part of the company.

There is also a vast replacement market, which doesn’t get as much attention, but provides a major source of growth nonetheless. Over 50% of the 180,000 irrigation pivots in use in the U.S. are over 10 years old. So you see that, even in developed markets, there should be strong demand for irrigation equipment.

The final bit of positive news does not directly deal with water, but rides the back of the ethanol boom. There are 79 ethanol plants under construction. There are already 116 ethanol plants producing ethanol now. And there are at least 200 more ethanol plants in the blueprint stages.

All told, ethanol distilleries will pull in 139 million tons of corn from the 2008 harvest. That’s about half of the projected corn harvest for 2008. The price of corn rose 80% last year, largely due to demand from ethanol producers.

So farmers have a great incentive to ramp up production. They also have lots of cash, since 2006 was good for them. The USDA farm income report, published late last year, was strong with $253 billion in cash receipts. It looks like it should have a pretty good year in 2007, too. For 2007, the USDA estimate is about $255 million in cash receipts.

As it turns out, there is a pretty nice link between rising crop prices and farm equipment sales. So expect a strong year for farm equipment sales in 2007. That is the final reason to pick up shares of Lindsay Corp. sooner rather than later. Get ahead of the strong results that should come as the year rolls on.

Second, I also think buying Nalco Holding now should prove particularly timely. Nalco has a great water treatment business for industrial and institutional applications. It has over 70,000 customers spread out over 130 countries. The company is in all the relevant markets in the area of water filtration and improving water efficiency. As a result, Nalco is in a great position to take advantage of the long-term water story.

It is also involved in partnerships and joint ventures with numerous industry players to develop new ways of dealing with old problems. For example, one joint research partnership plans to develop advanced technologies to reduce, reuse and recover power plant cooling water. Cooling water is essential to power plants, which consume more than 100 billion gallons daily in the United States.

All of these projects provide an “option-like” component to owning the shares. In other words, there is always the potential for large, unexpected gains coming from some breakthrough in the research and development efforts.

Nalco is particularly timely, though, because of its ability to take advantage of the current strong push to increase energy efficiency and protect the environment. “Nalco’s water and air treatment expertise enables our industrial and institutional customers to significantly improve the energy efficiency of their operations,” says Nalco’s executive vice president and chief operating officer Bill Roe.

To give you a case study, consider that Nalco’s products recently helped a Houston building owner save more than 1.36 million kilowatts of electricity per year and reduce greenhouse gas emissions. There is a huge market for these kinds of products that includes not only commercial buildings, but also hospitals, hotels, schools and manufacturing facilities.

With the increased focus on reducing greenhouse gas emissions, Nalco’s products should be in even more demand.

In a recent report I predicted that Nalco’s earnings would rise 50% in 2006. I was wrong; they rose 80%. Much of that growth came from China, India, Brazil and the states of the former Soviet Union.

This year, don’t be surprised to see earnings rise another 30-40%. Nalco is one of the best — and least known — global investments on the water idea you can own.

Meanwhile, I continue to find some really great small- and mid-cap stocks in the water sector. A couple of months ago, I recommended a small chemical company involved in water treatment that sells for only half of the replacement value of its assets! I doubt this stock will still be so cheap two years from now.

The water boom is still young, but the boom won’t stay young forever.

Chris Mayer
for Markets and Money

Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in Markets and Money. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.

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One other thought on the ethanol boom as it relates to water…in addition to the need for more crops, the ethanol plants themselves will require lots, and lots of water. In many cases, that will mean new pipes and equipment because the existing infrastructure in the rural communities won’t be able to handle the expanding load.

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