Given the abundance of water on the earth, you'd think supply wouldn't be an issue. Alas, it's not that simple. The oceans make up nearly 97% of the earth's water, leaving only 3% in fresh water -- of which two-thirds is frozen in the icecaps and glaciers. So, less than 1% is suitable for human consumption. And that's clearly not enough.
In some parts of the world, the "simple" solution to the shortage of water lies in converting sea water into fresh water. As I mentioned in
my last column, I hold shares in a desalination company that does exactly that. Although
is very small (with a market cap of just over $191 million), competing in the desal market with the likes of
, it's also the only pure desalination play available.
Cayman Islands-based CWCO is region-specific, designing, building and operating reverse osmosis desalination plants and producing fresh water, then supplying it to customers in five Caribbean and Central American nations -- the Cayman Islands, the Bahamas, Bermuda, the British Virgin Islands and Belize. Fresh water is difficult to source in these areas, and desalination can produce a steady source of water from an unlimited supply of saltwater. Through reverse osmosis, a gallon of sea water can be turned into 0.4 gallon of fresh water.
The company currently operates 14 plants and these are relatively small, producing from 600,000 gallons to several million gallons of water per day. CWCO specializes in plants capable of producing between 1 million and 12 million gallons a day and is actively seeking to build new plants in the US Virgin Islands and Aruba through a bidding process currently under way.
While it's difficult to compete with the likes of GE in the desalination space, Consolidated has carved out a nice geographic niche for itself in an area of the world that is growing. It's doubtful the company will ever go up against GE to build the huge plants the latter is capable of delivering, but will rather stick with the 1-million- to 12-million-gallons-per-day plants that serve it so well.
It hasn't been all plain sailing for CWCO over the past few years, though. Shares are down 62% since hitting an all-time high in the $34 range in October of 2007 and there have been some pretty risky developments. For one, the company is still in a dispute the government of the British Virgin Islands as to who owns the Baughers Bay desalination plant. The BVI government claims that it owns the plant and has filed suit with the Eastern Caribbean Supreme Court, asserting ownership. While that case is ongoing, the British Virgin Islands have been paying CWCO, which continues to deliver a sizeable chunk of its water, less than the company's cost of production. As a result, CWCO has been recording losses related to its equity in the operation, including $1.6 million in Q3. While the court recently ruled that the BVI government must pay Consolidated $10.1 million for the water it has produced from December 2007 up to now, the amount has not yet been paid.
As the company is based in the Cayman Islands, it does not pay income taxes, which is one of the reasons that its profit margins have averaged just over 20% for the past seven years. While 2008 was a rough year in that regard, as CWCO's net margin was just 11%, it bounced back to 14.6% for the first nine months of 2009.
With regard to the current wrangle with the British Virgin Islands government, I believe the risks of operating in nations whose laws are different to those of the US are already priced into the stock. At $13.00, CWCO trades at about 21.5x trailing earnings and 16.5x 2010 consensus estimates, both well below the seven-year average of 32x. While I don't believe CWCO warrants a 32x multiple at this point, if the company can move past those BVI plant ownership issues and reinvigorate investor confidence, I think a low to mid-20s multiple is not unreasonable. This would put the value of the stock in the $20 range, with a yield of 2.3%.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider CWCO to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
At the time of publication, Heller was long CWCO.
Jonathan Heller, CFA, is president of KEJ Financial Advisors, a fee-only financial planning company he recently launched. Jon spent 17 years at Bloomberg Financial Markets in various roles, from 1989 until 2005. He ran Bloomberg's Equity Fundamental Research Department from 1994 until 1998, when he assumed responsibility for Bloomberg's Equity Data Research Department. In 2001, he joined Bloomberg's Publishing group as senior markets editor and writer for Bloomberg Personal Finance Magazine, and an associate editor and contributor for Bloomberg Markets Magazine. In 2005, he joined SEI Investments as director of investment communications within SEI's Investment Management Unit.
Jon is also the founder of the
, a site dedicated to deep-value investing. He has an undergraduate degree from Grove City College and an MBA from Rider University, where he has also served on the adjunct faculty; he is also a CFA charter holder.