Water Service Stocks Supply Double Digit Sales Growth with High Margins: Credit Suisse Equity Research Expert Provides the 2012 Winners

Wall Street Transcript

67 WALL STREET, New York - August 27, 2012 - The Wall Street Transcript has just published its Utilities, Alternative Energy and Water Services Report offering a timely review of the sector to serious investors and industry executives. This special feature contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Outlook for Biofuels and Biochemicals - Asia Pacific Demand for Solar Energy - Grid Parity Timelines for Alternative Energy - Water Infrastructure Development - Irrigation and Metering Technology - Water Industry Consolidation

Companies include: Donaldson Company Inc. (DCI), Pall Corp. (PLL), Flowserve Corp. (FLS), Pentair, Inc. (PNR), Clean Harbors Inc. (CLH), W.W. Grainger, Inc. (GWW), Fastenal Co. (FAST) and many others.

In the following excerpt from the Utilities, Alternative Energy and Water Services Report, a sector expert from Credit Suisse discusses the outlook for water services stocks:

TWST: Would you begin with a brief overview of your coverage as it pertains to water services, including the specific names you follow?

Mr. Mazari: So from a water services perspective, we cover largely industrial-based companies that provide and that make or provide pumps, valves, any kind of filters into various water markets, whether it be municipal water, residential water market, any kind of industrial water market and the pumps and filters that essentially clean as well as move around water that is required or used in any industrial manufacturing process, whether it be food and beverage, whether it be energy, chemicals or other manufacturing end markets.

And the companies that we cover are Donaldson (DCI), Pall Corporation (PLL); we cover Flowserve (FLS), Pentair (PNR), as well as Clean Harbors (CLH). Clean Harbors is a little more environmental, but they essentially clean up hazardous waste and get rid of some waste water as well. So that's another name that we cover.

TWST: These companies provide services to several different end-market customers. Which end markets do you believe provide the best opportunity at the moment, and which of your companies have exposure to those?

Mr. Mazari: Right, that's a good question. When we look at end markets, heavy manufacturing continues to be relatively strong, although the growth rate has been moderated recently. However, we expect that business to be up midsingle digits in terms of revenue growth, which is still pretty good.

The health care market, biopharma is pretty strong as well. That's a business related to much more growth production. That business is probably up 10%.

And energy markets have still been relatively resilient, even though you've seen some pullback in the oil price. I think if oil continues to drop and goes sub-$80, I think you'd see folks that sell into that energy end market if the growth rate is slow. But the energy end market seems pretty strong as well. We think that grows high single digits as well.

And when you look at - we prefer more U.S.-centric exposure relative to Europe, which clearly the growth there is probably much more negative than has been baked in the numbers.

And so when we look at companies that have exposure to some of those end markets, we like Flowserve a lot, but their energy exposure we estimated about 40%.

We also like Pall Corporation. Even though they have European exposure, most of that business in Europe is levered to biopharma or health care end markets, which are pretty strong, as well as they've got some general industrial and energy exposure as well, which we think is strong as well. And their overall exposure, we think that both biopharma as well as the energy end market is upwards at 30%, so we like that business.

The other important point to consider here and keep in mind is that we like businesses that have a reoccurring revenue stream that is an aftermarket sort of business. When you look at Flowserve, when you look at Pall, they've got - Pall has 75% of its business that's just consumable. It's reoccurring filter usage. Flowserve has 40% of its business that's aftermarket, so actually just going in and fixing their existing products that are already in the install base or in the market fixing the existing pumps, valves and seals. And the aftermarket business we think is growing close to 10%. So we like the defensive nature of that high-margin revenue stream as well besides being levered to some other stronger end markets.

TWST: How would you describe the competitive landscape for water services companies? Are there many companies providing similar services, or does each fulfill a different need in the marketplace?

For more from this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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