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The Best Way To Profit From America's Water Shortage

I am a recent convert to the clean-energy revolution.

As I write this, solar panels are generating roughly five times the amount of energy my home is consuming (with two air-conditioning units blasting). Fast-forward a decade into the future, and more advanced solar panels and better battery technologies might just help make solar an obvious choice for almost any homeowner.

But clean energy technologies obviously have drawbacks. As we've seen over the past five years, a wide set of variables have led to sales booms and profit busts, as industry capacity and pricing for both wind and solar fight to compete with low-cost natural gas.

Right now, solar stocks are in favor. Tomorrow: Who knows?

That's why a more grounded investment in clean energy may be the wiser approach, focusing on companies that stand to prosper, regardless of the zigs and zags of clean-energy pricing and profits. And my favorite business model for such an approach remains Abengoa (Nasdaq: ABGB), which I profiled back in December.

As a quick primer, this Spanish company, which only began trading in the U.S. last year, builds out the massive infrastructure to support new clean-energy production facilities, desalination plants, and energy-efficient electricity networks. Though shares have doubled since December, a lot more upside remains. And there's even a way for investors to now derive solid dividends from this business model.

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Contracts Galore
The charm of this business model is that it can go wherever the action is. Amid long-term water shortage concerns in Texas, Abengoa is constructing a massive pipeline that will quench San Antonio's thirst. In late June, the company announced that it will build a huge water desalination plant in the parched regions of northern Chile. These types of major projects tend to extend over decades, leading to a high degree of revenue and profit predictability year after year. 

More to the point, the company's areas of focus are likely to be the high-growth segments in global infrastructure: Climate change suggests the world will need more desalination plants; advances in biofuels will lead to more large-scale production facilities. Constrained power grids will need to deploy more advanced utility and generation systems. It's amazing to consider that some other infrastructure provider such as General Electric (NYSE: GE) or ABB (NYSE: ABB) didn't look to dominate these growing niches.  

Of course companies like these will represent formidable completion in coming years as these niche markets grow, but based on Abengoa's solid contract win rate, the company is bound it get its fair share of future new contracts.

One of the reasons that investors were slow to grasp the appeal of this business model was its extreme complexity. Investors assign varying valuations to engineering and construction (E&C) firms, biofuels production and power generation projects, so it was hard to come up with the right value for this stock. Making matters worse, Abengoa sometimes builds plants (on a cost-plus basis) and sometimes operates infrastructure assets on its own (under long-term toll contracts).

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The Yieldco Option
At least latter aspect of the business model just got a lot easier to assess. Abengoa recently placed 10 of its income-producing assets into a yieldco

Abengoa Yield PLC (NYSE: ABY) began trading last month, and will receive the income produced by many of Abengoa's long-term contracts (which average 26 years in length). Analysts at Citigroup think this yield vehicle will generate 12% annual increases in income, and they see shares rising to $43 from a recent $37. They figure the dividend will rise from around $1.04 this year to $1.92 in 2016, which equates to around a 5% yield.

You can find higher yields elsewhere -- but not the expectation of such solid long-term dividend growth that this yieldco offers.

But back to the parent company: Abengoa retains a 64% stake in Abengoa Yield, and coupled with the company's other assets, is likely worth around $44 a share, according to analysts at Cannacord Genuity. (These analysts add that Abengoa Yield is worth $49 a share in their view, based on a dividend discount model.)

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In effect, the yield vehicle has solid upside and a nice yield, while the parent company has more than 50% upside with no yield. So you can choose which one is better suited to your portfolio. 

Risks to Consider: Major infrastructure projects often get the green light only when the global economy is healthy. A weaker global economy in coming years would lead to much slower growth for both the parent and yield vehicle.

Action to Take --> These are truly buy-and-hold stocks. The factors driving their growth now are directly related to the most robust segments in energy. In fact, Abengoa's focus on solar power and desalination are mutually reinforcing. As the cost of solar power continues to come down, the appeal of water desalination grows, as it is an energy-intensive technology. You may not know about this company right now, but all signs point to it becoming a household name in coming years. 

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