Hose-pipe bans have become a regular feature of British summers. Paul Hill tips two stocks that stand to profit from Britain's increasing lack of water.
New Britain Palm Oil (LSE: NBPO), rated a BUY by Liberum Capital
This summer we may have a heat wave, according to the Department of the Environment. If as a result of water shortages the price of vegetables and cereals soar, food producers who import into Britain will do nicely.
Papua New Guinea-based grower New Britain Palm Oil (NBPO) is the world's leading producer of sustainable palm oil, with around a 17% market share. In 2011, sales leapt 69% to $780m due to record production, while earnings per share (EPS) rose 141% to $1.41 (or about 88p), excluding the distortive effects of plantation accounting. Global demand for palm oil remains robust because of the urbanisation of developing economies, especially China and India.
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As NBPO breeds seeds, plants trees and processes the oil itself, it guarantees 100% product traceability to customers such as Jordans. This is an attraction for food manufacturers as they continue to distance themselves from environmentally destructive practices.
NBPO's programme has been so successful that it's invested £20m building a sustainable oil refinery in Liverpool, servicing firms such as United Biscuits. It aims to double capacity by adding a second deodoriser (part of the refining process).
Consequently, income visibility is strong: 35% of 2012 production has already been pre-sold. Liberum estimates for turnover and underlying EPS are $774m and $1.21 respectively, rising to $818m and $1.31 in 2013. On this basis I rate the stock on eight times earnings before interest, tax, depreciation and amortisation (EBITDA). Adjusting for $260m of net debt, that generates an intrinsic worth of about £10 a share.
So what could go wrong? Volatile currency and commodity prices could bring their usual headaches, and crops could be affected by natural disasters or outbreaks of disease. But given the strong fundamentals, there is every reason to jump on board. Liberum has a target price of 1,081p.
Rating: BUY at 850p
Modern Water (LSE: MWG), rated a STRONG BUY by Nomura
Another potential beneficiary of Britain's driest spell for 35 years is desalination and monitoring specialist Modern Water. Its patented forward osmosis (FO) technology reduces costs by 30%, uses fewer chemicals and is more environmentally friendly than conventional reverse osmosis.
In June, it landed a contract to build the world's first commercial FO plant in Oman, perfectly positioning it in a market that GWI Global reckons will tip $56bn by 2015. Executive director Neil McDougall believes FO could also find major buyers in China and even Britain.
China's water networks have been cited as the single largest impediment to the nation's long-term success. It has 21% of the world's population, but only 7% of its renewable water resources. Worse, 90% of its fresh water has been contaminated by industrial spills.
In the next five years, it's due to spend $60bn on urban waste water infrastructure. Modern Water's Cymtox equipment, which detects when toxic leaks may occur and tests effluent before its release into water supplies, is selling well in China. Recent acquisitions Cogent Environmental and Microtox should also make its Cymotox division profitable this year on turnover of £5m. In five years' time, it could be churning out sales of £40m with operating margins of 20%.
I rate the stock on a ten-times earnings before interest, tax and amortisation multiple. Discounting back at 12% and adding in the net cash of £11.3m (or 19p per share) generates an intrinsic worth of about 80p a share.
Being a small firm, that comes with a fair dose of risk. Orders will be lumpy and the adoption of its breakthrough technologies may take longer than anticipated. Despite being protected by 89 patents and having a further 58 pending, the company's cutting-edge science could be challenged, or even superseded, by new inventions.
Nonetheless, interest in Modern's products is strong, making it a potential winner in the global drive for cleaner water. Nomura has a target price of 92p per share.
Rating: SPECULATIVE BUY at 51p
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments. Seewww.moneyweek.com/PGI, or phone 020-7633 3634 for more.
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Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.
Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.
Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.
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