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Share tip of the week: water purification play
If there's one thing for certain about the future, it's that access to clean water will become increasingly important. Here, Paul Hill tips a promising play on the global thirst for water purification.
Scorching temperatures in western Europe have led to one of the hottest and driest periods in living memory. Western Russia has also suffered a crippling drought, destroying crops on land equivalent to the size of Portugal. Elsewhere, there's been the wettest monsoon for 80 years in Pakistan. And as extreme weather occurs more and more frequently, water security is becoming increasingly important.
This is where ITT Corporation steps in. It is the world's biggest producer of the sophisticated pumps that measure, clean and control drinking water. It is also the number-two maker of advanced filtration systems. So it develops top-notch units that use cutting-edge technologies, such as UV radiation, to purify supplies rather than killing germs with chlorine.
That way you avoid the associated health problems. Once the kit has been installed, it spins off recurring repairs and maintenance work under multi-year contracts.
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All told, water purification accounts for 33% of ITT's turnover, with the rest coming from its defence (54%) and flow-metering (13%) divisions. The military side of the business includes products such as clever gadgets for missiles, night-vision goggles for soldiers and jamming gear to protect troops against improvised explosive devices. It also sells next-generation air-traffic control and space-based weather-forecasting applications; the latter is used to second-guess where, say, the next hurricane will strike.
ITT Corporation (NYSE: ITT), rated a BUY by Keybanc
All three divisions operate in growth industries. As such, the CEO believes he can drive the top line from $10.9bn in 2009 to between $17bn and $20bn by 2014. That in turn will boost earnings by 10%-15% per year. Some of this growth will be organic. However, ITT recently forked out $390m to buy Nova Analytics and another $585m on Godwin Pumps to bolster its leading water franchise.
I would also not be too surprised, given Western military budget cuts, if the board decided either to spin out or dispose of its defence unit to unlock value. It is, after all, now in a strong position, having just secured two prestigious contracts worth $850m for the US Army in Afghanistan. That's boosted the orderbook to more than $4.5bn.
Wall Street predicts 2010 revenues and underlying earnings per share (EPS see page 36) of $11.1bn and $4.17 respectively, rising to $11.6bn and $4.55 in 2011. That means the stock trades on unchallenging earnings multiples of 10.7 and 9.8. On a sum-of-the-parts basis, I'd value the divisions on earnings before interest, tax and amortisation (EBITA) multiples of: water (12 times), defence (10 times) and flow (8 times). After deducting the estimated $1.2bn of net debt, $0.9bn in legacy costs and a $1.9bn pension deficit, that delivers an intrinsic value of about $12.7bn, or $68 per share.
So what are the possible pitfalls? ITT is exposed to tough competition, troop withdrawals from the Middle East, and the economic cycle. But, armed with a tier-1 brand and global footprint, the company looks a sound play on the future growth in water infrastructure. KeyBanc has a price target of $62 per share.
Recommendation: BUY at $44.5
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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.
