Earlier this year, I did an article that suggested if governments faced their growing problems with aging infrastructure and opened up their wallets to fix the problem, a number of engineering and construction firms could benefit.
Of course, there's the alternate theory: Governments have little money to spare and even less appetite to raise taxes to get it. In which case, they'll get by patching up their infrastructure, piece by piece, when it finally crumbles.
For those that believe, understandably, in the latter scenario, I give you Pure Technologies Ltd., a Calgary company that makes its money helping the owners of water pipes identify and fix problems, rather than ripping the whole system out and starting from scratch.
The company is – so far – little known. It spent years on the Venture exchange before its promotion to the main TSX a couple of years ago. It has a market capitalization of just over $300-million. The six analysts who provide coverage of the company generally work for small research firms.
Yet they are unanimous in their appraisal: Strong growth, a unique market position, and its ability to let investors get in on the business of repairing aging infrastructure make it a "buy" – despite its high valuation.
"We believe Pure is a one-of-a-kind company. A dominantly positioned, publicly traded infrastructure, Pure play poised to benefit from the shift in water asset management, with significant upside and limited downside risk," says Dev Bhangui of Byron Capital Markets. "We rarely find this kind of skewed risk/reward profile in publicly traded entities, and urge investors to make Pure an essential name in their portfolios."
Most of the water pipeline infrastructure in North America and Europe was laid down between the First and Second World War, Mr. Bhangui and other analysts note; even the youngest of those pipes are bumping up against an expected life of 60 to 80 years. Nearly one-third of the U.S. water system is expected to be in "very poor" or "life elapsed" condition by 2020, according to federal-government assessments cited by Mr. Bhangui.
Replacing a kilometre of water pipeline currently costs about $1.8-million, versus $93,000 to assess and fix cracks and leaks, the company figures. And Pure Technologies is happy to help the systems' owners save that money, either through selling the tools to assess the systems, or by doing that work themselves.
Among its patented products is "SmartBall," a floating ball with instruments in its core. The SmartBall can travel through a pipeline for hours, recording pressure and temperature changes and detecting leaks and cracks. Other offerings include acoustic, video, electromagnetic and robotic technologies, and can be applied to oil pipes and bridges, expanding the possible markets for the company.
Until recently, the company was uncomfortably concentrated from both a geographic and product standpoint: Nearly half of its sales came from a single project in Libya, and its expertise centred around concrete pipes, which represent just a single-digit share of global water infrastructure. The company has since signed several new clients in the United States and elsewhere in the world, and it made a 2011 acquisition of a Salt Lake City-based company with technology that works on the metallic pipes that represent the majority of the global water network.
All of this is coming together; so far this year, the company has reported three quarters of what Jacob Securities analyst Khurram Malik has called "strong execution." Earnings before interest, taxes, depreciation and amortization jumped 30 per cent from prior-year levels through the first nine months, and the gain may top 50 per cent for the full year after a strong fourth quarter, he suggests. (Net income has lagged in part because of the way the company recorded income taxes on its financial statements.)
With the company's latest earnings release, most analysts raised their target prices to $7 or more; the shares closed at $6.44 Wednesday. Sara Elford of Canaccord Genuity says her $7.25 target price works out to an enterprise value (market capitalization plus net debt) of 14 times the company's EBITDA, and nearly 30 times her forecast of next year's earnings. Since Siemens AG just sold its slower-growing, lower-margin water-technologies business to a private-equity firm for an EV/EBITDA multiple of 11, she says, "we are comfortable defending 14 times for Pure."
Mr. Bhangui's position that the stock has "limited downside risk" may be overstating the matter; Pure Technologies has wonderfully high gross margins, and while its products are patented, it's unlikely that larger companies will sit still and let Pure Technologies have all it can eat at the infrastructure-repair buffet. But Mr. Bhangui suggests these larger players might just solve that problem by taking out Pure Technologies at an attractive premium, since its market capitalization is a "rounding error" to them.
At least it is, for now. If it keeps up a pattern of new contracts, stellar results and more Bay Street attention, Pure Technologies won't be a $300-million company for much longer.
David Milstead