A Mainstream Water Play: Aqua America (WTR)

At Cheap Stocks, our research is sometimes esoteric, and often way off the beaten path, but this week, we go mainstream in our never-ending quest for value. We are big believers that investors should have some exposure to water in their portfolios, but our typical ideas are not for everyone. So today, we highlight a very liquid way (no pun intended) to gain exposure to the sector.

There’s been no shortage of attention given to the growing demand for water. Theoretically, there’s the same amount of water on the earth now as there was 1000 years ago, not a drop more, or a drop less (global warming advocates: when we say water, we also include water equivalents such as ice). Yet populations continue to grow, while supplies of fresh water do not.

In the US, water distribution, supply, and treatment is typically handled at the local level. The ranks of publicly traded water utilities have continued to shrink, leaving the following list as the only publicly traded water utility plays in the US.

data as of 2/6/07
(WTR) AQUA AMERICA INC
Price:$22.83
PE: 33.57
Yield: 2.51
Market Cap: 3016

(CWCO)CONSOLIDATED WATER CO-ORD SH
Price:$25.54
PE: 38.12
Yield: 0.98
Market Cap: 355

(CWT) CALIFORNIA WATER SERVICE GRP
Price: 39.98
PE: 31.73
Yield: 3.11
Market Cap: 826

(SJW) SJW CORP
Price: 38.45
PE: 31.78
Yield: 1.45
Market Cap: 703


(PICO) PICO HOLDINGS INC
Price: 42.4
PE: 21.47
Yield: No Dvd
Market Cap: 672


(AWR) AMERICAN STATES WATER CO
Price: 38.99
PE: 29.32
Yield: 2.35
Market Cap: 664

(SWWC) SOUTHWEST WATER CO
Price: 13.14
PE: 32.85
Yield: 1.71
Market Cap: 310


(MSEX) MIDDLESEX WATER CO
Price: 18.69
PE: 21.99
Yield: 3.54
Market Cap: 218


(CTWS) CONNECTICUT WATER SVC INC
Price: 24.8
PE: 32.63
Yield: 3.86
Market Cap: 204


(YORW) YORK WATER CO
Price: 17.97
PE: 31.9
Yield: 2.36
Market Cap: 1.99


(ARTNA) ARTESIAN RESOURCES CORP-CL A
Price: 19.372
PE: 22.44
Yield: 3.18
Market Cap: 127

(PNNW) PENNICHUCK CORP
Price: 21.25
PE: 47.22
Yield: 3.56
Market Cap: 90


(BIW) BIW LTD
Price: 15.75
PE: 121.15
Yield: 4.23
Market Cap: 26


(BDDD) BIDDEFORD & SACO WATER CO
Price: 130
PE: unknown
Yield: 2.5
Market Cap: unknown


(NESW) NEW ENGLAND SERVICE CO
Price: 41.5
PE: unknown
Yield: unknown
Market Cap: unknown



On a price/earnings basis, most of these companies are not exactly cheap, due in part to the growing interest the sector has received from investors. Furthermore, most of the remaining publicly traded water companies are tiny in size, and have little liquidity (see BDDD and NESW). Some are not traditional water utilities (PICO, for instance, which has several other operations and CWCO, a Cayman Islands based desalination player).

Aqua America serves nearly 2.8 milliom customers in 13 states:

2005 Operating
Revenues
(000's)
---------

Pennsylvania $279,691
Ohio 39,839
Texas 37,953
Illinois 35,300
North Carolina 29,840
New Jersey 22,588
Indiana 16,867
Florida 15,286
Maine 9,418
Virginia 8,337
Other states 1,660
--------
$496,779
Source: 2005 10K ========


The company is always on the acquisiton trail, and spent $250 million in 2005 on cap ex ($195 million for the 9 months ended 9/30/06). In fact the company made 123 acquisitions in the 5 year period ended 12/31/05.

Below is WTR's acquisition philosphy:

We believe that acquisitions will continue to be an important source of growth for us. We intend to continue to pursue acquisitions of municipally-owned and
investor-owned water and wastewater systems of all sizes that provide services
in areas adjacent to our existing service territories or in new service areas.
We engage in continuing activities with respect to potential acquisitions,
including calling on prospective sellers, performing analyses and investigations
of acquisition candidates, making preliminary acquisition proposals and
negotiating the terms of potential acquisitions.

Source: 2005 10K


The Fundamentals
Fiscal 2005 sales were $497 million, up 12% from 2005s $442 million. For the 9 months ended 9/30/06, sales were $397 million, so full year 2006 results should break previous annual sales records. Net income for 2005 was $91 million, representing a solid net profit margin of 18.3%. This was up from 2004s $80 miillion, and 18.1%. For the 9 months ended 9/30/06, net margins are lower, at 16.7%.


Conclusion
If you want to add water to your portfolio, and are not crazy about our method of doing so (PICO Holdings (PICO), JG Boswell(BWEL), we also have a position in small player Southwest Water (SWWC)), take a look at Aqua America. We stongly urge that you read through the companies 10K (always a worthwhile exercise)>

*The author has a position in the following stocks listed in this report: PICO, BWEL, SWWC. The author does not have a position in the primary focus of this report, WTR. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Watch out Exxon, Washington has an Eye on You
Is Wrigley’s Next?

$39.5 Billion. Bigger than the market caps of most publicly traded US companies. That’s what Exxon Mobil bottom lined in 2006. Many call it obscene. Others shake their fist in disgust that one corporation can earn so much taking advantage of the little guy, dependent on the company’s product for survival. Politicos in Washington use this in order to win votes, raising the ire of the grass roots with one-sided and often blind rhetoric.

Even USA Today, “McPaper”, put it this way in an article by Matt Krantz:

Consumers who wondered where some of the $3 a gallon they paid for gasoline this summer ended up might want to take a look at ExxonMobil’s bottom line.

That’s how these stories typically start. This one in particular goes on to break down ExxonMobil’s profit per day ($108.2 million), per hour ($4.5 million), per minute ($75,150) and per second ($1250). I can see the senators salivating upon seeing that data. I for one am embarrassed to have a small position in USA Today parent company Gannett (GCI).

The talk in Washington has started already, so has the legislation. One Senator from New York (we will not name her) suggested in the fall that big oil should be forced to pay a portion of their profits into a fund that would seek renewable sources of energy. Wow, what a great idea. Lets punish big oil, how dare they make 50 cents in net profit per dollar of sales. What’s that? Their net margins aren’t 50%; well surely 30% is still reflective of price gouging, and not fair to the consumer. Wait, they don’t earn 30% per dollar of sales? Well, doesn’t matter, 25% is still unfair. We could go on with this drivel, but we’ll stop here. Exxon Mobil’s 2006 net profit margin was 10.46%.

Yes, 10.46%. Thats about 1/3 of Microsoft’s profit margin. Less than chewing gum giant Wrigley’s 2005 net margin of 12.43%. Hey senator from New York, why don’t you go after Wrigley’s? That’s an obscene amount of profit relative to sales, and it’s to the detriment of gum chewers everywhere. Why not force Wrigley’s to pay into a fund that would seek alternative sources of stuff people can chew? We know, were getting ridiculous here. Gum isn’t imperative for survival, is not a huge cost to consumers, but hopefully you see our point.

We know that energy is a huge issue. But let’s not bite the hand that finds the energy for us. The hand that is taking all of the risk, the hand that has expended billions and billions in what is a highly capital intensive industry. We want them to find more oil; we want the technology to get better, to drill deeper, to extract oil from places where it was not possible 30 years ago. And yes, we want them to earn a profit.

Is it important to identify renewable sources of energy? To be less dependent on foreign oil? Absolutely. But Uncle Sam can’t do it, and should not even try. Sorry, Unc, your track record just is not that great in these matters. You have never shown the ability to effectively deploy capital. Leave it to the private sector. Through technology, companies can now efficiently extract oil from the Athabasca oil sands in Alberta. And our neighbors to the north have a lot of oil sands. Perhaps technology will get to the point that the vast amount of oil shale in Colorado and Utah can one day be utilized. Renewable sources? No, but may buy us some time to develop scalable, efficient renewables. We’re not sure corn is the answer.

In conclusion, we understand the ire this issue creates. We don’t like paying $3.00 a gallon either. But big oil is not the villain here.

*The author does not have a position in ExxonMobil (XOM), but does have a position in Gannett(GCI) and Wrigley (WWY). This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Blair Corp (BL): A Former Perennial Net/Net Gets Taken Out

Warren PA based clothing retailer Blair, which we last reported on in August, will be acquired by Golden Gate Capital, a San Francisco private equity firm, for $173.6 million in cash, or $42.50 per share. This represented a 23.6 premium to Blair's price at the announcement of the deal.

In our last research report on Blair, we suggested the company might go private, following a relatively huge transaction in which the company bought back more than half it outstanding shares. At the time, Blair was trading in the $24 range, so relative to that price, the buyout price of $42.50 represents a 75% gain in 5 months.

Former Net/Net
In years past, Blair's name was always at or near the top of the list (in terms of market cap) of companies trading below their net current asset value. In fact, if our recent report The Top Ten Net/Nets Four Years Later had gone a little further, Blair would have been 12th on the list.

Original Blair Research
2/14/03

*The author does not have a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Stretching the definition of a Net/Net
Wake Up and Smell the Coffee: Farmer Brothers(FARM)

We hope Ben Graham wouldn't take offense if we loosened up a bit, and took a gander at some "double net/nets", or companies trading at less than two times their net current asset value. Afterall, we've already taken liberties with Ben's philosophy; he preferred companies trading at less than 2/3 of net current asset value, and we tend to focus on those trading below 1 times NCAV. Truth be told, it's slim pickings these days to find these companies (not unusual), but we'd thought it would be interesting to see what we could dig up at 2 times NCAV.

What we found was a list of about 300 companies, and one of the most interesting name we found was that of Farmer Brothers, a manufacturer and distributor of coffee. We remember this company as a thinly traded issue, trading at $400 per share a years ago. After a 10 for 1 split, and some difficult times, this company currently trades around $20--and shareholders are not happy. More on that later.

California based Farmer Brothers was founded in the 1920's, and sells coffee and other products primarily to restaurants and other institutions. Coffee accounts for about half of sales, but the company also provides 300 other products, many of which are coffee related. The company's primary raw material is green coffee, an agricultural commodity subject to many different factors that can cause wide and severe price swings. The company does utilize derivatives to hedge risk.

The Controversy
Lets face it, business at Farmer Bros has not been all that great in recent years, and sales have been flat. Investors have not been happy either. Five year total returns are in negative territory, and after looking at the balance sheet, you'd wonder whether this is a coffee company, or very bad money market fund. Much of the problem has been attributed to company insiders, who own more than half of the outstanding shares.

Tons of Cash and Marketable Securities
Farmer Brothers has $180 million in cash and marketable securities, mainly comprised of treasuries ($113.5 million)and preferred stock($61.7 million). That amount might not be that remarkable, except for the fact that the current market cap is $323 million, leaving the company with an enterprise value of just $143 million. Or in per share terms, thats $11 in cash and ms, while the stock trades at $20. The company currently yields 2.2 percent, hence the reference to being a "very bad money market fund".

The Numbers
Revenue for 2006 (year ended 6/30/06) was $207.5 million, up 4.5 % from 2005s $198.4 million. The company mananged net income of $4.75 million in 2006, up from a loss of $5.4 million in 2005. However, all of 2006's net income is attributable to dividends and interest from the companies cash and S/T investment hoard, an amount which exceeded $8 million. In other words, the operating business is not profitable.

Shareholder Revolt
Dismayed by poor operating performance, the poor use of excess capital, and disdain shown for minority shareholders, Farmer Brother's investors have become increasingly active over the years. For more on this, visit the Forum for Shareholders of Farmer Bros. Co.

Conclusion
This is one we'll be following. Frankly, we are intrigued by what might be an excellent business, with a relatively large amount of working capital. Shareholder influence can ultimately force change, and that's what it will take to right this ship.

*The author does not have a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

PICO Holdings(PICO)Hits 14 Year High
Nevada Land and water giant PICO, which we've labeled the "poor man's Berkshire Hathaway" (much to the chagrin of some of our readers) hit a 14 year high today, closing at $38.35, up 4.3%. Shares traded as high as $38.95 on about 2.5 times normal average volume. There was no news on PICO today, which is typical. Stay tuned.


*The author has a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Lazare Kaplan (LKI): A Diamond Has it Rough;
Tumbles on Second Quarter Results

Perennial net/net (trading below net current asset value) and diamond company Lazare Kaplan (LKI) took it on the chin today following the announcement of 2nd quarter results. Net sales for the 3 and 6 month periods ended November 30, 2006 were $94.4 million and $233.3 million, down slightly from last year's $96.3 million, and $235.1 million. Gross margins for both periods also fell. Net loss for the quarter was $1.4 million ($3.2 million for six months), vs. a loss of $1.4 million (income of $500K).

The company cited an increase in the sale of lower margin products (rough diamonds) for the fall in sales, and declining margins. We've yet to see a 2nd quarter balance sheet.

Shares fell nearly 7 percent today (to $9.96) on triple the average volume....that's triple the typical 3000 shares normally traded, hardly meaningful. The company had been on a nice run as of late, recently approaching the $11.00 mark.

We continue to hold LKI in our portfolio, and see it as a rare opportunity to own a net/net with potential and undervalued assets. Our shares are still up 28 percent since we took a position this past March.

Previous LKI Research:
10/21/06
1/07/06



*The author has a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

The Top 10 Net/Nets Four Years Later
We recently discovered an interesting relic, (interesting in our minds anyway) that being a complete list of net/nets from early February 2003, when we initially launched this site. There were more than 500 companies on this list, some legitimate, and some destined for the scrap heap. We thought it would be a worthy exercise to see how the top ten net/nets by market cap fared in subsequent years. The results were very positive, exceeding even our expectations.

Times Were Different

Keep in mind, we’d just come off of a market meltdown, which is the major reason there were so many net/nets in 2003. Many were “busted” technology companies reeling from the NASDAQ collapse. Just as a rising tide lifts all boats—which is why there are so few net/nets these days-when the tide recedes, the boats will follow, and often the smaller and weaker ones are most affected.

The Numbers

The average annual return of each of the ten stocks over the period (2/7/03 through 12/29/06) was 33.5 percent. For perspective, the S&P 500 was up an average of 16.9%, the Russell 2000 23.9%, and the NASDAQ Composite 18.4% during the same period. Keep in mind, those comparisons are apples to oranges, as the average market cap of the companies on this list was about $250 million, squarely in microcap land.

The Companies (returns are cumulative, from 2/7/03-12/29/06

Circuit City(CC) up 299%
Corvis(formerly CORV, now Broadwing(BWNG)) up 116.94%
Enterasys(fromerly ETS, acquired 3/2/06) up 1.16%
Silicon Storage(SSTI) up 66.42%
Infocus(INFS) down 56.59%
New Focus(NUFO-acquired 3/8/04) up 56.21% at acquisition
Valueclick(VCLK) up 750%
Audiovoxx(VOXX) up 52.32%
Netratings(NTRT) up 191.35%
National Presto(NPK) up 149.35%

In typical fashion, there was one huge winner, Valueclick, which was extremely beneficial to the average return. Only one of the companies, Infocus, was in negative territory. What's the lesson here? If the net/net strategy is to be succesful, it needs to be done through the construction of a net/net portfolio, spreading the risk among several names. Seemingly easier said than done these days, with slim pickings among net/nets. Or is it? Stay tuned.

*The author does not have a position in any of the stocks mentioned in this report. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.