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Northwest Pipe Satisfies Thirst for Water Stocks


It's a solid company with long-term prospects at low valuation.

Water is a key issue in many areas, but in the Southwest United Sates, it's critical. The ability to find new sources and transfer water is key. Over the past few years, a couple of high-profile transmission projects have been in the news. One of the largest is a $3.5 billion pipeline Las Vegas is exploring as an alternative to sourcing water from Lake Mead. Lake Mead is hitting its lowest water level since 1965. At my firm, we don't subscribe to paranoia and fear, however, the lake's level is falling due to drought and increasing consumption. The need for new sources among other conservation and reuse strategies is real and will grow in importance.

Enter Northwest Pipe

Northwest Pipe (NWPX) is one the leaders in water-transmission pipe. However, on November 12, 2009, the company pre-announced earnings below expectations as well as announced a review of certain internal accounting matters including revenue recognition practices. Further, backlog dropped to $125 million from approximately $189 million. The stock traded down nearly 20% before rebounding slightly.

Northwest Pipe operates in two segments: the Water Transmission Group (WTG) and tubular products. WTG is a little more than 60% of revenues and predominantly manufactures large-diameter high-pressure water-transmission pipe. The tubular products group manufactures an array of smaller-diameter pipe. The key focus for tubular is rig count, where the product goes in to the energy markets.

Accounting irregularities always concern my firm. However, we believe accounting is centered around the water transmission group, where a percentage of completion method of accounting is used and an error in allocating appropriate costs/revenue to a specific time period occurred.

The earnings and backlog, while troublesome, aren't entirely unexpected in the poor municipal environment. Northwest Pipe has maintained that it's somewhat less sensitive to overall economic conditions because many of the water projects it's involved in are part of long-term planning projects (25 years or more). While this is true, it's still "easy" for municipalities to push funding out for a period of time. Further, the hope for stimulus funding may have caused municipalities to delay orders.

My firm is interested in the name because at the current levels, it's trading below tangible book value ($29.85). Despite the accounting problems and the short-term slowdown in activity. current valuation provides a nice risk-reward scenario.

The tangible book value should create a floor for the stock as Northwest Pipe has traded on average 1.2 tangible book over the past 10 years. The company is one of few real players in the high-pressure wide-diameter pipe market. The company is very active in the Southwest United States where water supply is a critical issue, with a few headline projects in the wings ($3.5 billion Las Vegas pipe line).

While the headline projects maybe years off, there are plenty of smaller, lucrative opportunities available. And if the large projects come to the forefront, Northwest Pipe will be a prime beneficiary. The key drivers and area to watch will be 1) WTG backlog and projects; and 2) rig count, which is important to the tubular products line.

To recap: There are some accounting issues which shouldn't be life-threatening, a temporary slow down in deal activity, and muted earnings. This is balanced by a cheap asset valuation (.87x tangible book value), few competitors, and a large long-term need for transmission.

The stock was a cult hero trading in the $60s for a period of time with the hopes of one of the headline projects coming through. The opposite is now in play. You can buy into a solid company with long-term prospects at low valuation with the potential for large project opportunity. My firm would expect some near-term volatility, but you can pick away at it in the mid to low 20s and do well over a period of time.

Editor's Note: See also, Are Water Stocks More Valuable than Gold?

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No positions in stocks mentioned.
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