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Buffett’s Bet On Water, Naclo (NLC)

 March 05, 2009 08:01 PM

Naclo stock chart With a $1.6 billion market cap, Nalco is a small-cap stock, but it's actually one of the world's largest water-treatment companies. Customers use Nalco's products and services to prevent corrosion,
contamination, and the buildup of harmful deposits. It operates in three divisions: Industrial and Institutional Services, Energy Services, and Paper Services. The Industrial and Institutional Services division provides water treatment programs, process-focused programs, and emissions reduction services, as well as involves in the treatment of boiler water, cooling water, influent, and wastewater for pollutant control.

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Buffett picked up 8.7 million shares. That makes Berkshire the second-largest shareholder in the company, with a little more than 6% of the shares. It's easy to see what Buffett likes. Nalco generates a steady stream of free cash flow, $142 million in its fiscal year ended September 30. Today, the market cap is about $1.6 billion. So you're getting nearly a 10% free cash flow yield. Put another way, you're only paying about 10 times free cash flow. Not earnings, but cash flow.

On the downside, Nalco has a leveraged balance sheet with $3.1 billion in net debt. However, its business model ensures steady cash inflows from service contracts, which is less of a risk than it might seem. Also, the first significant maturities don't come until November of 2010, plenty of time for the credit markets to return to some friendlier state. In any event, the debt was not enough of a risk to put Buffett off the scent.

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There is also a nice backdrop to the Nalco thesis. Water is a scarce commodity. Two-thirds of the world's population faces water shortages by 2025, according to the United Nations. And according to the U.S. Government Accountability Office, about 36 states face water shortages by 2013.  These issues may not seem so pressing to you, since every time you turn on the tap, the water flows. But it is an important issue for industrial users of water all over the world.

Nalco is right in the heart of this issue. Nalco's customers are industrial users. Nalco's services improve water efficiency. The company also offers services to reduce air pollution, treat industrial wastewater, and more. In this, Nalco is the global leader, with a 17% global market share. It's bigger than GE in water.

As a long-term investment, Nalco is among the more compelling ideas out there. In fact, the entire water spectrum looks attractive as a long-term investment theme. It's going to be an issue we're going to deal with for years, Warren Buffett's purchase of Nalco is further confirmation of the idea. It would not be out of the question to see water stocks have a run up like oil services stocks did down the road. NLC is trading at $10.50 just $2.50 off its 52 week low. No need to rush into this stock and put a full position on today but I think there is a place for NLC in a balanced
portfolio. I feel that at the $9.75-10 level NLC is an attractive buy, this is the bottom of the most recent trading range.

Note: I do not own NLC

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