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Rising Star Buy: Insituform Technologies

Bryan Hinmon, CFA
May 17, 2011

The Teenage Mutant Ninja Turtles may have glorified sewer life, but before you pack up and move underground, remember that a significant water line bursts every two minutes in the United States. The pipes carrying our water and wastewater could've been built during the Civil War.

The company best positioned to benefit from this crumbling infrastructure is still largely unknown to most investors, and thanks to its apparent link to cash-strapped municipalities, it's equally unloved. Insituform Technologies (Nasdaq: INSU  ) , the largest wastewater pipeline repair outfit around, is a classic unvestment. I'm establishing a 5% position for the Un Portfolio, and I look forward to gushing returns.

Tops in trenchless technology
Back in 1971, Insituform invented a trenchless technology for rehabilitating sewer pipelines, allowing cracked, leaky, or decimated pipes to be repaired in a quicker, cheaper, safer, and less obtrusive way. Previously, municipalities had to stop traffic, dig a trench, and replace the section of damaged pipe -- a big, costly to-do. But Insituform's cured-in-place pipe (CIPP) technology solved all of that. Typically, CIPP rehabilitations can be done from existing manholes by inserting a patented felt tube, curing it with resins and steam (which hardens the structure), and creating a new healthy pipe within the broken host pipe.

Demand today and demand tomorrow
The Office of Water Management, a division of the Environmental Protection Agency, reports that the funding needed to bring water and wastewater pipelines up to snuff tops $33 billion. This means big backlog and future demand for pipeline repair businesses like Insituform. And since there isn't much debate that worldwide water infrastructure has been equally neglected -- and it's only getting worse with time -- global prospects should flow heavily for Insituform.

However, Insituform's business goes beyond just water pipeline rehabilitation. It has a strong presence in the energy and mining industry, focusing on corrosion-protection coating services for industrial, mineral, oil, and gas piping systems. That segment accounted for 47% of 2010 earnings, and with oil and gas pricing still high and capital spending trends looking solid, the business should grow 10% to 15% this year. The pipeline of long-term growth (sorry, couldn't resist) looks robust, as new oil and gas finds are increasingly remote and require new pipeline infrastructure for transport to refineries.

The BIG THREE reasons I'm buying

  1. Reputation and scale. Insituform has rehabilitated more pipe than any other firm. It invented CIPP technology, has a large workforce that it can mobilize quickly, and has a 40-year track record, giving it a competitive advantage when bidding on rehab projects. Insituform wins nearly 50% of the contracts it bids on because of its cost advantages and reputation.
  2. Focus on operations to complement growth. Insituform's current CEO came aboard in 2008, and his management team has instilled a culture focused on operational improvement. Operating margins rose to 9.5% in 2010, up from only 2.7% in 2007. Improving operations, coupled with growing business, should bode well for Insituform's shares.
  3. Great stewardship. New management is focused on profitable growth. In fact, executives recently shuttered some European operations that didn't meet profitability hurdles and set a goal to achieve a 15% return on invested capital. (This ain't a hurdle the company can simply step over -- just a few years ago, the company's return on capital was barely 2%.) And the board of directors recently instituted share-ownership guidelines for all directors and senior management, ensuring that their interests are properly aligned.

What's so "Un" about Insituform?
As always, there is some dirt floating in the water, but with a shares trading at less than 12 times forward earnings, patient investors should be rewarded.

  • Insituform operates primarily in a dirty, boring business (the nice way to say it is "wastewater"), and Wall Street doesn't care that much. Only eight analysts, representing none of the big brokers, follow the company.
  • The company bids for projects and is responsible for cost overruns. This leads to lumpy revenue and unexpected profit revisions (types of uncertainty) that make the stock unattractive to some investors.
  • Insituform's sewer rehab business comes mainly from municipalities, which are largely broke. But many investors fail to understand that the bulk of pipeline repairs come out of water system user fees, not budget line items. So the company's revenue stream tends to be much more stable than budget- or capital-spending focused companies like Mueller Water Products (NYSE: MWA