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The Consequences of a Blistering Summer

by Chris Mayer
September 18th, 2006

The Daily Reckoning PRESENTS: We may have thought we had it bad with the heat this summer here in the United States, but in Spain, the summer of 2006 brought wildfires and drought. Chris Mayer reports on the effect this water shortage has had on the European lifestyle - and the possible solutions to this widespread problem...

Crops withering under the blistering gaze of the sun. Cracked mud flats curl along the edge of shrunken waterways. Fish lie dying on the dried riverbeds. And in the evening, the orange glow of wildfires pulses against the dark sky like the glow of a torch. This is not some eerie scene from a science fiction movie. This is summer in Spain in 2006, victim of drought.

Spanish water reservoirs were at only 45% capacity in August. In the tourist-heavy southeast, they were as low as 8%, getting close to the sludge at the bottom. Spanish farmers face severe water restrictions and the prospect of a much smaller harvest. They will lose hundreds of millions of euros as a result. Fires peppered Spain's parched forests. In the first week of August alone, there were over 100 forest fires in northern Spain, killing at least three people. But it's not just Spain that is parched. Much of Western Europe suffers from unyielding drought.

Drought has even touched the normally deep and powerful Rhine, the busiest waterway in Europe. The proud old river is a shallow and feeble portrait of its old self. Ships must carry less cargo than they once did. And shipping companies recently imposed surcharges of 50% to make up the lost revenue.

The hot dry summer has a ripple effect on European life. According to the Financial Times: "Desperate to conserve water, Paris has for the first time decided not to dampen the dusty paths of its public gardens. English gardeners are banned from using hosepipes, while swimming pools remain empty in many Spanish towns."

The tight water constraints also threaten livestock, as favored lush meadows and cool watering holes are now dusty fields and clumpy mud puddles. Harvest of beets, rice and corn will approach record lows.

Some may think that this is all just temporary. After all, occasional drought is part of life on this unpredictable little planet - like rain on summer barbeques and clouded-over picnics. But it is more than that. The record high temperatures expose deeper problems in how we manage our precious water resources.

Among those lying exposed are farmers. Farmers waste a lot of water. They would probably prefer not a lot of people know about this habit (as don't bed-wetters). But it is impossible to ignore.

In Spain, agriculture uses about three-quarters of the country's water. Yet according to Spain's environment ministry, at least 80% of that water is wasted. Some is lost through leaking infrastructure or inefficient irrigation techniques. Heavy farm subsidies also discourage efficient use of water resources and lead to waste.

The solution is apparent. Europe needs more investment in water infrastructure, such as reservoirs and improved pipe systems. It needs more efficient irrigation systems and greater reliance on market incentives to encourage smarter water use. It's a tale told in hundreds of other places.

The irrigation angle is really the cake frosting to this story. It is the most appealing part, because the need for greater efficiency is so widespread. And there is actually an investment idea buried in here.

In most countries, agriculture is the largest consumer of water. The less developed the country, the more agriculture tends to consume. As I've said, much of this is wasted. By some estimates, half of farmers' water use does not produce any food at all.

Therefore, minor changes in use can have a dramatic impact on the supply of water. As Fredrik Segerfeldt writes in his excellent book Water for Sale: "A 10% improvement in the distribution of water to agriculture would double the world's potable water supply." Using drip irrigation to grow tomatoes, instead of traditional irrigation, for example, lowers the amount of water used by about a third.

Improved irrigation is a crucial component of better management of water resources. The most telling statistic of all is this: Irrigation waters only about 17% of the world's farmed acreage. Yet that irrigated acreage produces 40% of the world's food supply. That is astounding productivity. It also shows why irrigation technology will figure prominently in solving water supply problems.

One company I recommended in Mayer's Special Situations makes irrigation equipment. Though its headquarters are deep in the American Midwest - in Omaha, Neb. - this company is a global player. Farmers use its irrigation systems to water crops, nurseries, turf, pasture and much more. Their products improve water efficiency and boost crop yields.

About a third of its sales come from overseas. This piece of the business has a bright future. Management estimates that international sales will make up half of the company's sales in the next five years. They are in all the hot spot markets you would want to participate in - China, Africa, Brazil, Australia and, of course, Europe.

And the business is booming. Revenues were up 34% last quarter. Profit margins are up. Earnings nearly doubled. The backlog is up 73%. The company is in great financial shape. It's got lots of cash and marketable securities - more than $4 per share on a $27 stock - and no debt. Finding companies with all these attributes these days is a rarity - like pitchers who hit home runs.

It may seem expensive at 31 times trailing earnings. But earnings are growing rapidly. Next year, this stock could easily earn well over $1 per share. Backing out that extra cash gives you a multiple of around 23. Not bad for a company ramping up earnings as quickly as they are.

Regards,

Chris Mayer
for The Daily Reckoning

P.S. Though there are always choppy ups and downs in the ag markets, I like the long-term story with this company. And every time we have drought and water constraints, practically anywhere in the world, it will be hard to ignore this company's solution.

To find out more about this small corporation in the midst of a powerful secular trend, see my latest issue of

Capital and Crisis
http://www.agora-inc.com/reports/FST/EFSTG908

Editor's Note: Christopher Mayer is the editor of Capital and Crisis and Mayer's Special Situations. Chris began his career in corporate banking after earning an MBA with a concentration in finance. He later started Capital & Crisis, a monthly newsletter that gave Chris' unique brand of financial commentary a more regular and expanded format.