Monday 29 November 2010

Waterfurnace Renewable Energy Q3 Report Good and Bad

Back in September when I rated Waterfurnace (TSX: WFI) a Buy at the then price around $25.50 it looked as though the near future would see no growth due primarily to the poor state of the US housing market. The 3rd Quarter report came out November 10th and things look even a little worse than merely flat results as Earnings Per Share dropped a fair bit from the same quarter last year. Profitability has been squeezed by a shift from residential to the more active but lower margin commercial market and due to the rising cost of inputs like copper.

The somewhat good news is that WFI continues to take back market share lost in 2009 to its main competitor LSB Industries (NYSE: LXU), as evidenced by WFI's 15% rise in sales while those of LXU (in the Climate Control business) fell in its 3rd quarter report. The company management in its Q3 earnings webcast and in an email in response to my questions state that things like a 3% price increase and bulk buying will improve margins.

We investors (yes, I still own the shares I bought in September) need to be patient. Maybe I'm just one of those "refuse to sell a loser stock" that all those behavioural finance books make fun of, but I'm not selling. I still think the payoff is two years away. The key US housing market is still looking very weak in recent data. The post Q3 report drop in price to around $22 makes WFI an even more attractive Buy in my opinion though two professional analysts have dropped their recommendation to Hold according to

The folks at Waterfurnace looked into why the US dollar version of the stock is not trading (and has not done so for a long while) on the TSX. This is their reply:
"WFI.U, WaterFurnace stock traded in U.S. dollars on the TSX, is still a valid symbol. When WaterFurnace set up WFI.U, there was expectation that there would be significant interest in trading in U.S. dollars. At first, the market maker made some attempt to get things going, but trading in U.S. dollars didn’t take off. The market maker has now posted its bid and ask orders so far apart that trading via WFI.U is not a feasible option. I think investors who want to trade in U.S. dollars simply use WFIFF.PK."
The Yahoo Finance chart for WFIFF.PK shows it is about as active in volume as it is in Canada.


Anonymous said...

I have been a shareholder of Waterfurnace since early 2007. My average purchase price is around $24. Counting the dividends, I have beaten the market by a very wide margin thanks to this investment. (note: I have a tendancy to put all my eggs in the same basket and watch closely the basket! Waterfurnace still represents more than 50% of my portfolio.)

I agree the next two years might be somewhat disapointing mostly as a result of the still very much depressed US housing market. At the same time, it is important to note that Waterfurnace management has accomplished miracles in the last two years by being able to switch swiftly to the replacement market as result of the collapse of the new construction market. I will buy more shares if price decrease to 20$. I am definitely a buy-and-hold on this one. New and improved products appear to be on the horizon for 2011-2012.

Also, out of curiosity, have you done an analysis of Computer Modelling Group and 5n Plus quoted on the TSX?


CanadianInvestor said...

It's nice to have my "confirmation bias" itch scratched. To help us both I'd be interested to hear what worries you most about WFI - what could go wrong?
No, I had not done any analysis of Computer Modelling Group nor 5n Plus.

Anonymous said...

My worries:

1) Products warranty: the Waterfurnace Envision system sets the standard in the industry. I personnaly own one. It comes with a five-years worry-free warrantee. From what I know, this product seems so far highly reliable. I think 15 years ago, Waterfurnace nearly destroys its brand with products of questionnable reliability. Ex-CEO Bruce Ritchey did a fantastic job turning around this company. So much that Waterfurnace products are now seen as the best products in the geoexchange market. Nevertheless, potential sizeable warranty claims always make me nervous with any company.

2) Natural gas and oil prices: I am somewhat a believer in the peak oil theory that high oil prices are here to stay. I am more nervous with natural gas prices. A total collapse of fossil energy prices -something I do not foresee but there is still a risk however depending on the health of the world economy- could prove disastrous for the company.

BTW- I very much like the dividend. The geothermal market is a slow moving market with lots of stakeholders (borehole drillers, installer-designer-dealer, HVAC contractors, unit manufacturer, etc). All these guys must move in lock step with Waterfurance expansion. If Waterfurnace is super agressive in its expansion strategy, this may force it to start dealing with inexperience geothermal installers/designers or borehole drilers. Even if your product is of highest quality, an inexperience or unqualified installer could make a lot of damage on your product reputation. In the ground source heat pump business, incremental steps type of expansion is beautifull. An all out push to maximise your profits in the short term would likely be a disaster in the long term. So I very much like Waterfurnace slow expansion and dividend policy.

I would strongly encourage you to do an analysis of Computer Modelling Group and 5n Plus. These two companies share many features with Waterfurnace as an investment:
1) exposure to energy prices
2) small company with a very sizeable market share in their respective market
3) no debt and great free cash flow
4)insiders own a big chunk of the outstanding shares (at least 20%)
5) few analysts following these companies


CanadianInvestor said...

Anon, thanks for the very useful comments, both on WFI and the other two companies. Looks like they might be worth a gander indeed.

On the possible collapse of oil and gas prices, that might happen short term for a few years but the history of the last 25 years or so is of significant (far ahead of CPI) real long term price increases. So WFI's absence of debt gives it the wherewithal to survive, as the current housing collapse is showing.

The warranty danger sounds more likely, along with other possible management messing up and self-inflicted damage.

Your point about expanding slowly echoes the comments I saw on a couple of chat forums of people who did an installation and had problems. The big risk is incompetent contractors / installers, not the equipment. As one person colourfully put it, you do not want the guy with the baseball cap and his bum crack showing.

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