Badger Meter: Q1 Earnings Analysis

Jun.21.11 | About: Badger Meter, (BMI)

Badger Meter Inc (NYSE:BMI) ($36.49)

Average Trading Volume (last 90 days)


Market Capitalization

551.0 m

Short Interest (% of float)




Click to enlarge

3/11 Q1/11

12/10 Q4/10

in $ millions

Revenue Growth

$57.3 v 61.8 m


$64.8 v 56.4 m


% Sales Surprise



% Earnings Surprise




59 v 60 days

-1 day

56 v 57 days

-1 day


128 v 81 days

+47 days

108 v 81 days

+27 days

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3/11 Q1/11 y/y



in $ millions


$57.3 v 61.8 m

$69.1 m

-$11.8 m

Gross Margin %

35.6 v 37.6


-50 bps

SG&A %

15.2 v 14.5


+10 bps

Operating Margin %

9.1 v 14.2


-610 bps

Tax Rate %

36.4 v 38.1



Diluted EPS

$0.22 v $0.36



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Key Issues

Badger Meter reported Q1 2011 EPS of $0.22 (vs $0.36 y/y) on revenues of $57.3 m (vs $61.8 m y/y). Both sales (-16% below) and EPS (-49%) were well below consensus. Normally, a disappointment of this magnitude would produce a meaningful decline in the stock price, but following an initial plunge the morning after the release, the stock price recovered and has since stabilized at levels approximately 8% below the pre-earnings release price. Street analysts currently expect FY11 and FY12 EPS of $2.10 and $2.20, respectively. Note that BMI trades at 11.3X EV/EBITDA (TTM).

The stock price likely stabilized due to soothing comments made by management on the Q1 CC (held April 19th). Specifically, management stated, "We also -- we normally don't talk specifically about short-term forecasts and the second quarter in particular, other than to say how we feel about it optimistically or whatever. But as we looked at the first half of this month, the first half of April, we did see an uptick in our backlog; we saw some very strong order entry and we saw some strong margins. And all of those things combined caused us to say we really need to tell the investment community that we are seeing a stronger second quarter as we move into it. So I thought that was an important statement to make. Obviously we don't want to quantify it and give you any specific details and a half a month doesn't make the entire quarter. But at this point we're pretty optimistic. We saw a very -- an unusually weak first quarter and we're seeing signs that it's trending and turning around." Note this optimism was based on business activity in the first 2 weeks of the second quarter. Consequently, while analysts are expecting sales to decline –1.8% y/y in the June Q, they are expecting a return to positive growth (+4.0%) in the September Q.

In the Q1 10Q, management explained the disappointing sales in Q1 as follows; "The decline was due primarily to lower volumes of the Company's AMR/AMI related products, as well as lower sales of commercial meters and lower revenues from installation services. Sales of the Company's ORION AMR technology products decreased 31.7% while sales of the Itron related products declined 15.0%."

We believe one of the keys to future stock price performance surrounds the question of whether the lower volumes of meters sold with AMR and AMI technology is a temporary blip (as supported by management's comments regarding improved business activity in the first 2 weeks of Q1) or whether the underlying reasons for the decline are likely to linger.

On the Q4 CC (held February 8, 2011) in response to a question about municipal demand, Badger Meter management had answered, "Yeah. We are -- there are certain areas of the country where they are still very concerned about the budgets, particularly some of the California municipalities. Some of the municipalities that are in the automotive business and they haven't seen the rebound that they had hoped to see, are still very constrained. But I would say in general, the attitude of the utilities we're talking to is that the money is there, they see this as an opportunity to improve efficiency and to save money in the future, and it is a priority for them. So I don't think we're going to have the crunch on municipal spending that we've seen over the last couple of years." On the call, management did mention certain delays in orders from Mexican municipalities as well as the possibility that some Orion customers may have delayed purchases as they awaited the roll-out of new ORION two-way fixed network technology, but otherwise the tone of the Q4 CC was upbeat, in our view. Furthermore, in the 10K (filed February 28th, 2011) management offered the following commentary, "The Company believes customers who had delayed purchasing decisions because of the possibility of funds becoming available under U.S. government stimulus programs made purchases in 2010 as funds were allocated and buying patterns returned to more normal."

In contrast, despite the good news regarding the uptick in activity in the first 2 weeks of April, there was abundant commentary in both the Q1 CC and 10Q that suggested a much more challenging environment than what was outlined in the February CC and 10K. In the 10Q, management commented that, "The Company believesthe volume decline was a combination of factors including concerns over municipal spending which delayed ordering decisions, poor weather in the Midwest and Northeast which affected budgets and installation rates, slower housing starts and the Company's introduction in early 2011 of the next generation of the ORION product that caused water utilities to wait for its release in the second quarter of 2011."

On the Q1 CC, management elaborated further on the environment. Commentary included the following: "The uncertainty over governmental spending, be it at the federal, state or local level, appears to be affecting our customers' decision-making processes. We suspect that even utilities that have the funds available are taking additional time before they make purchase commitments due to the uncertainty as to how federal and state funds will be allocated and their impact at the local level. We also believe the winter weather, particularly in the Midwest and Northeast, had an impact on the first-quarter sales … For many years we've made a point of saying that housing starts did not have a significant impact on our business. Now with housing starts at an all-time low there is some impact that does affect our business … Municipal budgets -- municipal budgets have also been with us. Last year was distorted dramatically, as you know, by the stimulus package where the government was giving out stimulus money, some utilities were waiting. We had a weaker fourth quarter of 2009 and first quarter of 2010, then a very strong second and third quarter as that money was put out there. So it's hard to compare this year to last year on the municipal budgets when everything got distorted by the stimulus money.I think this year the municipalities are looking at their budgets, they're recognizing that they don't have the stimulus money coming in and they have to make corrections. And we're seeing -- we saw some of those corrections …"

Badger has unquestionably experienced lumpiness in its business during past quarter, but given the far more cautious commentary offered in Q1 compared to Q4, it may be premature to cite the first 2 weeks in April as grounds to dismiss the substantial negative revenue surprise and the overall arc of management's cautious commentary.

Q1 gross margins were 35.6% (down 200 bps y/y) and 50 bps below expectations. Management cited higher copper and oil costs and a product mix that skewed toward lower margin manual meters. A price increase was instituted in January 2011, which management believes will offset higher copper costs as long as copper does not move materially above $4.00/lb. The mix shift toward manual meters has been ongoing with growth in the water applications segment (representing 73% of BMI's overall Q1 sales) exceeding overall water applications growth the past 2 quarters (+18% vs -21%, +15% vs +4.6%).

The key balance sheet concern is the rapid rise in inventory levels. In the Q1 10Q, the following explanation was offered, " The [inventory] increase was duetohigher material costs, particularly castings of which copper is a main component, increased lead times for electronics and lower than anticipated sales in the first quarter of 2011. On the call, management stated, "Inventories do remain high; we talked about a number of reasons on our last conference call why inventory levels are higher than anticipated. These include the fact that costs are higher, as we've been discussing, lead times on certain electronic components continue to be high even prior to the earthquake in Japan and we anticipate this will continue in the near-term. It is noteworthy that in the Q3 2010 10Q, management cited "more efficient plant utilization" as a positive contributing factor to gross margins, but that this factor has been omitted the past 2 quarters as presumably Badger Meter may have had to reduce production utilization until inventory balances are normalized.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.