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Watts Water Technologies Looks Like An Expensive Way To Play Water Themes

Apr. 08, 2021 3:10 PM ETWatts Water Technologies, Inc. (WTS)3 Comments
Stephen Simpson profile picture
Stephen Simpson
19.15K Followers

Summary

  • Water tech companies have generally enjoyed strong stock valuations, but the performance at Watts in terms of revenue growth and margin leverage hasn't really argued for a strong premium.
  • Management has made good progress with its smart/connected offerings, products that help with remote building operation and monitoring, including leak detection and automated shutoffs.
  • Non-resi new-build activity is still looking weak, but Watts can offset that with a pickup in deferred maintenance and a still-strong residential market.
  • Low-to-mid single-digit revenue growth and FCF margin improvement into the low double-digits isn't enough to make a strong case for the shares today.

Water technology remains an area of the market where you really don’t go looking for bargains, and this has been true for quite some time. What I find interesting, though, is that these stocks haven’t necessarily lived up to the hype – the growth has been fine, and there’s been margin improvement, but the sector hasn’t been that breakaway success you might have expected, and the returns haven’t been that exceptional over the last three or five years.

Turning to Watts Water Technologies (NYSE:WTS), there are a lot of things I like about this company, including its credible and growing leverage to smart/connected devices. What I don’t like, not surprisingly, is the valuation. I do expect non-residential demand to improve in 2022, and I do see a window of opportunity for connected devices to drive margin improvement, but that seems well-reflected in the share price.

An “Air Pocket” In 2021

With about 40% or so of Watts’ business coming from the U.S. non-residential market, I expect the company to see some lingering challenges in 2021, as I have been looking for meaningfully slower new-builds this year. Management apparently agrees as the company laid out an initial sales guide for the year of anywhere from a 5% contraction to flat revenue. Curiously, the Street isn’t buying that, with the average estimate calling for modest growth for the year.

Data for March should be out soon, but so far the rolling 12-month data through February shows a 28% year-over-year decline in new non-residential building starts, with a 7% decline in February and a 31% decline for the first two months of the year.

While improvement from here is certainly possible (likely, in fact), and the Dodge Momentum Index has been strong, I expect most of the upswing to come in 2022 (the Dodge Momentum Index usually leads

This article was written by

Stephen Simpson profile picture
19.15K Followers
Stephen Simpson is a freelance financial writer and investor. Spent close to 15 years on the Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That last part isn't entirely true. Probably.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (3)

Goose Hollow Investments profile picture
Thank you for yet another good article on a stock that I follow. I largely agree that WTS is overvalued, even in the context of the water/environmental space. I think you get better bang for your buck with XYL and MWA, both of which are also involved in the smart water space. However, WTS does have great tech and should do well too, at least from an operations perspective, but I'd expect the stock to continue to alright too, though a breather or pull back after the multi year run up would make a lot sense.

You touched on something else I agree with, which is that the growth in water hasn't been as robust as one would imagine. I do think the potential is still there and believe the infrastructure bill, if it passes, will be a good way to begin addressing the many areas of water infrastructure in need of upgrading. A freer market for water would open the floodgates, pun unintended. But also be a very complex and probably never look anything like most commodity markets. That said, I trend towards the water stocks that operate in the space but also do business in other areas. DHR, ROP, ECL, IDXX, and TTC being a few favorites of that mould. Thank you again for this, and the other articles, I always appreciate your analysis.
Stephen Simpson profile picture
@Goose Hollow Investments Thanks for the reminder that I need to look at IDXX again. What's TTC's leverage to water? I haven't looked at that name in a while.
Goose Hollow Investments profile picture
@Stephen Simpson TTC makes irrigation equipment, including water efficient drip irrigation systems. The Charles Company, which they purchased a couple years ago, got them into excavation for pipe repair too. They have an interest in a drone turf management company too, or at least did a couple of years ago, and if memory serves me one of the functions of the drone was to assess when turf needed to be irrigated and when you could wait and save some water.

IDXX is a beast, just always so expensive, whenever I buy I just hold my nose and do it small increments. I'd love to see you take on either company.
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