Xylem-Deep water or deep value?

The Stay Invested portfolio was UP today: $172.47 (-0.16%)

Overall GAIN/LOSS YTD: +$5,603.25 (+5.46%)

Start: $102,717.24

Current: 108,320.49

Our benchmark index, the S&P 500 is UP Year-To-Date +9.82%

http://money.cnn.com/data/markets/sandp/

(daily performance is updated after the close, early blog posts typically show the previous days performance)

"It costs ten times more to govern us than it used to, and we are not governed one-tenth as good."

― Will Rogers 1932

The Numbers

Note in the header above I've added the total portfolio value at the beginning of the year and the current portfolio value. Just wanted to add some clarity.

Xylem, Inc

My first stock review for 2019 is Rye Brook, New York based Xylem, Inc. When you think about water infrastructure, Xylem should be at the top of your list as a maker of infrastructure products for delivery of water and wastewater globally. Water infrastructure may not be as exciting as Nvidia, Amazon or Google, but as an agent of the world’s most valuable resource, Xylem could prove to be highly profitable for investors and year to date our portfolio has seen XYL grow over 13%.

  • Global growth in water infrastructure

  • Strong growth in China despite the trade war

  • A big future in India

  • Digital solutions provide biggest strategic moat

  • Xylem is capturing share from competitors

Background

Xylem Inc. engages in the design, manufacture, and service of engineered solutions for the water and wastewater applications. It operates through three segments: Water Infrastructure, Applied Water, and Measurement and Control Solutions. The Water Infrastructure segment offers various products, including water and wastewater pumps, and controls and systems, as well as filtration, disinfection, and biological treatment equipment under the Flygt, Godwin, Wedeco, Sanitaire, and Leopold names for the transportation, treatment, and testing of water and wastewater applications. The Applied Water segment provides pumps, valves, heat exchangers, controls, and dispensing equipment systems under the Goulds Water Technology, Bell & Gossett, A-C Fire Pump, Standard Xchange, Lowara, Jabsco, and Flojet brand names for residential and commercial building services, and industrial water applications. The Measurement and Control Solution segment provides smart metering, communications, measurement, and control technologies and services that allow customers to use their distribution networks for the delivery of critical resources, such as water, electricity, and natural gas. This segment also offers software and services, including cloud-based analytics, remote monitoring, data management, leak detection, and pressure monitoring solutions, as well as sells smart lighting products and solutions. This segment sells products under the Sensus, Smith Blair, WTW, Visenti, and YSI brand names. The company markets and sells its products through a network of direct sales force, resellers, distributors, and value-added solution providers in the United States, Europe, the Asia Pacific, and internationally.

Key Points

It should be no surprise that we are facing a global water crisis. This crisis isn’t just about droughts that come and go, it’s about pollution of both fresh water and sea water. It’s about ever increasing population’s demand on water. How we use water, where we use water and how to distribute new sources of water; that’s namely desalinated water. One of the key problems in developed countries like the U.S is our distribution system is designed to deliver water to the sea, not suck it up and deliver it inland. We literally would need to reverse our infrastructure design to make use of desalinated sea water.

China, India and other developing countries are in desperate need of modern water infrastructure along with the ability to monitor water resources, usage and system integrity. The digitization of water and wastewater systems has just begun and Xylem is a leader in this area and the revenues from software and updates should develop into a strong subscription revenue business. Boeing is an excellent industrial example of this business model.

Xylem has been able to show tremendous pricing strength as rising input costs from tariffs and commodities prices, namely steel, aluminum and copper have been successfully passed onto the customers in their global markets. While increasing prices Xylem has also managed to increase productivity to offset higher input costs.

Valuing Xylem

Most water stocks were selling below their 52-week highs at the beginning of this year. XYL’s 52-week low was $60.65 and traded as high as $82.44 in the recent past. At today’s close of $72.68, XYL still looks attractive. My buy below price was set at $65 and I made the first purchase at $64.23. Xylem finished 2018 with organic revenue growth of 8% and operating margins of almost 14%. The company has stated 2020 goals are to raise operating margins to 30% and they appear to be on track. Most important, business in China has shown no evidence of a slowdown. China grew 37% year-over-year; while India slowed the overall emerging markets segment. However, the fourth quarter results from India appear to be a onetime event. The company states that India is expected to be their fastest growing market due to a backlog in growing project pipelines from new wastewater treatment regulations.

Ratios

Compared to its peer group, XYL trades at a premium on several metrics which normally would lead me to remove it from consideration. However, I looked a bit deeper to see if this higher multiple stock was hiding something.

Price/Earnings:

Trades at a premium, might signify higher growth ahead

Price/Proj. Earnings

Trades at a premium, might signify higher growth ahead

Price/Book Value

About the same as its peers

Price/Sales

Shows the value investors place on each dollar of sales. XYL is almost double its peers suggesting that investors are confident in top line growth and Xylem’s ability to increase prices and lower costs. XYL trades at a premium to its peers. This feels like the wound tight spring. A resolution with the trade war could cause investors to bid up the stock price upon announcements of new contracts in China and on the lowered cost of their input materials.

Price/Earnings Growth

Here’s the hidden gem, the PEG Ratio. XYL trades at a significant discount to its peers on a PEG Ratio basis. The 5 year average PEG ratio is about 1.19, but at the end of 2018 it was about 0.50 in an industry that averages about 2.3. While a low P/E ratio may make a stock look like a good buy, factoring in the company's growth rate to get the stock's PEG ratio can tell a different story. The lower the PEG ratio, the more the stock may be undervalued given its earnings performance. The degree to which a PEG ratio value indicates an over or underpriced stock varies by industry and by company type, though a broad rule of thumb is that a PEG ratio below one is desirable.

Qtrly Earnings Growth

Year-Over-Year quarterly earnings growth is exceptional at 23.80% but on par with others in its peer group with similar P/E ratios. Looking deeper outside the peer group at other water infrastructure companies, XYL stands alone on this metric with these competitors sporting negative and single digit quarterly YOY earnings growth.

Qtrly Revenue Growth

I like comparing this metric to the one above. Basically it tells me how hard the company’s sales team had to work on the top line to achieve the earnings growth. At just 7.70% YOY revenue growth, I like to think the double digit earnings growth numbers are sustainable.

Verdict

I like Xylem as a long term investment. There is a great deal of value in this company and as yet untapped growth. Management has it's eye on the balance sheet, the company is well entrenched in all the important markets and making good progress. The business is focused on the most important resource we have and they've taken the leadership position for the future with the development of digital tools. With a Beta of 1.12, XYL can deliver growth without undue risk for the patient investor.

My Buy below price: $65 (January 1, 2019)

My price target is $77.75.

Analysts average PT is $78.19

Low PT: $54

High PT: $89

If we reach $77 I’ll look at the company again and decide if the portfolio should sell Xylem around $77 or hold with the expectation of getting closer to $89.

Stay Invested,

Clay Baker

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Keep Me Honest

  1. S&P 500 declines to 2,350 or more (1-3-2019)

  2. Healthcare and Biotech sectors outperform (1-3-2019)

  3. S&P reaches 3,000 by year end (1-11-2019)

  4. CSCO reaches $60/share (1-18-2019)

Disclosure: I am personally invested long in some or all of these stocks or funds that appear in the Stay Invested portfolio and may purchase or sell shares within the next 72 hours. I am also invested in other stocks and funds that do not appear in the Stay Invested portfolio but may be mentioned or related to this article. It is not my intention to advise or encourage the purchase or sale of any security. I am invested long in these securities mentioned in this post:

CVS, CSCO, VEEV, STZ, AMZN, NVDA, BCRX, GS, BDSI, VEEV, VTI, GLD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is not intended to offer investing advice, guarantee 100% accurate predictions, or to be interpreted as providing a personal recommendation.

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This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice.
This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.

© 2016 by Clay Baker all rights reserved