ZWS - Zurn Elkay Water Solutions Is Poised For Long-Term Growth

2023-04-13 15:09:40 ET

Summary

• Zurn Elkay Water Solutions Corporation is a Milwaukee-based company that offers comprehensive water management solutions.
• The global water treatment systems market is projected to experience an 8.8% annual growth rate from 2022 to 2030, emphasizing the long-term potential for growth in this market.
• The recent merger between the company and Zurn is poised to bolster profitability, leading to a growth trajectory of consolidated sales ranging from $1.5 billion to $1.55 billion for 2023.

Thesis

At a time when water scarcity and sustainability are becoming ever more pressing issues, Zurn Elkay Water Solutions Corporation (ZWS) is taking the lead as an eminent participant in the water management sector.

While its stock may occasionally be slightly undervalued to fairly valued, its potential for growth in light of a continuously increasing global demand for efficient water treatment systems gives this company's future outlook great promise. This article examines Zurn Elkay's strengths, weaknesses, and foreseeable opportunities within the rapidly changing landscape of modern-day water management.

Brief Company Overview

Zurn Elkay Water Solutions Corporation is a Milwaukee-based entity, which traces its origins back to 2006, and has made its mark by developing and supplying a comprehensive array of water management solutions. Their suite of products - spanning water safety and control, flow systems, remote tank monitoring, and water-efficient fixtures - has become increasingly pertinent.

Zurn Elkay's versatile offerings cater to a broad spectrum of industries, from healthcare and higher education to retail, restaurant, and hospitality sectors. Moreover, its reach extends to government facilities and fire protection agencies.

Peer Evaluation

In my view, Zurn Elkay Water Solutions finds itself delicately poised between being fairly valued and marginally undervalued vis-à-vis its rivals. This assertion is rooted in a series of the following valuation metrics:

Primarily, ZWS's Non-GAAP P/E ratios (FY1, FY2, and FY3) are lower than most of its counterparts, save for AWI and SSD. This insinuates a more budget-friendly valuation for ZWS. Furthermore, the GAAP P/E ratios (FWD and TTM) exceed the Non-GAAP equivalents but still fall short of the industry average. In my estimation, this signals a tendency towards fair or slightly undervalued pricing.

Secondly, ZWS possesses a P/S ((TTM)) ratio of 2.43 and an EV/Sales ((FWD)) ratio of 2.68, both of which undercut the majority of its peers. From my perspective, this implies that ZWS generates higher sales per share, making it a relatively undervalued investment.

Moreover, ZWS's EV/EBITDA ((FWD)) ratio registers at 12.13, lower than most competitors with the exception of AWI. I believe this indicates that ZWS yields a greater EBITDA per dollar of enterprise value, thereby potentially rendering it a more alluring investment opportunity. ZWS's P/B ((TTM)) ratio stands at 2.25, which is lower than the bulk of its peers. To me, this unveils that its share price is comparatively more reasonable relative to the company's book value.

Finally, ZWS's P/CF ((TTM)) ratio clocks in at 37.30, surpassing most of its competitors. This might imply potential overvaluation based on this lone metric. However, I maintain that the array of other metrics previously discussed offers a more well-rounded picture. Therefore, taking into consideration all of these valuation metrics, I am inclined to posit that ZWS teeters between being fairly valued and somewhat undervalued in comparison to its peers.

Bull Case

From my perspective, in the realm of investment opportunities, the drinking water solutions market is one that cannot be ignored. Zurn Elkay Water Solutions, a leading force within the sector, demonstrates the market's potential for expansion with its extensive installation base of point-of-use drinking water systems. The global water treatment systems market , valued at USD 36.41 billion in 2021, is projected to experience an 8.8% annual growth rate from 2022 to 2030, emphasizing the long-term potential for growth in this market.

The growing awareness of lead in drinking water has created an urgent demand for reliable solutions. Nearly half the U.S. population, with school-aged children standing out as particularly vulnerable, are exposed to potentially contaminated water from lead service lines. As a result, firms such as Zurn Elkay have been presented with a great chance to provide invaluable secure drinking water options and take immediate action against this alarming public health issue.

With a disquieting 43% of the U.S. population having experienced high blood lead levels ((BLLs)) in early childhood, and a quarter reaching 10 µg/dL or greater, I think that it's a no-brainer that providers offer reliable solutions to access clean water. I am convinced that Elkay's point-of-use drinking water systems are just the answer for these consumers who need safe and uncontaminated tap water.

My assessment is that, as legislative action and heightened awareness converge on this issue, an immense opportunity arises for the company to cater to schools and public areas. And according to the company, this would enable the filtration enterprise to develop a high-margin, recurring revenue stream, potentially exceeding $100 million in the years to come.

In the wake of the recent merger between the company and Zurn, an air of promise seems to be pervasive. The strategic implementation of the 80:20 simplification measures is poised to bolster profitability, which would ultimately reflect positively on the company's financial standing and leverage.

Peering into the future, the company's ambitious forecast of consolidated sales, ranging from $1.5 billion to $1.55 billion for 2023, appears attainable. This growth trajectory can be traced back to the myriad strategic initiatives undertaken to streamline and optimize the operations of the newly-formed business entity.

Drawing attention to the projected adjusted EBITDA, which falls within a range of $325 million to $345 million, we witness a noteworthy margin expansion of 110 to 170 basis points year-over-year. The origins of this margin enhancement can be attributed to the synergistic opportunities arising from the merger and the aforementioned 80:20 simplification measures that have been diligently executed.

Finally, the company's low net debt leverage of 1.4 times and its intention to allocate a minimum of $100 million from its 2023 free cash flow toward share buybacks underlines its robust financial footing and prospects for growth.

Bear Case

Zurn Elkay Water Solutions Corporation boasts a striking 46% year-over-year growth; however, it seems to me that the undercurrents could reveal a somewhat more disconcerting narrative. A 300 basis point contraction in core sales to the residential sector may well serve as a harbinger of future instability, while the tepid expansion in non-residential end markets - merely low single digits - leaves much to be desired.

Meanwhile, the merger, though engendering a 50% year-over-year augmentation, has not been without its tribulations. A 100 basis point reduction in sales, courtesy of foreign currency translation, is one such impediment. The more disquieting revelation, however, is the 30% decline in residential end market sales, signifying a market environment that may have been underestimated by some 10 points. This raises the specter of the company's potential inability to penetrate these markets effectively or a misalignment between their offerings and the demands of this particular segment.

The first-quarter margin, temporarily marred by the sell-through of higher-cost inventory acquisitions in 2022, and accelerated investments in safe drinking water initiatives, warrants further scrutiny. From where I stand, Elkay-related synergy savings, projected to amount to $25 million this year, may potentially fail to fully counterbalance this transitory margin impact.

Furthermore, with a less-than-rosy sales forecast , the company's prospects appear somewhat muted, particularly in light of improved lead times. The company's circumspect approach to purchasing patterns within the channel suggests that its offerings may have lost their erstwhile allure, or that rivals have managed to capture a portion of their market share.

And finally, my personal belief is that the company's fourth-quarter sales report sketches a rather bearish portrait, featuring declining core sales and a cautious stance in channel buying patterns. Therefore, despite the promise held by investments in safe drinking water initiatives, the transient margin impact and sluggish sales growth warrant ongoing vigilance.

Takeaway

In light of the recent strategic undertakings, including optimization of operations and streamlining of Zurn Elkay Water Solutions Corporation's structure via a merger, my assessment is that they serve to underscore the company's solid financial footing and paint a promising picture for future prospects. So while it's true that certain factors may be interpreted as bearish indicators, such as waning core sales and lackluster sales growth, I would contend that the company's steadfast commitment to safe drinking water initiatives, coupled with its robust financial standing, renders Zurn Elkay Water Solutions Corporation an enticing investment opportunity that warrants attention and therefore, a "buy" rating.

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