2023-11-08 02:25:56 ET
Summary
- Advanced Drainage Systems reported weak Q2 results with a decline in revenue across all business segments, particularly in the Pipe segment.
- The company's future growth prospects are weak due to a slowdown in the domestic agriculture and construction markets.
- WMS is trading at a relatively high PE multiple compared to the sector, and there is no significant upside potential for the stock price. Investors should hold, but new investors should avoid.
Investment Thesis
Advanced Drainage Systems, Inc. (WMS) is an American water management product and service provider headquartered in Hilliard, Ohio. In this thesis, I analyze the company's second-quarter results and its future growth prospects. I will also be discussing its valuation at the current price level. With subdued performance in the recent quarter and weak future guidance, I would recommend investors to hold WMS.
Company Overview
WMS manufactures stormwater pipes and provides onsite septic wastewater solutions. The company's business can be segregated into four categories: Pipe, Infiltrator water technology, International, and Allied products. The pipe segment contributes 53% of the total revenue, followed by allied products at 22.5%, infiltrator at 15%, and the international segment at 9.5%. It has operations globally, but the majority of its revenue comes from domestic construction, housing, and agriculture sectors. The company has around 40 distribution centers across the United States through which it markets its products.
Q2 FY 2024 Results
WMS reported weak Q4 results with a slight decline in top-line and bottom-line numbers. The results were in line with the market expectations. WMS experienced a decline in revenue across all business segments, with the Pipe segment being the worst performer. As per my analysis, the weakened demand from the domestic agriculture and construction industry, which are the primary target markets for WMS, resulted in a decline in revenue.
WMS reported sales of $780.2 million in Q2 FY24, a significant decline of 11.8% compared to $884.3 million in the corresponding quarter last year. Although all business segments witnessed a decline, the Pipe segment proved to be the worst performing, with a y-o-y decline of 14% to $420.8 million compared to $490.2 million . I believe the company won't be able to increase the topline unless they see a revival in demand from the domestic market for the pipe-related products, but this seems unlikely as the overall agriculture market is witnessing a slowdown, and it doesn't seem to get better in the near future. As per my analysis, the worrying factor is that the company achieved these sales by increasing the average product price; this reflects that the organic sales growth is missing. It reported gross and net profit margins of 38.7% and 17.4%, respectively. Another point that I would like to highlight is that the company is incurring significant interest expenses. WMS incurred $43.6 million in interest expenses in the first half of FY24, up a significant $14 million compared to $29.3 million in the first half of FY23. Higher interest expenses are putting a dent in the company's profit margins, and the interest rates are not expected to go down anytime soon, especially after the recent commentary by the Fed. WMS reported diluted EPS of $1.71, down $0.09 from $1.80 in FY23.
Now, let us have a look at the company's balance sheet. As of 30 June 2023, it reported cash of $470.4 million against long-term debt of $1264 million. The company saw over a twofold rise in the cash balance over last quarter's cash balance of $217 million. I believe the company will be utilizing this cash for its share repurchase program, under which it has repurchased $101 million worth of shares in the first half of FY24. The issue that I mentioned earlier is the increasing interest expenses due to its high debt obligation. The company is planning on building a new manufacturing facility in Florida, which might help it grow in the long term. However, the company will have to invest a significant amount as capital expenditure in the next 12 months. I do not see any significant issue with the balance sheet currently, but if the debt increases in the future, it could put stress on the company's balance sheet and result in higher interest expenses.
Overall, the quarterly results failed to impress me with declining revenues and profits. WMS management revised its FY24 revenue and adjusted EBITDA guidance to $2.7-$2.8 billion and $800-$850 million, respectively. Even if we consider the higher range of the guidance still, it's a decline of 9% in the revenues compared to FY23 and a 6% decline in the adjusted EBITDA. I believe the investors should not initiate a fresh buying position in this stock due to weak future growth prospects, both on revenue and profit fronts.
Valuation
WMS is currently trading at a share price of $111.5, a YTD increase of 37%. It has a market cap of $8.7 billion. The company is trading at a twelve-month trailing non-GAAP PE multiple of 18.8x with EPS at $5.94. The company is trading at a relatively higher PE multiple compared to the sector PE of 16.4x. I do not see any reason for the company to trade at a higher multiple than 19x, and the forward EPS is expected to be in the range of $5.80-$5.90. With all these considerations, I believe there is no significant upside potential for the stock price. I would recommend existing investors to hold the stock, but new investors should not invest in the stock at current price levels.
Conclusion
WMS experienced a y-o-y decline in both revenues and net profits. The FY24 guidance is weak, and there is no significant growth prospect for the company in the near future. It is trading at a PE multiple of 18.8x, higher than the sector PE. The management guidance doesn't instill much confidence for FY24, and till the agriculture and construction demand picks up, it would be very difficult to achieve a significant growth trajectory. Considering all these factors, I assign a hold rating for WMS.
For further details see:
Advanced Drainage Systems: Weak Q2 Results With No Significant Growth Prospect