Watts Water (WTS) to Grow on Segmental Growth, Costs Ail

On May 23, we issued an updated research report on Watts Water Technologies, Inc. WTS. This maker of water safety and flow control products is anticipated to benefit from higher volume and pricing actions as well as restructuring actions. However, material cost inflation, incremental investments and product rationalization costs will weigh on margins in the near term.

 

Let’s illustrate these growth factors in detail.

 

Segments Well Poised for Organic Sales Growth

 

In the Americas segment, organic revenue growth is now expected at the higher end of its previous guidance of 3-5% in 2018, backed by solid first-quarter performance with robust growth across most of its key products as well as platforms along with the impact of recently announced price increases. In the Americas, much of the non-residential construction data remains positive while in residential new construction, repair and replacement indicators remain healthy. Overall, the residential market should continue to grow at a moderate pace for the year.

 

The company projects organic sales growth in the range of 1-3% in Europe segment for the full year. In the Asia-Pacific segment, Watts Water projects organic sales to grow between 7% and 10% for the year, with strong growth both inside and outside of China. All segments are anticipated to show operating margin improvement compared with 2017. The company anticipates its overall organic sales to increase approximately 3% in 2018.

 

Higher Volume to Boost Operating Margin

 

Watts Water estimates its consolidated operating margin to expand in the band of 50-70 basis points in 2018 on the back of higher volume and continued productivity-increment efforts, including restructuring savings. The company continues to reinvest a portion of productivity savings in selling and marketing, R&D and IT systems to fund near-term growth.

 

The company believes Asia-Pacific segment's margin will expand primarily driven by higher volume. Further, operating margin in the Americas segment will expand on volume leverage and productivity initiatives. Watts Water anticipates that its pricing actions should also help to partly mitigate commodity inflation. Consequently, the company’s pricing actions and restructuring benefits will drive margin performance in 2018.

 

Product Innovation Will Prove Beneficial

 

Watts Water strives to invest in product innovation. Over the past couple of years, the company invested in sales and marketing, and R&D to roll out fresh products. It witnessed success in 2017 in underpenetrated regions like Korea and Latin America, on the back of products like IntelliStation, SmartSense and Benchmark Platinum. These have originated from the company’s product-development initiatives which will stoke growth.

 

Cost Woes

 

Material cost inflation due to the recent imposition of tariffs is expected to affect margins in the near term. Further, transportation costs are rising owing to oil cost increases and labor shortages. Though the company has implemented price increases, it will become effective in July. Consequently, second-quarter margins will be impacted. Moreover, in case the company is unable to pass on increases in raw material to its customers in the future, its margins will be affected.

 

Increased internal investments might impact margin expansion in the near term. The company plans incremental investments of $3-$4 million in the second quarter, approximately $2 million in Americas, $1 million in Europe and approximately $0.5 million in Asia-Pacific. Product rationalization cost should be around $2.5 million in the second quarter comprising $1.5 million in Europe and $1 million in Asia-Pacific. This will be a hindrance to Europe and Asia Pacific margins in the quarter.

 

Share Price Performance

 

 

Watts Water has outperformed its industry with respect to price performance over the past year. The stock has appreciated around 25%, while the industry has recorded growth of 23%.

 

Zacks Rank & Stocks to Consider

 

Watts Water carries a Zacks Rank #3 (Hold).

 

Some better-ranked stocks in the same sector include Nanometrics Incorporated NANO, Allied Motion Technologies Inc. AMOT and Sensata Technologies Holding PLC ST. Nanometrics Incorporated sports a Zacks Rank #1 (Strong Buy), while Allied Motion Technologies and  Sensata Technologies carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

 

Nanometrics Incorporated has a long-term earnings growth rate of 12%. The company’s shares have been up 39% in a year's time.

 

Allied Motion Technologies has a long-term earnings growth rate of 16%. The stock has gained 86% in a year’s time.

 

Sensata Technologies has a long-term earnings growth rate of 11%. Its shares have gained 29%, over the past year.

 

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