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Xylem (XYL) Gains From Solid End Markets Despite Forex Woes

Zacks Equity Research

We issued a research report on Xylem Inc. XYL on May 13.

This water solutions provider currently has approximately $14.1 billion market capitalization. Presently, it carries a Zacks Rank #3 (Hold).

A few growth drivers, as well as certain headwinds, which might influence Xylem, have been discussed below.

Factors Favoring Xylem

Segmental Performance and Outlook: The company operates through three business segments — Water Infrastructure, Applied Water, and Measurement & Control Solutions. Its revenues increased 1.6% year over year in the first quarter of 2019 on the back of sales growth in all three segments. Organically, sales grew 7% for Water Infrastructure, driven by strength in transport and treatment businesses; expanded 7% for Applied Water, driven by growth in commercial, industrial water and residential businesses; and improved 5% for Measurement & Control Solutions, driven by growth in the water business.

For 2019, the company projects revenues to increase 2-4% year over year to $5.3-$5.4 billion. Organic sales are predicted to increase 4-6%, including 5-7% for Water Infrastructure, 3-5% for Applied Water, and 4-6% for Measurement & Control Solutions.

Strengthening Business: Xylem serves a large number of customers in end markets, including utilities, industrial, commercial and residential. Business from utilities end markets generated the largest share of revenues for the company in 2018.

Notably, Xylem performed in all the end markets in the first quarter of 2019, with organic sales increasing 6% in utilities, 4% in industrial, 12% in commercial and 4% in residential end markets. For 2019, the company anticipates organic sales to grow in a mid-single digit in the utilities end market, in a mid-single digit (higher than the previously stated low- to mid-single digit) in commercial, low- to mid-single digit in industrial and low-single digit in residential.

Shareholder-Friendly Policies: Xylem believes in rewarding its shareholders handsomely through dividend payments and share buybacks. In 2018, dividend payments totaled $152 million while share buybacks amounted to $59 million. The company rewarded shareholders with $44 million in dividends and $39 million of share buybacks.

Notably, a 14% hike in quarterly dividend rate was announced by Xylem in January 2019. Also, the company anticipates distributing dividends of $175 million and predicts share count to be approximately 181 million in 2019.

Factors Working Against Xylem

Share Price Performance and Poor Valuation: Xylem reported weaker-than-expected results for the first quarter of 2019, with earnings and sales lagging respective estimates by 10.3% and 1%. The company’s share price has declined 3.5% since the earnings release on May 2.

Notably, the stock price has increased 3.9% in the past three months versus the industry’s growth of 4%.

Also, the stock currently seems overvalued compared with the industry, considering the Price-to-Earnings (P/E) multiple for the past three months. The stock’s P/E (TTM) multiple is 26.5x, above the industry’s 20.6x and the industry’s three-month highest level of 20.6x. This overvaluation somewhat makes us cautious about the stock.

Projections Lowered: Xylem’s first-quarter results suffered from adverse impacts of unfavorable movements in foreign currencies, rise in costs and operating expenses, and weak margins. Notably, the company stated that cost inflation adversely impacted adjusted operating margin by 3.2 percentage points while growth investments impacted margin by 80 bps. However, effective pricing actions were a relief.

For 2019, Xylem lowered its adjusted earnings per share guidance from $3.20-$3.40 to $3.12-$3.32. Also, adjusted operating margin is predicted to be 14.5-14.9%, down from the previously mentioned 14.7-15.2%. The downward revision was due mainly to weak first-quarter results and forex woes.

We believe that poor first-quarter performance and lowered guidance for 2019 created bearish sentiments for the stock. In the past 30 days, earnings estimates for the stock have been revised down by 2.7% to $3.24 for 2019 and by 2.1% to $3.74 for 2020.

Xylem Inc. Price and Consensus


Xylem Inc. Price and Consensus

Xylem Inc. price-consensus-chart | Xylem Inc. Quote

Huge Debts and Forex Woes: Xylem’s highly leveraged balance sheet — with long-term debt pegged at roughly $2 billion at the end of the first quarter of 2019 — if unchecked, can inflate its financial obligations and prove detrimental to profitability. It predicts that it will incur interest expenses of $72 million in 2019.

Also, geographical diversification exposed the company to headwinds, arising from geopolitical issues and unfavorable movements in foreign currencies. Forex woes lowered first-quarter 2019 earnings by 5 cents per share and sales by 4%. For 2019, the company predicts that forex woes will dilute earnings by 4 cents.

Stocks to Consider

Some better-ranked stocks in the industry are Roper Technologies, Inc. ROP, DXP Enterprises, Inc. DXPE and Dover Corporation DOV. While Roper currently sports a Zacks Rank #1 (Strong Buy), DXP Enterprises and Dover carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

In the past 60 days, earnings estimates for all three stocks have improved for the current year. Further, average earnings surprise for the last four quarters was positive 48.47% for DXP Enterprises, 8.43% for Roper and 8.61% for Dover.

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