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Coverage Initiation: Xylem Inc.
Value Line has initiated coverage of Xylem Inc. (XYL) in its flagship product, The Value Line Investment Survey. The cover of the company’s annual report reads, “Let’s Solve Water,” which is a good indication of its business. (The company is named for the tissue that transports water in plants.) Xylem has two business segments: Water Infrastructure, which involves the transport, treatment, and testing of water (64% of 2012 revenues); and Applied Water, which involves the uses of water for building services, industrial applications, and irrigation (36%). Water Infrastructure has a higher operating margin than Applied Water. The markets that Xylem serves amount to about $35 billion. The majority of its customers are industrial users or water utilities. Recurring revenues make up about 37% of its top line. The company is headquartered in White Plains, New York and has about 12,700 employees.
Xylem became a public company on October 31, 2011, when it was spun off from ITT Corporation (ITT). Stockholders received one share of Xylem for each share of ITT. Although Xylem has a short history as an independent public company, it has more than 100 years of experience in water-related operations.
The company performs functions that encompass the water cycle, ranging from water intake to water return. Xylem’s products pump water, transport it, treat it, treat wastewater, and test water quality. It also serves the commercial building, industrial, and irrigation markets. The company is the #1 or #2 participant in each of its markets except irrigation, in which it is #3. In the fall of 2012, Hurricane Sandy provided examples of what Xylem does. Its equipment pumped water out of flooded areas and monitored water quality following the storm.
Xylem is geographically diversified, serving more than 150 countries through over 360 locations. Well-established in developed countries, the company’s revenue breakdown last year was 37% United States, 35% Europe, 12% Asia Pacific, and 16% Other. Emerging markets generated 20% of Xylem’s revenues in 2012.
This company has various means of growth. In 2012, it established a presence in Panama, Vietnam, Russia, and Saudi Arabia, and is planning to expand its presence in the Middle East. China is another key market. Xylem plans to strengthen its presence in Europe by establishing a headquarters on the continent. The company also expands via acquisitions. Xylem has made nine purchases since 2009, including two in the first quarter of 2013. There is an active pipeline of prospective acquisitions. Research and development is important, too. The company spent $106 million on R&D last year. All told, management is counting on organic growth to provide 3%-5% annual revenue growth, with acquisitions adding another 2%-4% to the top line each year. Xylem believes that it can achieve its targets through 2017 without issuing any common stock.
Xylem increased its operating margin by nearly five percentage points from 2008 to 2012. To reduce costs, management underwent a Six Sigma program, initiated a global sourcing program, and consolidated its information technology systems. Xylem isn’t finished with these moves. The company expects to incur $60 million-$70 million this year on a restructuring and realignment program that is mainly focused on Europe. Among other things, this will create a more efficient tax structure there.
Its presence in Europe provides opportunities, but entails some risks, as well. The sputtering economies on the continent have hurt the company’s business. Also, Xylem’s reported results can be affected by fluctuations in exchange rates of foreign currencies. Management is targeting a compounded annual earnings growth rate of 7%-14% for the period from 2013 through 2017, which is an ambitious goal.
Xylem shares are suitable for many investors. The stock has not been extraordinarily volatile in its brief trading history. The company pays a modest dividend, and has stated that it expects to increase it 15% in 2013. The debt load appears manageable.
For a more thorough look at Xylem’s business prospects, and the particular investment merits of its stock, subscribers should examine our full report in The Value Line Investment Survey.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.