Key takeaways:
· Weak organic sales due to COVID-19: few cancellations in projects but delay of orders
· China showing signs of early recovery
· Europe and US experiencing steeper declines than initially expected
· Due to operational pressure, XYL is seeing new inquiries from the Utility sector about remote sensing and automated operations
Current Price: $65 Price Target: $81
Position Size: 2% 1-year performance: -23%
Xylem reported total organic growth declining 8% in the quarter, with the company estimating that ~5% of the decline was related to COVID-19. Orders were down 2% organically (up 2% excluding ~-4% impact of COVID-19). Management estimates that organic growth in 2Q20 will be down 20-30% due to the impact of COVID-19. To manage the impact on profits, the company identified ~$100M in immediate spending reductions for the year. The $100M breaks down to $40 million of reductions in CapEx (both critical and less need for certain capacity due to reduced demand), and $60 million of OpEx spend (spending outside such as consultants professional services, etc). Operating margins declined 460bps y/y: volume/mix impact of -330bps, productivity +390bps, cost inflation -260bps, COVID-19 -150bps, price +80bps.
Geographic comments:
· Rapid disruption in Europe and Americas in March: Europe and US had steeper declines than they had expected
· 36% decline in China. China is showing early signs of recovery and factories now operating at near-normal levels but don’t anticipate a quick global bounce back
· India has the only facility that was shut down due to COVID-19
End-markets comments: declines across all end markets
· Utilities the most stable at a 5% decline, some project work was delayed, but operations and maintenance spending remained relatively steady: biggest covid-19 challenge is addressing their labor impacts, whether actual infections or quarantines, they struggled to keep their frontline operators in the field. XYL expects the majority of utility operators OpEx spending to be quite resilient in the short term as they focus on mission-critical applications and maintaining their operational continuity. XYL is actually seeing increased opportunities because of their operational pressures. On the CapEx side, XYL expects spending to hold up as it did in the period after the global financial crisis of 08 and 09, which is supported by the multi-year CapEx funding mechanisms that utilities can access and the government commitments to continue investing.
· Industrial (-10%)
· Commercial (-11%)
· Residential (-14%)
· weakness in Oil & Gas markets
· limited construction activity from COVID-19 in dewatering (-13%).
XYL expects a greater impact on industrial, commercial and residential end markets, as long as sites remain closed. Verticals like marine and beverage dispensing are likely continue to remain soft as long as stay at home orders are in place.
While it is disappointing to see such a big hit to sales predicted for Q2, it is reassuring to hear the company is not experiencing many cancellations of orders and rather delays. We remain positive on the name long term.
Xylem’s investment thesis is:
Xylem has strong sustainable secular growth drivers in a fragmented industry:
Access to clean water is a necessity
Population growth & urbanization
Aging infrastructure
More defensive sales base thanks to:
50% of sales to utility sector
sticky client base due to high switching costs
high level of replacement parts demand
Long-term contracts with ½ of the revenue base recurring
Margin expansion overtime from productivity efforts
M&A strategy has increased their scope in the water cycle
Valuation is attractive today
XYL.US
Category: earnings
Tag: XYL
Julie S. Praline
Director, Equity Analyst
Direct: 617.226.0025
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square
Suite 500
Boston, MA 02109