Update August 15, 2016 Today, Xylem, a maker of wastewater and water treatment systems, and a member of my Jubak Picks portfolio since September 4, 2012, announced that it would acquire Sensus, a maker of smart meters for the utility market, for $1.7 billion.
The market cheered with shares of Xylem climbing 3.86% today to close at $50.32, just off the 52-week high.
The deal addresses one of the lingering doubts about Xylem, which trades with a growth stock price-to-earnings ratio of 26.87 in trailing 12-month earnings without showing a lot of growth recently amid a slow down in capital spending by the water utilities and corporate water units that make up the bulk of its customer base. Analysts peg Xylem’s long-term growth rate at 3%. That 3% is very solid and that quality has led investors to award it a premium to its water peers, who by and large have more exposure to an energy sector where companies have been radically cutting capital budgets. (It also helps that Xylem isn’t a construction company, as so many water infrastructure companies are. As a result it hasn’t been hit by the collapse in spending on new deep water oil and gas drilling rigs, for example.) But the stock is up 37.86% year to date and 51.71% year over year. And that has led to some questions on valuation.
Those questions got more insistent when, on August 2, Xylem reported second quarter earnings that showed only an 1.3% year over year increase in revenue.
Analysts peg long-term growth for Sensus at 6% to 7% a year, by contrast.
The fit is likely to add to the combined company’s growth prospects as well. Sensus has an installed base of 80 million smart meters in the electric, gas, and water sectors. The data collected by smart meters let utilities manage demand in order to improve efficiency and cut costs. Cost cutting for utilities has been a big selling point for Xylem so the marketing argument here seems a natural. The entry into smart meters gives Xylem access to a faster growing market and does suggest that the company may be able to expand into new markets.
Does all–or any–of this justify hanging onto these shares at this price? Xylem has climbed above my earlier target price of $47 a share and the premium on these shares does give me pause at this point in the market. But I do like the Sensus deal and the growth opportunities it suggests. Certainly there won’t be any results from the deal to see when Xylem reports third quarter earnings on November 2, but in that quarterly report and in the weeks between now and then I expect the company to articulate the opportunities it sees from the deal and its plans for exploiting them. I’m going to hang on, raising my target price to $53 a share on the deal, until I have a chance to digest those plans.