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We have reiterated our Underperform recommendation on provider of liquid flow measurement products and control technologies, Badger Meter Inc. (BMI - Analyst Report). Our view reflects subdued growth for automation sales, higher operating costs and negative foreign exchange impact.

Why the Reiteration?

Badger Meter, on Jul 18, reported earnings per share of 44 cents for the second quarter of 2013, down 15.4% year over year and below the Zacks Consensus Estimate of 55 cents. The decline was caused by the litigation and pension charges, which together impacted earnings by about 5 cents per share. However, net sales rose 7.8% year over year to $88 million, mainly contributed by higher sales of municipal water as well as industrial flow products.

Even though sales of Industrial flow products increased 2.4% year over year to $1.1 million in the reported quarter, the segment remains affected by the challenging construction sector. Higher construction costs, labor shortage, lack of funds for real estate projects and adverse effects of sequestration are likely to remain headwinds for the construction sector.

Gross profit fell 1% year over year to $29.8 million in the quarter. Gross margin contracted 300 basis points year over year to 33.8%, driven by lower prices and foreign exchange impacts. Operating costs are expected to be higher due to added headcount.

Commodity costs, particularly brass and copper-based materials, constitute a significant portion of Badger Meter’s costs. If costs are to rise and the company is unable to pass on the raw material price increase, margins will be affected.

Moreover, weak growth expectation for automation sales, a tepid macro economy and unfavorable foreign exchange translation impact may affect the performance of Badger Meter going forward.

Following the release of second quarter results, Zacks Consensus Estimates for 2013 and 2014 have went down 8.1% and 1.3%, respectively, to $1.70 per share and $2.27 per share, respectively. With earnings estimates for both 2013 and 2014 are moving down, Badger Meter now retains a Zacks Rank #5 (Strong Sell).

Other Stocks to Consider

Among the other stocks in the same  sector, Transcat Inc. , National Instruments Corp. (NATI - Snapshot Report) and Coherent Inc. (COHR - Snapshot Report) look favorably placed with a Zacks Rank #2 (Buy).

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