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Watts Water Technologies, Inc.’s (WTS - Analyst Report) fourth-quarter 2013 adjusted earnings decreased 5% year over year to 57 cents per share. Earnings fell short of the Zacks Consensus Estimate of 64 cents by 11%.
 
On a reported basis, including special items, earnings in the quarter were 23 cents per share against 51 cents in the year-ago quarter.
 
Total revenue rose 6.1% year over year to $376 million, surpassing the Zacks Consensus Estimate of $372 million. The company reported organic sales growth of 4.6% in the quarter, which was the highest in its history.

Cost and Margins
 
Cost of sales increased 8% year over year to $245 million. Gross profit increased 1.7% to $130.9 million. However, gross margin contracted 150 basis points (bps) to 34.8% in the quarter. Selling, general and administrative expenses rose 17% year over year to $111.7 million.

Adjusted operating profit dropped 0.8% to $36.7 million from $37 million in the year-ago quarter. Adjusted operating margin also contracted 60 bps to 9.8% primarily due to incremental customer rebate costs and manufacturing inefficiencies related to lead free conversion.
 
Segment Performance
 
North America: Net sales grew 7% to $220.6 million, aided by organic sales growth of 7.9%. This was partly offset by unfavorable foreign currency translation with the weakening of the Canadian dollar against the U.S. dollar. Adjusted operating profit declined 2.8% to $27 million.
 
EMEA: Net sales went up 4% year over year to $146 million. Adjusted operating profit improved 13% to $16 million from the year-ago operating income of $14 million due to productivity and cost savings initiatives.
 
Asia: Net sales increased 15% to $9.2 million from $8 million in the prior-year quarter. Adjusted operating profit fell to $1.8 million from $2.2 million in the year-earlier quarter.

Financial Performance

Watts Water ended 2013 with cash and cash equivalents of $267.9 million, down from $271.3 million as of 2012-end. Cash flow from operations was $118 million as of Dec 31, 2013, compared with $130 million Dec 31, 2012.

Long-term debt, excluding current portion of the company decreased to $305.5 million as of Dec 31, 2013 from $304.5 million as of Dec 31, 2012. Debt-to-capitalization ratio contracted 550 bps to 23.5% as of Dec 31, 2013 from year-ago comparable period.

During the quarter, Watts Water bought back 0.5 million shares for $3 million as part of the $90 million share repurchase program announced in April last year.

On Feb 18, 2014, the company entered into a new unsecured line of credit agreement with a syndicate of banks. The agreement provides a credit line of up to $500 million, which will mature in Feb 2019. Watts Water intends to use the proceeds for general corporate purposes, acquisitions and the repayment of existing debt.

The company also announced a quarterly dividend of 13 cents per share, to be paid on Mar 14, 2014 to shareholders of record on Feb 28, 2014.

Fiscal 2013 Performance

For full-year 2013, Watts Water reported adjusted earnings per share of $2.22, up 2.3% from $2.17 in 2012. The results however, lagged the Zacks Consensus Estimate of $2.29. Including one-time items, earnings per share (EPS) was $1.71, compared with $1.95 in the prior year.

Revenues for the year 2013 increased 3.2% year over year to $1.47 billion, driven by organic sales growth and favorable foreign exchange movements. Revenues were in line with the Zacks Consensus Estimate.

Our View

Watts Water has made significant progress in the lead free conversion program, facilitating successful transitioning of manufacturing processes and the fulfillment of   product requirements. Its continuous focus on restructuring action and business transformation initiatives in Europe will drive further growth. Watts Water will benefit from expansion of its business and capitalization of opportunities in the booming markets of Asia.

In 2014, we expect to the company to be aided by residential construction recovery and a steady repair and replacement market. However, the weak economic scenario in Europe remains a headwind.
 
Watts Water, which operates through its subsidiaries, is a leading manufacturer of innovative products that control the efficiency, safety, and quality of water within applications (residential, commercial, and institutional). At present, Watts Water carries a Zacks Rank #2 (Buy). Another stock to consider in the same industry is Badger Meter Inc. (BMI - Analyst Report), which has the same Zacks Rank as Watts Water.

Peer Performance
 
Roper Industries Inc.’s (ROP - Analyst Report) earnings rose 14.5% year over year to $1.65 per share and beat the Zacks Consensus Estimate by a nickel.

On the other hand, Thermon Group Holdings, Inc. (THR - Snapshot Report) reported weak results in fourth-quarter 2013. Adjusted earnings per share came in at 18 cents, which was lower than 21 cents in the year-ago quarter and lagged the Zacks Consensus Estimate of 25 cents.

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