On May 10, we downgraded our recommendation on provider of liquid flow measurement products and control technologies, Badger Meter Inc. ( BMI - Analyst Report ) from Outperform to Underperform. The downgrade followed its lackluster first quarter results, lower sales in the municipal water business, weak industrial sales and the expectation of higher operating costs.

Why the Downgrade?

Badger Meter’s first quarter revenue declined 6% on a year-over-year basis to $71.8 million in the quarter. Higher-than-average snowfall, which significantly impacted meter replacement activities, a 30% decline in sales to utilities in communities in the Northeast affected by Hurricane Sandy as well as concerns related to municipal budgets affected sales. First-quarter earnings per share were reported at 20 cents, down significantly from 42 cents earned in the year-ago quarter.

Badger Meter’s earnings per share had been affected since 2011 by the continued weakness in the municipal water business as customers were compelled to stretch their decision-making process driven by concerns regarding the economy. Purchase decisions are subject to budgets, politics, pricing, service demands, etc. Approximately 75% of the company's revenue is directly related to water utility and municipal spending cycles, which historically has been volatile and difficult to predict.

Even though improvement was noted in the last two quarters of 2012, sales declined in the first quarter of 2013. Badger Meter cited higher-than-average snowfall as the largest headwind to sales in the quarter. This is because fewer meters get replaced in adverse weather conditions. There were also concerns related to municipal budgets.

Industrial sales were up slightly due to an extra month of sales from Racine Federated in the first quarter compared to the prior-year quarter. However, on an organic basis (excluding one month of Racine Federated) sales were down 14% as customer uncertainty and soft industrial markets restrained sales.

Operating costs are expected to be higher due to added headcount and amortization from the Aquacue acquisition. Commodity costs, particularly brass and copper-based materials, constitute a significant portion of Badger Meter’s costs. If costs rise and the company is unable to pass on the raw material price increase, margins will be affected.

Other Stocks to Consider

Other players in the same industry, which look attractive at current levels include Roper Industries Inc. ( ROP - Snapshot Report ) , Cubic Corporation ( CUB - Snapshot Report ) and Coherent Inc. ( COHR - Snapshot Report ) which carry a Zacks Rank #2 (Buy).