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Xylem (XYL) Battles Cost Pressure on Solid Growth Drivers

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On Jul 9, we issued an updated research report on premium diversified machinery company, Xylem Inc. (XYL - Free Report) . The company currently carries a Zacks Rank #3 (Hold).

Over the past 60 days, the Zacks Consensus Estimate for the stock’s earnings remained unchanged for both 2018 and 2019 at $2.89 and $3.37, respectively, reflecting neutral brokers’ sentiments.

Let’s dig into the fundamental aspects influencing the performance of this stock.

Existing Growth Drivers

Xylem has been steadily enhancing its product portfolio on the back of the company’s value-added water solutions and leading-edge technological know-how. The company recorded organic growth of 4% in 2017 on the back of elevated demand from utilities, commercial, industrial and residential end-markets. Notably, its top line improved 7% year over year in first-quarter 2018.

The company expects that stronger utility and industrial end-market’s demand, increased water infrastructure spending in emerging countries like India and superior customer relationships will bolster its revenues in the upcoming quarters. Xylem currently anticipates securing organic revenue growth of 4-6% in 2018. The company’s revenue guidance for this year currently lies in the $5.1-$5.2 billion range.

Per our estimates, Xylem’s year-over-year revenue growth is currently pegged at 9.4% and 5.1% for 2018 and 2019, respectively.

Xylem pulled off an average positive earnings surprise of 1.27% over the last four quarters. The company has been steadily widening its margins backed by the ongoing productivity-enhancement programs and diligent cost-saving moves. Xylem anticipates to secure around $160 million cost savings in 2018. Also, the company’s operating margin for 2018 is predicted to expand by 60-100 basis points (bps).

Per our estimates, Xylem’s year-over-year earnings growth is currently pegged at 20.4% and 16.4% for 2018 and 2019, respectively.

We also expect that strategic business acquisitions will continue to drive Xylem’s revenues and profitability in the upcoming quarters. For instance, the acquisition of Pure Technologies (January 2018) has been reinforcing the company’s infrastructure analytics business. The company also expects this buyout to boost its revenue growth by 2% in 2018. Moreover, the EmNet and Valor Water acquisitions (February 2018) will likely continue to fortify Xylem's advanced analytics business in the quarters ahead.

Causes of Concern

Rising material cost, if unchecked, might weigh over Xylem's profitability in the upcoming quarters. The company’s cost of sales had escalated 23.6% and 2.7% in 2017 and 2016, respectively. Notably, in first-quarter of 2018, the company’s cost of revenues flared up 14.9% year over year, primarily on the back of material cost inflation. Notably, the company's gross margin shrunk 70 bps due to elevated cost of sales.

Notably, on a P/E (TTM) basis, Xylem's stock looks a bit overvalued compared with the industry, with the respective tallies of 26.6x and 21.7x for the 12-month period. Also, the stock looks relatively more leveraged than the industry. Its debt/capital ratio is currently pegged at 0.5x, higher than 0.3x recorded by the industry.

In addition, other headwinds like stiff industry rivalry or issues with third-party suppliers remain major risks for the company.

Price Performance

Over the past year, Xylem’s shares have rallied 22.3%, outperforming 2.6% growth recorded by the industry.

Stocks to Consider

Some better-ranked stocks in the industry are listed below:

Chart Industries, Inc. (GTLS - Free Report) sports a Zacks Rank #1 (Strong Buy). The company’s earnings per share (EPS) are predicted to grow 26.9% for the next three to five years. You can see the complete list of today’s Zacks #1 Rank stocks here.

Graco Inc. (GGG - Free Report) carries a Zacks Rank #2 (Buy). The company’s EPS is projected to be up 10.33% over the next three to five years.

Roper Technologies, Inc. (ROP - Free Report) also holds a Zacks Rank #2 (Buy). The company’s EPS will likely be up 12.33% during the same time frame.

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