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Here’s Why You Must Hold on to Xylem (XYL) Stock for Now


We issued a research report on Xylem Inc. XYL on Sep 7.

This water solutions provider currently has approximately $14.1 billion market capitalization. Presently, it carries a Zacks Rank #3 (Hold).

Few growth drivers, as well as certain headwinds, which might influence Xylem, have been discussed below.

Factors Favoring Xylem

Financial Performance & Outlook, Share Price Performance: Xylem pulled-off a positive average earnings surprise of 1.10% for the last four quarters. This includes the impact of 2.8% earnings beat recorded for the second quarter of 2018. Further, in the reported quarter, the bottom line expanded 23.7% year over year on the back of solid sales growth and operational performance. Segmental performances were impressive, with year-over-year growth of 13.3% recorded for Water Infrastructure, 7.5% for Applied Water, and 19.3% for Measurement & Control Solutions.

For 2018, the company anticipates organic sales to grow 6-7%, higher than 4-5% anticipated earlier. Total revenues are now predicted to be at the higher end of $5.2 billion of the previous forecast of $5.1-$5.2 billion. Adjusted earnings are now predicted to be $2.85-$2.95, reflecting growth of 19-23% from the year-ago figure. Moreover, the bottom-line projection is a revision from the previous anticipation of $2.82-$2.97, with the mid-point constant at $2.90.

Sentiments currently seem to be favoring Xylem. In the past 60 days, earnings estimates on the stock for both 2018 and 2019 have been increased by four brokerage firms and lowered by two firms. Currently, the Zacks Consensus Estimate for earnings is at $2.91 for 2018 and $3.41 for 2019, reflecting growth of 0.7% and 1.2% from the respective tallies 60 days ago.

Further, the company’s share price has increased 7% in the past three months, outperforming 4.5% growth recorded by the industry.

Diversified Business Structure A Boon: Xylem, through its three reporting segments, caters to the demand of its customers in end markets, including utilities, industrial, commercial and residential. By revenue contribution, utilities were the largest end market for the company in 2017. For 2018, it anticipates organic sales to grow in a high-single digit in utilities end market, low- to mid-single digit in commercial, mid-single digit in industrial and low-single digit in residential.

Further, the company has operations in the United States, Western Europe and emerging markets, including China, the Middle East, Latin America, and others. Such business diversity is a boon for the company as weakness in any end market/geographical location can be offset by gains in others.

Shareholder-Friendly Policies: Xylem believes in rewarding its shareholders handsomely through dividend payments and share buybacks. In the first half of 2018, the company used $76 million cash for distributing dividends and $58 million for repurchasing shares. Moreover, it has announced the payment of a quarterly dividend in September. For 2018, the company anticipates paying roughly $150 million dividends.

Further improvements in the company’s profitability in the future will enable it to reward its shareholders handsomely.

Factors Working Against Xylem

Poor Valuation: Xylem, when compared with the industry, appears overvalued, considering the Price-to-Earnings (P/E) multiple for the past three months. While the stock’s P/E (TTM) multiple is 29.6, above the industry’s 22.6 and the median multiple of 28.2. This overvaluation somewhat makes us cautious on the stock.

Adversities Arising From Mounting Costs: Xylem is grappling with the adverse impacts of rising cost of sales and expenses. The cost of revenues in the last five years (2013-2017) moved up 4.1% (CAGR) while operating expenses increased 2.7%. Further, in the first six months of 2018, the company’s cost of sales increased 13.8% over the year-ago comparable period while operating expenses grew 8.3%. For 2018, it believes that the input cost inflation will continue to escalate costs; however, price realization will be a relief.

Huge Debts Raise Concerns: Xylem’s long-term debts in the last five years (2013-2017) increased 12.9% (CAGR). Despite some respite coming in from 1% decline from the balance at the end of 2017, long-term debt as high as $2.2 billion at the end of the first half of 2018 is concerning. Moreover, the company’s total debt-to-total equity has increased from 55.4% in 2013 to 87.3% in 2017 while stood at 100.4% at the end of second-quarter 2018. A highly leveraged balance sheet can inflate its financial obligations and hurt profitability.

Stocks to Consider

Some better-ranked stocks worth considering in the industry are Colfax Corporation CFX, DXP Enterprises, Inc. DXPE and Altra Industrial Motion Corp. AIMC. While both Colfax and DXP Enterprises sport a Zacks Rank #1 (Strong Buy), Altra Industrial Motion carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

In the last 60 days, earnings estimates for each of these stocks have improved for the current year. Also, average positive earnings surprise for the last four quarters has been 7.91% for Colfax, 101.32% for DXP Enterprises and 4.01% for Altra Industrial Motion.

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