Xylem Knows Where the Profit Flows
The company is focused on the technology-intensive $30 billion piece of the $280 billion global market for water equipment and services. Much of that larger water market consists of commodity products and services that carry relatively low margins.
But by concentrating on new technologies and new products in sectors such as water treatment, analysis, and transport, Xylem was able to achieve gross margins of 38.4% in 2011, and will hit margins of 39% in 2012, S&P projects.
As part of the company's focus on where the money is in water, Xylem has been gradually shifting its market mix from developed to emerging economies, where growth is faster and margins higher. In the second quarter of 2012, when overall company revenue grew by 4% in constant currency for the company as a whole, revenue grew by 22% in emerging markets.
The company's big exposure to slowing European economies (about 37% of sales in 2011) is a major reason that the stock has lagged this year, with shares down 4.3% for 2012 to date as of September 3. But I see that as a chance to buy the stock at a reasonable price-Standard & Poor's projects operating earnings will climb by 17% in 2013, but the shares trade at just 13.7 times projected 2012 earnings per share.
The company's revenues are likely to be stronger in developed economies (such as Europe) than the market now expects: about 40% of company revenues come from sales of products and services in the aftermarket, and those revenues are much more stable than those that require new capital spending on equipment.
I'm adding these shares to my Jubak's Picks portfolio today, with a target price of $30 a share by September 2013.