The water industry is one of the most important in the world as it sustains all life. The segment is worth over $500 billion worldwide and over $100 billion in the U.S. alone.
Xylem, Inc. (NYSE: XYL) engages in the design, manufacturing, and servicing of engineered products and solutions for water and wastewater applications in the U.S., Europe, and developing markets. The company's segments include water infrastructure, applied water, and measurement & control solutions.
Pentair plc (NYSE: PNR) is a UK-based company that provides various water solutions worldwide. The company's segments include consumer solutions and industrial & flow technologies.
The company has seen continued demand for its products, with organic growth up 14% year-over-year (YoY) in the most recent quarter. The majority of this growth came from the company's water infrastructure and applied water segments, with measurement & control systems seeing a decrease in revenues. Total revenue was up by only 1% as cost inflation and a write-down in strategic investments offset volume, price, and productivity increases.
Xylem has readjusted its full-year revenue guidance from a growth rate of 3%-5% to 4%-6%. This is on the back of price increases and robust demand, which has caused a 50% increase in the company's backlog across its entire portfolio. Dewatering systems -- used to clear mines -- are seeing high sales in developing markets as the demand for natural resources, remains high. Xylem also forecasts free-cash-flow conversion to increase from 77% in 2021 to 100% by the year's end. This is the ratio of free cash flow to net income. The higher this ratio is, the better it is for investors.
One risk to the company is the size of its international operations. As the U.S. dollar remains strong against most currencies, the company's reported sales will be lower in dollar terms. Due to current macroeconomic trends, the euro is discounted significantly to the U.S. dollar and it is difficult to assess when it will appreciate or by how much. One rule of thumb the company gives in its earnings presentation is:
"1 penny movement in EUR/USD rate, equates to 2 penny movement in EPS for the full year."
Pentair plc is roughly half the size of Xylem, Inc., with a valuation of $7.77 billion. Pentair saw its revenues increases by 15% to $1 billion in Q1 2022, compared with $866 million in Q1 2021. This was due to price increases and contributions from recent acquisitions. Net income also increased by 5% as price increases were able to offset cost inflation, and divestitures added a one-time increase in profits.
Pentair forecasts full-year sales to grow between 9% and 11% YoY as its commercial segment recovers from the pandemic slump and industrial orders improve. Adjusted earnings per share are forecast to increase at a similar rate of 9%-12% by the end of the year. The company believes that it can offset its cost inflation with price increases while growing volume sales and improved organizational effectiveness should raise its net income. Pentair has a similar aim to Xylem of achieving a free-cash-flow conversion ratio of 100% by the end of the year.
The company has roughly $1.1 billion in debt, 55% of which has a variable interest rate. This means that as interest rates rise, so too will the cost of Pentair's debt repayments, thereby lowering profits. At the end of the first quarter, the net debt/ adjusted EBITDA ratio was 1.3x. This is a relatively low ratio, which increases the company's risk level. A higher rate indicates that the company has lots of money to pay its debts and spend on other activities.
Pentair has higher growth rates, making it more attractive for investors looking for growth stocks. However, Xylem is the market leader, which provides better brand power and added stability. The stock is suitable for investors looking for a safer stock to park their money in but still want to gain from a megatrend. While both companies have seen large declines in their share prices this year, Xylem's decline was lower than Pentair's.
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