On Jan 9, 2015, we issued an updated research report on Watts Water Technologies, Inc. (WTS), manufacturer and seller of various water safety and flow control products.
Watts Water Technologies’ third-quarter 2014 adjusted earnings increased 21% year over year to $0.70 per share, driven by increased volumes in America, cost savings and more stable manufacturing in its lead free foundry.
In the Americas segment, orders increased 3% in the quarter and improved to the 6—7% range in October. This sets the stage for improved top line as well as margins in the fourth quarter. Moreover, management continues to expect solid growth in the residential construction markets, given that residential starts are projected to increase 6.3% in 2014 and 13% in 2015. The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) remained positive through September. Repair/replace activity also continues to be strong and the LIRA index persistently projects solid full-year growth in the remodeling market for 2014, with some moderation expected in 2015.
Signs of strengthening are also evident in the commercial markets. The Architecture Billings Index, which is considered a leading indicator of U.S. non-residential construction, continues to be positive. Similar to the recent initiatives adopted to improve its European operations, management is evaluating strategies to enhance both growth and the profitability profile of its businesses in the existing Americas platform.
In Asia Pacific, orders increased 27% exiting the third quarter. The company’s marketing strategy remains unchanged – achieving sales growth in heating products by expanding in Tier 1 cities and sales growth in valves by focusing on Tier 2/3 cities. Watts Water continues to expect revenue in Asia Pacific to grow 20% in 2014.
However, EMEA sales declined 4.4% as recent macro headwinds are putting pressure on volumes. Management continues to see sluggish economic growth in the Euro zone, with particular weakness in Germany and France. In 2014, EMEA revenue is expected to decline 2—3% year over year organically, further down from the previous expectation of a 1—2% decline. This downward trend is expected to continue in 2015 as well, given that the recent macro indicators have been strikingly weak. As Watts Water derives 40% of its revenues from Europe, economic conditions in the region remain the biggest risk.
Under the European transformation program, which is expected to continue through 2016, the company plans to develop better sales capabilities through improved product management, enhanced product cross-selling efforts and drive more efficient European sourcing and logistics. Total annual savings are projected to be $21 million by 2018, with approximately $4 million and $12 million expected in 2014 and 2015, respectively.
In another restructuring program, the company aims to reduce its European manufacturing footprint by approximately 10%, improve organizational and operational efficiency and better align costs with expected revenues in response to changing market conditions in the EMEA region. The program is expected to be completed by the end of fourth-quarter fiscal 2015. Watts Water hopes to record approximately $7.7 million in annual cost savings by 2015 from these actions.
Watts Water has acquired AERCO, a leader in high-efficiency commercial heating and hot water solutions in North America. The acquisition will increase Watts Water’s presence in the U.S. non-residential market. The addition of AERCO is a strategic fit for Watts Water’s operations which focus on a wide range of activities involving water and heating around the house and for small commercial businesses. The deal would be significantly accretive to margins and earnings.
Other Stocks to Consider
Watts Water currently carries a Zacks Rank #3 (Hold). Some better-ranked stocks in the same sector that warrant a look include Alamo Group, Inc. (ALG), Woodward, Inc. (WWD) and Adept Technology Inc. (ADEP). While Alamo Group holds a Zacks Rank #1 (Strong Buy), Woodward and Adept Technology carry a Rank #2 (Buy).
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