It has been nearly a decade since I last looked at Watts Water Technologies, Inc. (NYSE:WTS), which at the time acquired Aerco, a manufacturer of high-efficiency boilers and water heaters. Forwarding in time, we have seen relatively modest sales growth, but this was accompanied by huge margin expansion, driving shareholder value creation ever since.
This is to be applauded, certainly as the company made a nice bolt-on deal here again with Bradley Corp. This looks pretty alright, as the value re-rating to a 20 times multiple looks full, making me patiently await potentially lower entry levels.
A Recap
With the purchase of Aerco late in 2014, Watts added some $100 million in revenues from boilers, water heaters and aftermarket services, with synergies and cross-selling opportunities seen between Aerco and Watts.
With Watts operating with a very modest net debt load ahead of the deal, I pegged pro forma net debt around $300 million, resulting in a roughly 1.5 times leverage ratio, which was quite modest. The 35 million shares traded at $62, granting the business a $2.2 billion equity valuation which was applied to a business which generated $1.5 billion in sales, EBITDA of $170 million and net earnings of just $65 million.
The resulting 30 times earnings multiple was a bit rich with shares trading at $60 at the time, but the business posted relatively low margins, making that real progress could be seen if margins would improve as there was room for that, but great execution was needed.
On Fire – Mostly Margins
Since 2014, shares of Watts have risen from $40 in 2014 to a high round $100 pre-pandemic. Amidst momentum in the stock market in 2021, shares rose to the $200 mark, actually fell back to $120 in the summer of 2022, as shares have recovered to $190 at the moment of writing.
Earlier this year, Watts posted $2.0 billion in sales for the year 2022, marking modest growth versus 2014. More important is that high single-digit margins in 2014 have risen as operating profits of $315 million work down to margins of 15% and change, as the company has made a real and great transformation doing so.
Net earnings of $251 million came in at $7.48 per share, meaning that earnings have increased a lot amidst margin gains as well as some modest share buybacks. This earnings growth and building up a net cash position has supported the share price, with more growth likely seen in 2023.
That being said, growth so far this year has been quite modest. First quarter sales for 2023 rose by 2% to $472 million as the company posted strong operating leverage, with second quarter sales up 1% to $533 million. While sales results are flattish year to date, operating margins improved a bit, making that earnings of $4.19 per share are up about half a dollar year to date.
With 33.6 million shares trading at $193, the company commands a $6.5 billion equity valuation, which includes a net cash position of around $200 million here, for a $6.3 billion enterprise valuation. This values the operations at just over 3 times sales, and at roughly 22 times earnings, assuming they are coming in around $8.50 per share.
A Bolt-On Deal
Late in August, the company announced that it has reached a $303 million deal to acquire Bradley Corp., a manufacturer of commercial washrooms and emergency safety products which are used in commercial and industrial markets. Factoring in tax benefits, the price consideration drops to $268 million, while Bradley is set to contribute $200 million in sales, revealing a mere 1.3 times sales multiple has been paid.
The purchase price comes in at 8 times EBITDA, but this is after factoring in a non-quantified cost synergy number, based on the effective purchase price, revealing a $33 million expected EBITDA contribution. With the own business posting depreciation charges at just 1-2% of sales, such a similar ratio for Bradley would reveal $30 million in operating profits contribution, as this would make the deal highly accretive.
After all, the $30 million contribution comes in at $0.90 per share pre-tax and pre-interest costs, although that the company can pay this deal with existing net cash holdings, as it does not forfeit much interest income. This means that the deal could easily boost the pro forma earnings number to $9 per share, for a 20-21 time earnings multiple, as the business will operate with a pro forma flattish net cash position.
Final Thought
I must say that since 2014 I have not been too impressed with the revenue gains reported by Watts Water Technologies, Inc. over this period of time, but the contrary is the case for the margins, which have risen in a spectacular fashion amidst a gradual and successful business transformation. This has been the driver behind the solid share price gains over this period of time, as shares have seen quite some volatility, as this was just a $120 stock a year ago.
Given this backdrop, I am not keen to get involved here near the $200 mark. However, recognizing the volatility displayed by the shares in the past, I would become much more compelled to WTS shares if they would revert from the higher end of the range.
As such, I am cautious and would potentially get interested in Watts Water Technologies, Inc. as soon as shares would potentially end up in the $150-$160 range again.
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