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Why Watts Water Technologies could be a great value stock?

May 17, 2007 | About:
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Matt Clarke

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Watts Water Technologies, Inc. (WTS) is company that you don’t often hear about in the news. It seems that not a lot of people buying or recommending it, but a case could be made for it being a potentially good value stock according to the criteria often used by value investors.

According to their website, http://www.wattsind.com/, “Watts Water Technologies, Inc. designs and manufactures valves and related products that promote the comfort and safety of people and the quality, conservation and control of water used in commercial, residential, industrial and municipal applications.” They do not focus on city waters systems or sewers, but rather on products that control the water behind your walls.

The long-term demand fundamentals for water look inherently strong. Watts estimates that the demand for water increases at three times the population growth. The more people that are populating the earth, the more water will be demanded. Unlike diamonds or sports cars, water is not a luxury good; it is a necessity for life. It has been estimated that you can live for a few weeks without food, but only a few days without water. Fads may come and go, but certain things sustain life, and we will always need those things. You could strip away a person’s income and demand for many goods with a recession or market crash, but they will still want water. Granted, Watts does not actually make water, but the parts they do make are necessary for you to get water in to your home, unless you want to fill up buckets in a river.

One other case for strong fundamentals is the recent economic growth in China and India. According to Watt’s website, the Asian water infrastructure is inadequate to support the current population and economic growth that they are experiencing. Furthermore, many people argue that the United State’s water infrastructure is antiquated, and Watts may play a part in the solution.

Most value investors have heard that one solution to the problem of investing with a falling US dollar is to invest in American companies that have strong foreign sales in local currencies. Watts fits this perfectly, as 38% of their sales in 2006 were to foreign buyers, most notably Europe, Canada and China. They have sales in over 100 countries.

Watts has had a strong history of entering new markets via acquisitions as well, with 46 acquisitions since 1987. In the future, several emerging markets around the world could grow and demand reasonable water infrastructure. It seems sensible to bet that Watts would be a likely candidate to enter those markets via acquisition, given their history.

As value investors, we all know that we should be buying out-of-favor market leaders. Watts may be operating in an out-of-favor industry currently. Half of their sales come from the residential housing market, and we all know how well that market is currently doing. Another reason Watts could be considered out-of-favor is the fact that their number one input, copper, is selling at all time high prices. Combine the lower demand for Watt’s output (due to the slowdown in residential housing) with the high input prices that they are experiencing (copper), and you potentially have an out-of-favor company.

I would note though, that even though it could be argued that Watt’s operates in an out-of-favor industry, they are doing well, with a 14% compound annual growth rate in revenue since 1995, and an 18% compound annual growth rate in revenue since 2001. They had sales in 2006 of approximately 1.2 billion dollars.

Does Watts have an increasing competitive moat? I think so, and this is mostly because Watts probably has the market leading brand name. In 2003, Contractor Magazine took a survey of contractors to see what their preferred brand names were for various product categories. The results look great for the Watt brand name. For backflow prevention, 68% of respondents said Watts was the preferred brand. For regulators, 74% picked Watts. For plumbing and heating products, 66% chose Watts, and for hot water tempering and mixing valves, 70% preferred Watts.

I can think of two reasons why I might be wrong about all of this. One is that a lot of the insiders in the company have been selling; not buying. However, this is probably more due to stock option compensation rather than a general dislike of the stock.

The other reason, is that the value gurus don’t seem to be buying it either. John Keeley seems to be the main one catching on, as he bought shares as recently as the first quarter of 2007. David Dreman also owns some shares, but both of them have less than a half of a percent of their portfolios devoted to Watts. I personally prefer it when I discover a stock on my own, and find out that the value gurus have also been buying it. For Watts, that doesn’t seem to be the case.

Regardless, even though you don’t see a lot of people touting it (which may be a good thing if you are thinking about buying) it could be argued that Watts Water Technologies is a market leader with strong overseas sales and a long history of revenue growth and successful acquisitions in an out-of-favor, but fundamentally strong industry. As of this writing, it is selling at 15 or 16 times earnings, so it is probably not over valued (although to be fair, I wouldn’t argue that it is selling at a deep discount either). For those reasons, Watts may be something worth looking in to.

For full disclosure, I do indeed own shares of Watts Water Technologies, Inc. Credit the company website, http://www.wattsind.com/, for facts and figures.

About the author:

Matt Clarke
GuruFocus - Stock Picks and Market Insight of Gurus

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