Zurn Elkay Water Solutions Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Zurn Elkay Water Solutions Corporation designs, manufactures, and markets a comprehensive portfolio of water management solutions, including products for commercial, residential, and industrial applications.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Zurn Elkay Water Solutions Corporation (ZWS) is a diversified provider in water solutions with a diverse customer base with different needs.

Business Overview

Zurn Elkay Water Solutions Corporation (ZWS), formed through the merger of Zurn and Elkay, is a provider of water management solutions with products designed for a variety of end markets. Its operations are divided into three main reportable segments:

  • Water Management: This segment includes plumbing, drainage, and flow control solutions for commercial and industrial buildings. Products range from specification drainage products and flow control systems to various water management solutions in buildings.
    • These products often need to meet regulatory requirements.
  • Drinking Water: This segment focuses on providing clean and safe drinking water through water filtration and dispensing solutions in residential and commercial applications, such as water coolers and drinking fountains.
    • This sector is dependent on the need for safe and clean drinking water.
  • Finish Plumbing: This segment includes various kitchen and bath fixtures for residential and commercial settings.
    • This sector is susceptible to changing trends.

Zurn Elkay’s diverse segments reduce the risk that a single industry downturn will significantly affect the business.

ZWS operates in a competitive global landscape. Key industry trends include increasing awareness of water conservation, heightened demand for clean water, and a focus on sustainable and efficient building materials. The competitive landscape includes a variety of companies, ranging from large global manufacturers to specialized regional suppliers, each trying to win market share. Some well-known competitors are:

  • Watts Water: Watts Water is a major manufacturer of plumbing products, with a broad portfolio of related products and solutions. Watts Water is a company that offers products similar to ZWS.
  • Ferguson: Ferguson is a large distributor of plumbing and HVAC products. ZWS has a partnership with Ferguson, which is a huge plus, but it can pose a threat if they decide to switch from their products to other’s.
  • HD Supply: HD Supply is a major distributor of construction, maintenance, and specialty products. Similarly to Ferguson, they can also switch to other companies products.

What sets ZWS apart is the company’s focus on providing total water solutions, integrating various product categories, its strong presence in both residential and non residential markets and the ability to cater to niche markets. Its focus on innovation, sustainability, and a differentiated product portfolio are also important to the success of the business.

Moat Analysis: 3 / 5

ZWS possesses a narrow moat based on some specific competitive advantages.

  • Brand Recognition: Zurn and Elkay possess established brand reputations with a history of quality and innovation. Although brand recognition alone does not ensure a wide moat, it allows the companies to establish pricing power with some customer base, such as those willing to purchase durable and familiar brands.
  • Distribution Network: ZWS’ wide reach in different countries and having a good distribution chain, mainly within the North American region, can create some stickiness in the customers it caters.
  • Switching Costs: The plumbing industry has some inherent switching costs because of the time and investment required to install systems, and therefore, clients don’t usually switch frequently or with ease. This allows ZWS to extract more revenue from the clients.
  • Economies of Scale: As Zurn and Elkay combine to serve the market, they have greater purchasing power and can produce items at a lower price.

These factors combined give ZWS a competitive edge and the ability to generate profits, although it may not be as durable or strong as firms with stronger network effects or a more unique patent.

Risks to the Moat and Business Resilience

While ZWS demonstrates a moat, there are factors that threaten it, and affect its resilience:

Major risks that could reduce the moat and profitability are:

  • Industry Cyclicality: The construction industry—a primary end-market for ZWS—is highly cyclical, meaning revenue might fluctuate along with market trends. A decrease in construction spending or projects would directly affect ZWS sales and profitability, thus it makes the moat limited, and can only generate profits consistently over the cycles.
  • Raw Material Costs: Volatility in raw material costs, such as metals used in plumbing fixtures or polymers for filtration, can compress ZWS’s profit margins if the company is not able to pass these costs onto customers.
  • Competitor Actions: The industry is subject to intense competition, particularly in price-sensitive and commodity-type products. The ability of competitors to create similar offerings at lower costs, or to establish a dominant position in a region or market, makes it difficult for ZWS to sustain higher profitability.
  • Technological Change: Innovation, although a source of differentiation, may be outpaced by new technology and competitors. The products of ZWS should be continually updated and adapted to new and emerging technologies to keep the competitive advantage. Also the lack of investments in new product research could have a great negative impact on the company’s long term moat.
  • Dependency on Distribution Partners: Reliance on distribution partners like Ferguson and HD Supply creates vulnerability. if any of these partners cease to sell their products for any reason, then it will affect ZWS adversely.

ZWS appears to be of reasonably healthy financial situation and has an extensive business operation across multiple geographies. However, all of this may not be able to mitigate the risks coming from the above mentioned external factors.

Financials Overview

ZWS’s financial performance shows a combination of growth and profitability, albeit the profitability seems to be on the lower side. The company has seen decent growth in its revenues and margins are improving as the company continues to cut costs.

  • Revenues: The company’s revenues have seen fluctuations over the past few years, but is showing a solid recovery now. For the 9 months ended September 30, 2023, the revenues were recorded to be $1,315 million, compared to $1,215.8 in the same period in 2022.
  • Profitability: Net income has been fluctuating and is inconsistent, but it is trending upwards. The Net Income has increased from $59.2 Million in 2022 to $86.9 in the recent 9 month results.
  • Operating profit has also increased from $119 million to $143 million in recent data.
    • The management seems to be focused on improving margins by reducing operational costs which is beneficial for the long term.
  • Cash Flows: Cash flows from operations have increased from $140 million to $256 million, although capital expenditure is up to $91 million in 2023 compared to $44 million in 2022. The current free cash flow is around $165 million.
    • Although this is positive, the company should focus on creating a positive free cash flow, as it is essential for long term value creation.
  • Debt: Total debt for ZWS is around $1,175.6 million.
    • The company is taking on a lot of debt, and has used it in its recent acquisitions. Debt is useful for expansion, but it should be looked at closely and the company should keep debt levels at reasonable levels.
  • Share Buybacks: The company has recently approved a program to buy back shares. A share buyback typically increases shareholder value by increasing the earnings per share ratio, this seems to be a good sign for the long term.

The company has seen a sharp recovery in the past one or two years, and a continuation of the current business and economic trends can help it to create more value and increase its share price.

Understandability: 2 / 5

The water solution industry itself can be a little complicated and hard to understand.

  • Industry Knowledge An investor should have enough knowledge about the plumbing and building industries to really understand where the company is operating.
  • Accounting complexities: Although they follow standard rules, their business and valuation has some accounting related intricacies. There is some ambiguity in the operating income due to the way they present pension expenses and other similar items.
  • Debt Heavy: The company is debt-heavy which increases the complexity of its financials as well as its valuations.

Balance Sheet Health: 4 / 5

The company is pretty stable financially with some positive metrics but can also improve in some aspects.

  • Decent Liquidity: The company has about $152 million in cash, which indicates the company’s ability to meet short term liabilities.
  • Positive Cash Flow: Recent cash flow data from 9 month report are positive, but not at a level that could make the company financially superior than its peers.
  • High Leverage: The company has high debt-to-equity which could increase risks when the economy slows down or interest rates become higher.
  • Good Profitability: The company is improving its margins and profitability, which indicates a healthy growth pattern, but there is still more room to improve.
  • Solid Asset Base: ZWS has a sizable amount of assets, including both tangible and intangible assets, which are key for stability.

ZWS has improved its financials recently, but there are some areas where they can improve to have stronger and more robust financials in the long term.

Management Discussion

Management has acknowledged some of its failures in the past, and are trying to take corrective actions that are leading to more sales, higher margins and a wider moat.

In recent earnings calls, management has emphasized on the importance of integrating the two companies into one, reducing costs and improving efficiency. The management is confident in their approach, and believes they will show consistent growth and a higher profitability margin in the coming years. They are also working on reducing their debt, and improving the cash flows. They acknowledge that there has been inconsistent profit in recent years, due to the cyclicality of the industry and other factors, and are aiming for a more stable and growing revenue and profits in the future. Management is also aiming to achieve long-term profitability and growth with their current strategy, which has been reflected in their past few results.

They are also aware of the risks involved, like the highly competitive industry, and they plan to create a sustainable competitive advantage through innovation, brand recognition, customer relations, and a strong balance sheet. They have also recently focused on paying down the debt, which has been acknowledged by the stock market and is generally a positive sign.