Restructuring Supply Chain And Price Adjustments Will Reduce China Reliance

Key Takeaways

• Supply chain restructuring away from China and price increases are set to reduce tariff exposure and boost margins.
  
• Strong balance sheet enables strategic flexibility in share repurchases and acquisitions, enhancing potential EPS growth.
  
• Uncertainty around tariffs and reliance on non-GAAP measures could affect Zurn Elkay's profitability, margin stability, and revenue growth in various markets.

Catalysts

Engages in design, procurement, manufacture, and marketing of water management solutions in the United States, Canada, and internationally.

• Zurn Elkay Water Solutions is restructuring its supply chain to minimize reliance on China, with plans for China to represent only 2-3% of COGS by the end of 2026, potentially reducing exposure to tariffs and benefitting margins.
  
• The company has initiated price increases that should cover additional costs from tariffs, aiming to remain price-cost positive, which could boost revenues and maintain profitability.
  
• Productivity initiatives and improvements in the Zurn Elkay business system are driving margin expansion, with adjusted EBITDA margins improving by 110 basis points year-over-year, which strengthens net margins and earnings.
  
• The company has a strong balance sheet with a net debt leverage ratio under 1x, allowing flexibility for share repurchases and potential M&A opportunities, which could enhance earnings per share (EPS) growth.
  
• Zurn Elkay's focus on sustainability and new product innovations in drinking water and filtration are expected to drive future sales, which could positively impact revenue growth.

Zurn Elkay Water Solutions Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Zurn Elkay Water Solutions's revenue will grow by 4.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.5% today to 13.4% in 3 years time.
• Analysts expect earnings to reach $239.3 million (and earnings per share of $1.28) by about April 2028, up from $165.9 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $208.3 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 29.1x on those 2028 earnings, down from 34.7x today. This future PE is greater than the current PE for the US Building industry at 19.8x.
• Analysts expect the number of shares outstanding to decline by 2.57% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.55%, as per the Simply Wall St company report.

Zurn Elkay Water Solutions Future Earnings Per Share Growth

Risks

• The potential for increased tariffs on goods imported from non-China sources could raise costs, affecting Zurn Elkay’s cost of goods sold and resulting in narrowed net margins if prices cannot fully offset these costs.
  
• Continued uncertainty around the tariff environment may lead to demand destruction if customers reduce spending in response to higher prices, potentially impacting future revenue growth.
  
• Softness in residential markets and some areas within the commercial segment could constrain revenue growth if offsets are not achieved through stronger performance in other sectors.
  
• Heavy reliance on non-GAAP measures for financial reporting can obscure true financial health and lead to variability in investors’ perception of profitability and earnings stability.
  
• The shift away from China could incur short-term operational inefficiencies and transition costs, potentially impacting net margins if these costs are higher than anticipated.

Valuation

• The analysts have a consensus price target of $36.143 for Zurn Elkay Water Solutions based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $40.0, and the most bearish reporting a price target of just $30.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.8 billion, earnings will come to $239.3 million, and it would be trading on a PE ratio of 29.1x, assuming you use a discount rate of 7.6%.
• Given the current share price of $34.17, the analyst price target of $36.14 is 5.5% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.