Investors Are Treating Xylem As If There's Gold In Water Infrastructure

 

Medieval alchemists had it all wrong – if you want to transform common things into gold, the best way to do that is through a water infrastructure company. Xylem (NYSE:XYL), like many companies in the water infrastructure and metering equipment space, has seen its valuation multiples expand considerably over the last few years, the last 18 months in particular, as investors have been drawn to themes like infrastructure stimulus, increased adoption of smart digital solutions, and overall ESG exposure.

Xylem isn’t a bad company at all; management has managed to deliver better than 12% EBITDA, 8% FCF, and 5% BVPS growth over the past decade, and the shares have produced a very good return for shareholders – up around 160% over the last five years versus about 105% for the S&P 500, 150% for Watts (NYSE:WTS), 110% for Franklin Electric (NASDAQ:FELE), and 23% for Mueller (NYSE:MWA).

Not surprisingly, it’s hard to reconcile the Street’s enthusiasm for a hot water space with fundamental valuation. Relative even to the “compounders” – well-loved growth industrials like Ametek (NYSE:AME), Danaher (NYSE:DHR), IDEX (NYSE:IEX), Rockwell (NYSE:ROK), and Roper (NYSE:ROP) - Xylem screens as pricey at a little over 24x ’22 EBITDA (Danaher is at about 25.5x and its core markets are growing faster). Discounted cash flow offers even less respite. If you’re looking to play the water infrastructure/ESG angle and you don’t care about valuation, I suppose Xylem could be the stock for you, but the valuation really doesn’t make sense to me.

 

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Investors Are Treating Xylem As If There's Gold In Water Infrastructure