Turn-Off The Tap On Zurn Elkay Water Solutions Corp (NYSE:ZWS)

Zurn Elkay Water Solutions Corporation (NYSE:ZWS) is a lightly covered and lightly traded stock with a small following of investors despite its $3.7B market cap. We have been enthusiastic about water stocks for five years. At its current share price of about $21, we believe Zurn Elkay has upside potential but there are caveats to consider.

Great Market, Perplexing Execution

We are disappointed and somewhat flummoxed that Zurn Elkay shares do not perform better. The shares tumbled nearly -40% this past year and -42.7% YTD. This was the year of recovery from the devastating pandemic. ZWS flourished (+65%) over the past five years. Zurn Elkay’s portfolio of water resourcing, delivery systems, and products are just the ingredients The World Health Organization deems essential to its worldwide WASH program.

Milwaukee, Wisconsin Zurn Elkay sells water system solutions it designs for non-residential buildings. Products include finished plumbing, drainage and interceptors, water control and backflow, fire protection, PEX pipe fittings and accessories, and repair parts. Its brand-name products and markets are:

• World Dryer sells hand dryers, hair dryers, and baby changing stations.
• Just Manufacturing products include stainless steel sinks and fixtures for academic institutions, and assisted living homes: faucets, bubblers, drains, and accessories.
• Hadrian bathroom partitions and lockers add to the full product line Zurn Elkay offers needed to outfit washrooms completely.
• Elkay, in business since 1920, claims it “is America’s number one kitchen sink company,” selling sinks, faucets, filtration, water coolers, bottle filling stations, and support services.
• 16 years old Zurn Elkay Water Solutions Corporation serves retail, commercial, and government facilities with a wide range of water solution services.

The stock performed poorly this past year, as we warned last August that it might. It appears the investment community is still soured more on ZWS since then. Momentum collapsed according to SA as the stock fell off its 52-week high of $37.38:

Ticker	3M	6M	9M	1Y
ZWS	-19.78%	-21.65%	-42.40%	-39.22%
SP500	-0.89%	+3.99%	-14.37%	-16.34%

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Seeking Alpha’s current Quant Rating is a sell. Corporate insider selling of shares outweighs purchases this year. Hedge funds decreased holdings by 426.4K last quarter. SA’s Factor Grades for Zurn Elkay fell over six months in growth, profitability, and momentum. Valuation is fixed at F. The second quarter EPS reported last July was $0.32. In Q3, it dropped to $0.26. We conservatively estimate the Q4 EPS, to be reported on February 7, 2023, will be in the range of $0.17.

Stimulus and Headwinds

In Q3 ’22, revenue was reported to have fallen 25% Y/Y. EBITDA is down to 20% from 22.2 of net sales in Q3 ’21. Total revenue and gross profit were the highest in the last four quarters but the quarter ended with a substantial net income loss.

Zurn Elkay’s share price is taking a beating worse than other water building-industry stocks. For instance, the share price of the largest traded fund, Invesco Water Resources (PHO) slipped a mere -11.2% over the last 12 months; it is down about -15% YTD. Invesco shares rose 68.4% over five years mirroring Zurn Elkay’s +72.8%. Zurn Elkay appeared to be growing revenue until the pandemic. On a positive note, the Beta rating for ZWS is 1.06, down from 1.24 four months ago.

Zurn Elkay management is positive that the recently completed takeover of Elkay will contribute to heftier sales, better margins, and profitability for Zurn Elkay, as SA published in its transcript of the October shareholder meeting:

With respect to Elkay, margin saw a substantial improvement from low double digits in the prior year third quarter to mid-teens in the 2022 third quarter driven by the accelerating price realization I discussed earlier, as well some early benefits from an integration actions partially offset by some investments needed in the business…

The housing market is complex leaving no clear path for Zurn Elkay investors. House building continues apace. Building permits for future construction are falling in number and below expectations probably from uncertainty about rising mortgage rates. House sales dipped in November for the tenth straight month.

Yet, the DYI home improvement industry continues to be thriving. The construction industry recorded a hearty 8% increase in spending in 2021 during which Zurn Elkay stock climbed high.

The greatest headwind companies like Zurn Elkay face is the bon ton of analysts and economists who forecast a recession, the stock market demolishment, and the crashing national economy. Marcum’s Commercial Construction Index reports the sector has been constrained in FY ’22 by labor shortages and inflation. We conclude it contributes to the downward drag on ZWS.

Marcum is not enthusiastic the economy is going to improve and a leading financial reporting company “expects 2023 to be one of the worst years for the world economy since 2023.”

The financial position of Zurn Elkay is overall positive. Assets total $1.7M and liabilities $1.3M. Its equity as of September 29, ’22 is $1.62B and debt is $536.3M. That is a 28.7% satisfactory debt-to-equity ratio and it has been dropping for over 5 years. Operating cash though is negative. The dividend yield (or FWD) is 1.35% now that the share price is low and close to the industry average of 1.7%. It is disappointing that the CEO’s compensation boomed the same time company earnings molted.

Last Drop

Management focused a great deal on Elkay in its shareholder talk last October. The focus was on what Elkay can do for Zurn Elkay Water Solutions and not on what the parent can do for Elkay, except for highlighting marketing changes. That is disconcerting.

There are enough positives about Zurn Elkay to lead us to believe there is a potential opportunity for the share price to move up to the mid-$20s over the next 12 months if an economic disaster does not occur. Keep in mind the stock is pretty volatile. Nevertheless, we conclude the company is unlikely to overcome the torrents of absorbing Elkay, the stock’s slagging momentum, and headwinds to justify more than holding shares for now. That is more than SA’s Quant Rating.