Episode 49 | Evaluating Xylem: Growth, Margins, and Management in Transition

In Episode 49 of “Market News with Rodney Lake,” Professor Lake, Director of the GW Investment Institute, explores Xylem, a water technology company that serves individual consumption and critical infrastructure like data centers. The company maintains stable gross margins around 37.5% and has steadily grown its net income and free cash flow, reaching a 12% net margin and $889 million in trailing twelve-month free cash flow. Lake notes that while new CEO Matthew Pine is an industry veteran, his short tenure makes it difficult to evaluate management, especially following Xylem’s transformative $7.5 billion acquisition of Evoqua in 2023. With modest projected revenue growth and a high valuation multiple of 28x earnings, concerns remain about future performance. As a strategic position in the water industry, Xylem remains a portfolio holding but warrants close observation moving forward.

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Transcript

Thank you for joining “Market News with Rodney Lake.” This is a regular program for the GW Investment Institute where we talk about timely market topics. I'm Rodney Lake, the Director of the GW Investment Institute. Let's get started. Welcome back to “Market News at Rodney Lake.” I'm your host, Rodney Lake. Today we're going to stick with industrials again. We've been cruising down the path.
Lots of tech, lots of consumer. But we got another industrial name for you today Xylem which we own in one of our portfolios. This is a water and water treatment company. But we're going to get talking about it. So we're coming to you from Duquès Hall right here in the heart of Foggy Bottom, the George Washington University School of Business and the GW Investment Institute.
Remember, disclaimer, this is for educational and entertainment purposes only. This is one of our portfolio companies in the industrial sector. And if you've been watching the show, welcome back. And if you're new, welcome to the show. We're going to be talking about this company, and we're going to evaluate this company with the GW Investment Institute framework. So that is business,
that is the management, that is the price valuation, and that is the balance sheet, the BMPB. And so we're going to go through each one. We're going to score 1 to 10. And we'll have the composite score which we always finish depending on how we feel at the end of the show. So here we go. Xylem.
What is this company? Well, it designs and manufactures equipment and provides services in the water and wastewater applications addressing full cycle water. You know, from collections, distribution, you know, return of water to environment. So this is a company that's squarely in the water business. And so their clients be like a municipality would be a water treatment facility.
So this is super important. Now we talk about AI and AI, one of the big consuming features of that for the data centers is going to be water. So this is something that I think people need to pay close attention to. Who's in this business? Obviously water it can, you know, is a need for humans. And there's plenty of water around the planet.
But putting that in the, in terms that we can consume, safely and have it for different types of operations, for cooling and other things. Well, that you just can't pump seawater into something and make it work. It's highly corrosive. There's all kinds of other issues. So there's lots of things you need to do to treat water and treat wastewater.
So, this is an important business. So we're going to talk about this company. We've had it in our portfolio for a little bit. It's in the industrial sector. A couple of things that we'll talk about first. The t off as we do, we're going to dive into the business. So for the business, what's the market cap of this company?
Just this kind of level set. How does this stack up to some other companies? And so this is a $30 billion company. So with respect to the companies that we talk about, this would be a small company. But $30 billion market cap is not a small company. But it is small relative to Apple. It is small relative to Nvidia, Microsoft.
So, you know, by comparison, yes, it's a small company, but certainly not a small company by overall standards. And that's something that we need to think about here. So $30 billion market cap for this company. One of the things that's interesting about this, I told you, we're coming to you live in Foggy Bottom here in DC.
This company is actually based in Washington, DC, which is pretty interesting. Not a lot of big companies based here in Washington, DC, but Xylem actually is based here, right here, in Washington, DC. Maybe we'll have them on the show. Shout out to their CEO, Matthew Pine. This is your formal invite to “Market News with Rodney Lake.”
We hope to see you on the show. All right, so let's get into, to further into the business here. So let me talk about the overall business. Let's now get into the revenue and remember here. $30 billion market cap. This is early June, 2025. Revenues, for the trailing 12 months through March 31. That's the latest quarter that we have data for 8.5 billion, approximately almost 8.6.
So we also say, okay, well, let's look at that revenue number over a period of time, not just, you know, obviously we want to know what it is today. That's super important. And we're really concerned about where is it actually going. But let's look at, you know, where it's been just to have a sense of where the company has grown or not grown.
In this case, it has grown and grown substantially in some cases. So you look at, 2021 for the full year, for fiscal years. 12/31. So calendar year 5.1, in 21 and 21 ended 22 5.5. You know, so not huge growth numbers, you know, 6.5 for the year before 6.6 going ended for 22. And then excuse me, big year, 33%.
For 2023, we're going to talk about that 7.3 billion in revenue and then 8.5 billion revenue, 16% in 24. And then that growth has slowed down, for 2025, trailing 12 months, 8.2% and now projected to slow down even further for the full year, 25 to 2.2% and then to 26. This is the analyst estimates for those 4.8%.
So you could rounded up the five if you like, but obviously a fraction of that 33%. And even even you know, still a third or less, of that 16% that we saw, in the full year for 2024. 12/31, remember, is the fiscal year for this company. All right. So let's now moving on, further to the business is the gross in net profit margin.
So we'll talk about those here. So what are the net margins for this company or the gross margins rather? Let's start there. So the gross margins for this company not bad. Pretty good. 37.5%. For the trailing 12 months through March 31. And if you look back, these are pretty remarkably consistent. So if you look at, those numbers, the gross profit margins, excuse me, in 2021, 38%, 22 37.7, 36.9 37.5 37.5.
Projected. You guessed it, 38.1, 37.5. So very consistent profit margins here for this company. So not bad at all. Excuse me. And I would say that's remarkably good to be that consistent, especially we're going to talk about they had a big acquisition in there. That's fantastic. So you're already thinking, well, whoever managed to do that, obviously, did at least a good job to maintain those margins.
They're not these are not Visa margins. These are not Nvidia margins. These are not software margins, but these are good margins, for an industrial company. Now let's drop down to the net margins here. So for the trailing 12 months latest quarter March 31 again early June here we have 12% net margins. Not great. And on a on a number 8.5 again, is the gross revenue and then about a billion, in revenue for the net here.
So 12%. Not bad. Again, this is an industrial company. 12%. That's that's not bad. And so we could say, well, that's not great, but it also isn't bad. So when we start talking about the business, you know, we'll factor that in. But let's look at that over time just to make sure we have a sense where this company has come from and where it's going.
So and again we're always most concerned of where the company is going. Why do we look at where it's come from just so we can have some sense, especially of how it's grown over time, how management has deployed capital? We want to use that track record to help us understand, do we think that this management team or the or the, you know, maybe it was the same people or maybe it's different people?
Would you have also have to factor in, you know, can they keep this track record up? Is it sustainable? Can they, you know, accelerate it? That's why we would want to look at the past, not to, you know, tell us anything other than to try to give us context of where we think the company can go, because what we always care about is what what is happening today.
And really, what do we think is going to happen in the future, especially where do we think that that differs from where the market thinks? But back to the context here. So 2021, you know, revenue of 455 million, net margins of 8.8%. 22 511 million, 9.3%. 23 793 million, 10% 24 over a billion, just over a billion, 11.9 so about 12%.
And then again, the trailing 12 months, just over a billion, 12% projected, 12.9% and 13.7% for 25 and 26, respectively. Full year again, that's fiscal year 12/31 for this company. Excuse me. So now we look at free cash flow, just to have a sense of what's the free cash flow for this company? Yeah, it's through through the, March 31, which is the latest quarter, 889, for 2025 here.
March 31. And then let's go back for the full years 2021 through 2024. December 31st, remember, so you're looking at 330 million, 388, 566, 942. So a pretty big jump there and then back to 889 for the trailing 12 months, the projected full year numbers for 25 and for 26, 841 and 1.1 about 1.15 for the 26 number.
And so that's good. Increasing, free cash flow. That's great. We that makes us feel good. And that's all good news. But you know, the business, you wouldn't look at these metrics and they don't stand out to you and be like, oh, this is like a Visa. This is like a Nvidia. This is like Microsoft margins.
Now, you know, this is good especially for an industrial company, but it's not something that you're going to get super excited about and be like, oh, we have to own this company now. We already own this company. To be super clear now. And it's also in a critical space. Excuse me. Water. Obviously we need and we need it in a certain form.
Everybody knows there's plenty of water on the planet, but it has to be in a certain form for certain applications, certainly for drinking and consuming and but also for data centers and cooling and all kinds of other things, as we talked about. So getting in that form and treating it and all these other things, that's what Xylem does.
So now business let's that let's score the business and we'll move on to the management here. So if we talk about, you know, the things that we reviewed you know again these are decent numbers not fabulous numbers. Gross margins are not fabulous but steady 37%. Net margins are steady and growing a little bit now at 12%, projected to go to almost 14% in two years for an industrial company.
Good. Not great. So let's give this company a 6.5 to a 7. For this, for the business. Maybe it's closer to a 6.75. Let's not split hairs, right? Charlie Munger, generally right, not precisely wrong. So maybe we can go with a 6. All right. Next up is management. So Matthew Pine, is the CEO of this company, and he hasn't he hasn't been the CEO for very long.
So it is going to be difficult for us to make, you know, a huge assessment about his time there and his work. He's certainly an industry veteran, but how long has he been a CEO? 1.4 years here. So not a long time. But one of the things that's going to be super important is, you know, how does he obviously manage forward.
And there was a big acquisition in there. And we talked about management. We're going to talk about we always talk about capital allocation. And certainly that's part of the Investment Institute investment framework is the term capital. And that's capital allocation is part of that. We want to make sure that the management team is allocating the capital the best they can.
And so we saw that big number jump in 23 when we were looking at the revenue for example. Part of that is that Xylem acquired Evoqua in an all stock transaction valued at 7.5 billion. And that was the largest acquisition I had done to date. So that happened in 23. So this was it expanded its portfolio and the water treatment solutions and created the world's largest pure play water technology company with over 22,000.
That's including through some press releases. And so, parroting there a little bit from, from some of those things, but $7.5 billion, acquisition, on, you know, on, on again, not $1 trillion market cap. So when we remember when we talk about that 7.5 billion, that's not on a trillion, 7.5 billion, it's on a market cap of 30 billion now.
Right. And so it's important for us to think about that. And if you look at 23, the pre, you know, if you look at the full year, 22 number, that was a $19 billion market cap company. And you look at the post acquisition, you're talking 27 billion. So a very large acquisition with respect to the size of the company, expanded its services, certainly made it a much more global player.
You know, some of those competitors globally, you know, the big one, Veolia, which also acquired Suez, those are going to be the some, some of the big players for competitors and domestically. Pentair here in the US, as some examples, to talk about this. And so when we think about management, we're going to have to say, okay, well, you know, Matthew Pine is newer, he obviously inherited these things that are happening right now, so that that's important for us to watch and that's important for us to try to understand.
He he's definitely an industry veteran here in the space and in the industrial space. So no concern really there. But I think time will tell. It's early days, so I think it is important to see where they go from here, how they compete, in that space. There's certainly a much more robust company with that Evoqua acquisition in the water, you know, place, they call it a pure play, play on words here for water.
But this is an increasingly important sector. Water is going to continue to be important, for all the applications. Again, water is not scarce. Water in a certain form can be scarce, including freshwater and treated water for facilities. So an important, set up an important function. Likely, the dependance on these types of services are going up based on the industrialization of AI when AI goes from not just software, but into hardware applications, principally probably robotics as an example.
Are there going to be more demands for water? Possibly. And we'll have to pay close attention to that and how that plays out over time. So management again, early days, it's hard to really evaluate a management that's so new and give them a score. So we're going to take a ding on that score. You know he wasn't the person to necessarily do all these things obviously up to this point.
But he's in charge now. So we have to think about that. But we can say, well, maybe things are going okay. One of the things that we can say for sure, that is good to see for management is that even with the big acquisition, they were able to actually maintain their gross margins and their net margins and actually grow them.
And so slightly right now, but still, anytime you have that, that's a good sign that they've integrated that acquisition. Well, and that they are moving forward in the thesis is playing out, as they had probably projected for the people that were there, at the time. And maybe it didn't work perfectly at the time, but certainly it seems to be working now.
But now it's up to Matthew Pine and company to try to figure this out. So we got to pay close attention, you know, what's the growth of the overall businesses, if they can continue to increase these margins or keep them the same and then grow the business, we'll be paying close attention. Now. The projected revenue growth rates are not super high right now.
If you look at the full year 25 and 26 projections, 2.2% again, consensus and 4.8%, these are not numbers. We're like, oh my gosh, we gotta own this company. Again, we already own it. So now to decide should be trimming this company? Should we add to this company? Should we get rid of this company altogether? Well, we'll have to see.
I think it's important, for us to, you know, do the work. The fall semester will start. Certainly. We'll have people covering the industrial sector will ask them, look at this company. Obviously, this is maybe a derivative of a derivative play at this point, in the AI space. But it's something that we, we have to evaluate.
Obviously, it's a current holding, not a gigantic holding, but a current holding, and a company that is an important part of our portfolio. So management, we're going to give them a ding. So we're going to go down to a five right now management to be determined, on management. Alright. Moving on. So now let's look at the price versus the valuation.
So if you look at this company all right, what's the estimate? Now this company is not cheap. So if you look at the estimate almost 28 times. So you think like we just reviewed all these numbers. These numbers don't sound like 28 times the market's let's say 21 times. Why should we pay 28 times? Well lots of people have projections about how important this is and how important, you know, they want to be in this space.
It's a pure play in the water space. They, you know, they did. The act was a big acquisition. People are paying up. I'm not saying that that's the right thing to do right here. So this would be a concern of mine. And so if you look at the ten year, you know, if we use the PE over the last ten years, the high is going to be much higher at almost 67 times and the low 15 times.
And so the median is the average is 32. The median is 32. We're we're below the average in the median at 28 times. That doesn't make me feel great, but it makes me feel a little bit better. And so we're certainly historically relative to the company not trading at a premium to the for the median.
Let's use it. But they're at the same right now 32 times, but still a lot of optimism priced into this company that does not have great gross margins or great net margins in particular, it doesn't generate a ton of free cash flow, to talk about, but is certainly, again, is in an important space and people are paying close attention to it.
And certainly people have bought into this story that it's a pure play. They got the big acquisition done and now they're they're, you know, continue to pay up for this company. Now for us as analysts, business people, as investors, this is something we got to pay close attention to. This is something that should keep us up at night, you know, can they keep this high multiple?
Because if the multiple comes down, what happens? The value comes down right? So if the earnings stay the same and the multiple people say, you know what, I'm going to rewrite this. They're not achieving this growth. They're not achieving the you know they're not going to get it grow this market. Whatever, you know, doesn't happen that people are expecting to happen, that multiple is going to come down, that's going to compress, that's going to come right out of the valuation.
The only other the way to make up for that is if they grow earnings by a lot. And if you heard we just talked about the earnings are not expected to grow by a lot. Right. On the revenue side first. Right. So this is something that we should be concerned about. And so we got to really think about this.
So I would say a concern here on the valuation. The valuation I would put out a 5 also. So now we ought to get management at a 5, balance sheet, I mean, the valuation in the 5. Now let's move on to the balance sheet. So what's happening with respect to the balance sheet. So this is kind of better news.
Let's say than a 5 probably. Excuse me. Cash is, this is March 31, latest quarter 2025, about 1 billion and 2.2 billion in debt. So still a net debt position, but say 1.2 billion in net debt. Nothing crazy, generating about 889 billion in free cash flow. So this, you know, we can sleep at night with this and let's check the interest coverage ratio just to be safe as we as we talk about. What's the interest coverage ratio for a company like this 22 times.
Almost 23 times. We like that to be ten or better. So we're in good shape there. That is the earnings before interest and tax over the total interest expense almost 23 times. So again we're sleeping at night with that. Not like cash like all the cash that the tech companies have on the balance sheet. Not sleeping that well but still sleeping.
And so, the balance sheet probably gets a 7 here, for that. But if you go through, you know, the business, you know, mixed here, 6 we went down, the management. So we're going to pull it all together. The management here is we talked about newer. We'll see 5. Maybe you could get rated up to a 6, the valuation, you know, 5 or 6, maybe we were generous here.
6. And then the balance sheet, you're given a 7. So you're still talking about, you know, a 6.25. And if you really are more conservative, and use the 5 numbers, at least for some of those, you can say that the overall score, we're just putting some conservatism in this is a 6. So that's not great.
And certainly for this company, it's one of the ones that will say, hey, we need to pay close attention to this at the Investment Institute. It is an important industry. But with these metrics, it's telling us a story that, okay, well, we got to we got to have a better handle on the valuation. We got to have a better handle on what's the future of this company.
We got to have a better handle on the management. We got to have a better handle on all these things for this to stay in the portfolio. So we'll be asking our analysts to pay close attention to that. A 6 overall is not a fantastic score. Again, important business, pure play in the water space. Interesting, but more work to do.
So that's a wrap for this episode on Xylem And that's a wrap for Market News with Rodney Lake. We'll see you back on the next episode.
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