Badger Meter (BMI)
Badger Meter BMI 0.00%↑ sells meters that measure water (90% of product use), oil, steam, air, gas, and other liquids. Two entrepreneurs in Milwaukee founded Badger in 1905 after developing a “frost-proof” water meter.
Quality (4/5)
Starting with Badger’s historical performance, long-term sales growth is in the mid-single digits. Sales are cyclical, with declines in ‘08-09, ‘11, ‘17, and ‘19-20. Management would cite “innovation delays”, “deferred orders of new technologies”, pullbacks in the oil & gas industry, or sporadic foreign sales during declines. Recent sales growth is far above average at 20%+. About 87% of sales are based in the United States. Leverage on the balance sheet is consistently low at around 1.4X, as measured as total assets divided by total equity. EBIT margins are back to a high point after falling below average for several years. The growing software business should eventually help boost margins as it becomes a bigger portion of total sales. Badger is on 30 consecutive years of increasing dividend payments, making it a “dividend aristocrat”.
Visibility (4/5)
Badger sees recurring sales through steady replacement-driven activity and through its BEACON software sales. Roughly 80% of meters sold are replacements. Software-as-a-Service (SaaS) revenue is now 6% of total sales. There has been a lack of visibility in recent years with input costs like copper and electronic components. The visibility here is improving as inflation calms down. I like that management very rarely uses non-GAAP adjustments and also never issues quarterly or annual guidance.
"So Andrew, I know you're pretty new to us, and that was a nice try, but we'll never talk to you about months.
So we don't provide guidance. And frankly, there's a really good reason for it, and it's because we don't feel like it really provides value for investors for us to give a quarterly guidance.
Our customers think in 10-, 15-, 20-year cycles. We run our business from a very long-term strategic view. We certainly execute and we strive to deliver fantastic quarters every quarter. But we really do think for the long term. And whatever I would tell you in July would be meaningless to the future of what we're doing here." CEO Bockhorst Jul 2023
This sounds like a company that wants to be around for another 118 years! Global trends in water conservation and “ESG” should provide a solid foundation for Badger for the decades to come.
Management (4/5)
The management team saw changes at the CEO and CFO positions in 2019. Free cash flow (FCF) conversion has been greater than 100% in recent years, although FCF itself has only grown at a 2% CAGR over the last three years. That growth rate improves to 17% when looking out over 5 years.
I calculate return on invested capital (ROIC) to be 25% currently, with a median of 19% over the last decade. This is well-above the cost of capital, which I calculate to be about 10%. Stock-based compensation is less than 1% of net sales. Insiders own only 0.7% of shares outstanding. It would be nice to see insiders own more stock.
Management has a history of using acquisitions to further drive growth. Goodwill and intangibles are 24% of total assets.
Demand Creation (4/5)
Badger appears to have some ability to create demand. On top of underlying replacement-driven demand, Badger created new growth areas in its accelerating software and data analytics sales. These new meters only work if you get the software subscription with it, so once a customer installs the new meter, they will be paying for a subscription for at least the next ten years. The company spends about $15M annually on research & development. More demand is created through acquisitions.
“With 95% of our revenue stemming from water-related applications, we understand the crucial role of our offerings play in augmenting water efficiency and affordability, reducing water loss, optimizing asset life, promoting sustainability and providing resiliency across the water cycle.”
Its product portfolio offers many choices for customers. “A solution for any problem” as management puts it. With Badger’s 118 year history, customers see the brand as a safe and reliable choice, leading to a sticky and loyal customer base. Its meters are seen by customers as the “cash registers” of water distribution, making them mission critical. Badger has a size and scale advantage, operating in an oligopoly with Xylem and Roper. Together, these three companies account for 85% of the water meter market in North America. Badger has no customers that account for more than 10% of revenue.
Pricing and Value (1/5)
Attached above is my discounted cash flow (DCF) analysis. I gave Badger 8-10% sales growth over the next 5 years with EBIT margins improving to 19% as software sales become a higher portion of the total. I thought this seemed generous- high growth combined with slightly lower risk than the industry, along with lower reinvestment needs. EBIT grows by close to 200% over the next decade compared to 115% growth during the last decade. However, my estimated value came to $68/share versus the current market price of $144.
The pricing of the stock does not look much better. Badger has by far the higher price-to-earnings ratio in its peer group. At 41X, the nearest peer is Roper at 28X. I suppose one could argue that Badger’s P/E ratio could be lower if it played all the non-GAAP games that Roper does. It is more difficult to financially engineer the sales number, so looking at the EV/Sales column, Badger is at 5.3X versus Roper’s 9.2X. Going back to the Koyfin historical chart above, Badger’s mean P/E ratio over the last 20 years is 28X. The stock is currently at one standard deviation higher than that. Overall, I think a 30X multiple would be fair. With EPS approaching $3.75, that leaves a price of $112.
Combining my valuation and pricing, I get a target buy-below price of $90, which is 37% lower than today’s price. That might seem low, but BMI stock was in the $70s just last year.
Risks
First off, I look at the stock chart and go, “wow, that is an awesome stock” and then I look at the growth and say, “wow, that is some strong growth”. I feel like that could set me up for low returns given the cyclical nature of Badger’s business. There has been a lot of stimulus money going to local governments in recent years for infrastructure investments. It is clear that the water infrastructure in the US is getting old and needs upgrading. Badger’s management says it does not need infrastructure bills to grow its order book. But, what if municipalities or utility companies have to pull back on spending at some point? What will higher inflation, higher interest rates, and/or a potential recession do to budgets? Badger serves over 50,000 water utilities, so we could see a small percentage of them hold off on new technology if budgets get strained. I am a bit afraid to jump in here when everything seems to be going so great.
Other longer-term concerns would be environmentally linked, or Badger’s relationship with its employees and union. I do not see any signs of this today, but one could imagine a story about Badger’s materials causing an environmental issue with the water supply, or with the recent rise of unions, its employees demanding more benefits and wages. Employee turnover has been higher, around 10% in recent years, according to recent filings. Management cites pressures from the abundance of work opportunities in the job market. Lastly, I wonder a bit about Badger’s security with its relatively new software and internet-of-things products. I would think the US’s water supply is a major target for hackers.
To conclude, Badger Meter scores a 17/25 in my latest review of the company. See where it stacks up with the other companies I follow, now on Tableau!
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Disclosure:
I do not own BMI stock. Please see my holdings disclosure located in the Google Sheets link.
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