Stock Pitch - Water Intelligence (LON:WATR)

5th May '21 by Jack Brumby

17 comments 6722 reads

Water Intelligence (LON:WATR) is a high flying water leak prevention company with global ambitions and some eye-catching growth rates. Five-year compound annual growth rates (CAGRs) for revenue, net profit, and operating cash flow per share are 35%, 35.1%, and 42.5% respectively.

In fact, just about the only thing growing faster than the group’s revenue is its share price, up some 242% over the past twelve months. There’s no doubting the trading momentum here but the recent multiple expansion means there is precious little room for error.

The stock was pitched to the Stockopedia Investment Club on Wednesday April 21st 2021 at 806p.

Is this a hidden gem on AIM, with genuine longer term compounding potential? Or, at 48.7x forecast earnings, are we just getting excited about an overpriced franchise network of plumbers?

Summary

Bull points: profitable, high margin corporate/franchise model; increasing growth capex; small, growing player in global structural growth market (water conservation); intellectual property, trademarks, and patents; ESG trends; high QM stock; clear strategy; acyclical essential services provider.

Bear points: high valuation multiples and limited scope for multiple expansion; possible future disruption to clean water issues; growth rates may slow; international expansion could prove trickier than expected.

Profile

About the Stock:

Water Intelligence is a part of the Machinery, Equipment & Components industry group, which belongs in the Industrials sector.

The company was incorporated in England and owns the entire issued capital of American Leak Detection (ALD). This is Water’s principal trading subsidiary.

ALD provides non-invasive water leak detection and remediation services in the USA, Canada, Australia, Spain, Belgium and other countries. Unlike traditional plumbing methods, ALD leak specialists locate leaks without the breaking of walls or floors, allowing for reduced repair costs and better water conservation.

A share price of 929p and an exchange market size of 500, about £4,645k worth of stock can be reliably traded. A spread of 124bps should also be taken into account.

Liquidity issues aside, Water Intelligence is classified as a Speculative Small Cap High Flyer with strong exposure to the Quality and Momentum factors. Its StockRank is 74 and its QM Rank is 96.

About the Opportunity:

This is a small, niche, fast growing business that is being neglected by the market.

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Its services are required throughout the economic…

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Traver

5th May '21

Good stuff. Question: the secret sauce is presumably the " innovative technologyincluding infrared, acoustic and correlation equipment."

Given the $23 trillion market mentioned, perhaps inevitable somebody elbows in with an alternative technological answer - given the size of the pot, and the arms race in 'disruption' - so that it's not just Pimlico Plumbing etc competing against them?

Apols in advance if dummy question

Will Marsh

Malcolm Stacy at Shareprophets picked up on this stock a while ago and it has been an excellent tip. What I like about it is, sector, market opportunity and decent financial performance. I have to say I fretted about the price at £5 and I very much regret not buying more at the time. Its high risk but i think the quality will show in the end. If the share price does re-rate lower as long as the issue is not structural it may well pay to accumulate more as water is getting increasingly precious and the demand for this service must rise.

Effortless Cool

Your Club's a bit late to the party here, Jack, although I am cautiously optimistic there is more to come from Water Intelligence (LON:WATR).

There are a couple of important points omitted from your note that are worth highlighting, I think.

Firstly, the engine of growth in their US Corporate segment has been buying back their own franchisees. This has obviously suppressed growth in the Franchise Royalty segment as the number of non-corporate franchises has reduced as the corporate franchise count has risen. This strategy has suppressed earnings over the last few years as the US Corporate segment delivered lower margins than the Franchise Royalty segment. However, US Corporate margins have been tracking up, as shown in the exhibit below (green actuals, red my forecasts) and are now close to the Franchise Royalty levels. Additionally, this reinvestment strategy has absorbed large amounts of cash that would otherwise have accrued on the balance sheet. The underlying cash generative capability of the business is much greater than recent years net cash generation would suggest.

Secondly, the Franchise-Related segment is really two segments in one. It originally covered franchise territory sales and sales of parts and equipment to franchisees, but has subsequently expanded to cover business sourced through agreements with national insurance companies, six or so of which have been signed up since 2019 H1. It is these national insurance accounts that drive growth in this segment. It is lower margin business than otherwise, but serves to strengthen WATR's stranglehold on the sector.

Jack Brumby

Hi Traver,

Not a dummy question at all and it is a risk to Water Intelligence (LON:WATR) that some kind of technological disruption changes the picture, or competition picks up in some form.

But the company is growing fast into a very large market so it looks like the demand is there for now. Its core business has been growing steadily for many years. And WATR itself is hoping to bring about some of this tech disruption with its own R&D.

With a market cap of £144m and such a high forecast PE ratio, the market is anticipating quite a lot of growth. Water can meet these expectations - but it will have to stay ahead of the curve and continue to invest in its technologies in order to provide a leading service. It looks like this is happening.

At these prices though it is fair to say that the good performance has to continue and there's not much room for error.

Perfect, thanks Jack.

As for "And WATR itself is hoping to bring about some of this tech disruption with its own R&D." - that makes sense, and perhaps should have been obvious to me. D'Oh!

AlexB1966

6th May '21

I have for a long time loved the Water story - there is a pressing need to maximise the use of this precious resource - and leak detection and thus reduction in wastage is a crucial part of the story..... but, this is very richly priced stock. I understand wanting to get on board with this long term trend but why not e.g. Xylem (US:XYL)? Arguably a safer bet on this story. I personally would prefer a number of other stocks before this one with as good momentum and better value.

GrahamF

Hmm.

Effortless Cool has reported extensively on this stock over the years on the SCVR, and a fine job of it he has done too. So, most regular readers of the SCVR should already be aware of this one. That and the way the share price has been run up suggests to me that this is not a hidden gem.

In the past there has been quite a bit of discussion about De Souza having some reputation baggage that makes this a high risk investment. I recall looking at some of the numbers, sorry cannot remember which, and thinking that they were so remarkably consistent it made me wonder if they were real. Perhaps this was too soon after the Patisserie Valerie debacle.

To some extent, the argument here is whether this stock deserves a tech type rating or a more modest rating associated with service companies. I really struggle to believe that they have developed any significant tech that is not available to others so I would say that the stock does not deserve a tech rating. It is significant to my mind that they have made little progress in the UK when our water utilities are notorious for their leaks and there is strong regulatory pressure on them to improve this performance. It suggests that their tech is nothing special. Also, could it be that the biggest competition in some countries is actually the in house leak detection and repair capability that the water companies have here? The theory that they can roll out the same business internationally must be questionable.

It seems to me that the historic growth has not been organic, rather it has been buying back franchises, which is more like a growth by acquisition strategy. This has a natural limit by the number of franchises if nothing else so is not sustainable. The insurance business in the US does look promising however.

I was surprised the investment club decided to buy this but it’s good to be surprised now and again. Hopefully it works out well for you. No position myself, as you’ve probably already deduced.

Brookeda

Whilst being an holder for 9 months and making a nice return I do welcome the diversity here on these forums and someone offering the bear argument. I've ben considering top slicing a part of this given the current valuation and your comments give me more things to ponder, thanks

Hi Brookeda

You’re welcome. One thing to note of course is that I have been consistently bearish on this one and so ‘wrong’ in as much as the share price has risen a lot, whereas Effortless Cool has been consistently bullish and so he’s called this one ‘right’.

We all get some wrong and hopefully more correct. I like many others often think of all the bullish points relating to my stocks and need reminding of the bears so I take every viewpoint as just another data point.

smilingmickey

Hello Jack,

Thanks for this very comprehensive report.

I have a small investment in this Company.

There are three things I would add.

1) Expenditure by the new US administration has been specfically targeted towards updating the US water infrastructure. This should have some benefits for Water Intelligence.

2) There are a lot of US properties which do not benefit from mains drainage. This places the onus in case of sewage blockage on Private Householders. Water Intelligence;s plan to assocate with house insurers seems a good move.

3) Finally I think there is merit behind the plans to buy some of the Franchise Operations, who can then provide support to expand business of other privately owned operations as well as expend their own sales.

First quarter profits more than doubled from a year ago. It's a very small Company. Difficult to value. My strategy is to buy on share price weakness.

Terry Dickens

Can anyone tell me why (WATR) Water Intelligent is down 58.75p (6.46%) today?

It has taken out my stop, so I was wondering why.

Profit-taking. I would say it got a bit ahead of itself last month.

Logical David

Hi Terry,

WATR is heavily overpriced in my opinion. As Effortless Cool has stated the share price has got ahead of itself. Its forward PE is 47. I am reluctant to buy companies when their PE rises above 20. I believe at 862p the price is too high and the true price is somewhere between 513p - 707p and I expect the share price to pull back to somewhere in this range.

David.

Peter171

7th May '21

Used to be in this a couple of years back , maybe I should have stayed in it for the ride!

silverfern

This is still a trucks and tools business; a plumbing repair service for consumers that also has some public sector business. Many years ago the business was franchised out, and since PdeS took over it's been buying back. EC has described this very well here and on advfn. I invested in2016 and heavily therafter butmust learn the art of patience. I had 40 k shares ave 180p, sold ave 350p. (covid reasons primarily) but I thought the corporate issues were too loaded, a one man boat. Well done those who held on, but it's way overvalued now imho for reasons already stated.

11th May '21

I bought in at 326p last August and decided to heavily cut my position when 900p was hit as whilst I like what the company is doing and where it's going I just the valuation crazy at the moment. I have now a smallish holding and will keep it. If it remains elevated I may eventually cash in but if it goes backdown to about 600p I may add back in.

Long term I still think there's a lot of growth potential

Stock Pitch - Water Intelligence (LON:WATR)

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Jack Brumby

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