Investing in the Inevitable - Itron

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Benjamin Franklin said there were only two things certain in life: death and taxes.  While not one to argue with a genius, I’d contend that there are other truths that will drive the world for the foreseeable future.  One example is that water is vital to human existence, and the demands for drinkable water will continue to increase as populations increase and emerging markets continue to develop around the world.  Another example is that the planet has rapidly growing demand for resources and there is a finite supply of many of the resources we rely upon today.  I consider these trends to be inevitable, so companies that focus on sustainability solutions are at the sweet spot of some critical trends.

Enter Itron

With 8,000 customers in 130 countries around the world, Itron, Inc. (NASDAQ: ITRI) develops and deploys technologies that help to more efficiently meet the increasing demand for water, electricity and gas around the world.  Through industry-leading smart metering technology, Itron contributes to smart grid development with a range of partners including Cisco Systems, Siemens and Verizon Communications.  Together, these companies create solutions that not only improve efficiency and make scarce resources go farther, but they are also cost effective too.  This creates a unique situation where consumers, companies and the environment all win at the same time. 

This value proposition is attractive to utilities looking to upgrade infrastructure, either out of necessity due to the increasing age of utility infrastructure worldwide, the need to stretch limited resources as far as possible, or the desire to save money (and resources) through smart metering.  Recently, Itron announced a large 3-year project with Sydney Water in Australia, which will deploy Itron’s solutions to its water distribution system that serves 4.6 million people over 1 billion gallons of water per year.  Deals like this are just the tip of the iceberg; a recent presentation by Itron’s management estimates that the worldwide adoption of smart meters is just 10% to date.  This creates quite an opportunity given the early stage of adoption for smart metering technology.

Intriguing Valuation

On top of industry leading position and a massive global opportunity fueled by inevitable trends, there’s another compelling reason to give Itron a look: the current valuation.  At the July 12 closing price of $41.31 per share, Itron’s $1.7 billion market cap creates some intriguing valuation multiples:

<table> <tbody> <tr> <td> <p>TTM Revenue</p> </td> <td> <p>$2.4 billion</p> </td> </tr> <tr> <td> <p>P/S</p> </td> <td> <p>0.7</p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p> </p> </td> </tr> <tr> <td> <p>TTM Net Income (excluding one-time charges)</p> </td> <td> <p>$142 million</p> </td> </tr> <tr> <td> <p>TTM P/E (excluding one-time charges)</p> </td> <td> <p>11.8</p> </td> </tr> <tr> <td> <p>Forward P/E (based on analyst consensus)</p> </td> <td> <p>10.5</p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p> </p> </td> </tr> <tr> <td> <p>TTM Free Cash Flow</p> </td> <td> <p>$210 million</p> </td> </tr> <tr> <td> <p>TTM Free Cash Flow yield</p> </td> <td> <p>12.5%</p> </td> </tr> </tbody> </table>
 
The number that jumps out at me the most is the free cash flow yield.  Itron continues to generate some serious cash, which to date has been used to fund acquisitions and reduce the company’s debt.  In just two years, Itron managed to reduce its leverage ratio from 3.2x in Q1 2010 to 1.1x in Q1 2012.  That’s pretty impressive!

This Stock Looks Cheap, but Why?

The overall investment thesis for Itron is solid and the company appears to be cheaply valued, but what’s the catch?  Well, there are several.  The obvious first pressure facing Itron is the continued global economic slowdown.  A significant number of utilities that represent potential Itron customers are owned by government entities, which don’t seem inclined to spend money at the moment even if it will pay off over the long term.  Even companies specializing in electricity and water have had struggles recently; a good case study for this is Veolia Environnement (NYSE: VE), which reported a $411 million loss in 2011 and is undergoing a massive restructuring in order to obtain the liquidity needed to pay down a portion of its massive $27 billion in debt.  Companies in Veolia's position are unlikely to undertake large capital projects like the Sydney Water project mentioned above.  The result of the stress on Itron’s customer base is a significant decline in backlog, from a record high of $1.7 billion in Q1 2011 to $1.2 billion in Q1 2012.  Revenue growth has not exactly been stellar either.  These metrics are clearly something to keep an eye on.

Additionally, there is plenty of competition in the metering space.  In addition to independent companies such as Badger Meter (NYSE: BMI), Itron’s competitors have become acquisition targets; recent examples include Toshiba’s $2.3 billion acquisition of Landis+Gyr and Melrose’s $2.3 billion acquisition of Elster.  Badger Meter competes directly with Itron in water and gas metering, but is significantly smaller based on 2011 revenue of just $263 million.  The size difference between Itron and Badger Meter is largely due to the fact that Badger Meter has not participated in the industry's M&A binge thus far.  While Itron remains the leader in smart metering, it is impossible to ignore larger companies, such as General Electric and Siemens, that have devoted significant resources and expertise to developing products that serve the water, gas and electricity needs of customers.

What’s Next?

​​A market leading position, growth opportunity and compelling valuation are certainly three reasons to put Itron on your watchlist.  The question is, is Itron worth a portion of your investing dollars?  In order to answer that question, I suggest analyzing the total market opportunity and estimating how much of that market Itron can capture.  This is much easier said than done, since any conclusion relies heavily on each investor’s assessment of management’s ability to execute in the future.  It may not be a perfectly smooth ride along the way, but I believe the market is discounting Itron’s experienced management team at today’s prices.


BrewCrewFool owns shares of Itron. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Veolia Environnement (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.

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