Three Utility Infrastructure Plays
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In a previous blog post, I identified three trends that should be drivers of revenue and profits for California gas and electric utilities. The one I'll discuss today is increased capital investment in aging utility infrastructure to absorb rising demand. This trend in electric and gas utilities is present nationwide and in Europe as well. Water utilities are no exception, as recent surveys indicate that aging infrastructure is a top concern of both water and electric & gas utility executives. Three U.S. companies, Itron Inc. (NASDAQ: ITRI), Badger Meter, Inc. (NYSE: BMI), and Roper Industries, Inc. (NYSE: ROP) stand to benefit from future spending on infrastructure that has been deferred or delayed by the recent economic recession.
Itron serves electric, gas, and water utilities worldwide by designing and manufacturing products and software for both automatic and handheld meter reading systems. The company generates more than three quarters of its revenue from gas and electric metering and slightly less than 25% from water meters. Itron’s market capitalization is $1.5 billion.
Badger Meter’s sales mix is essentially the inverse of Itron with more than 78% of its revenue coming from water meters. With a market capitalization of $530 million, the company manufactures flow measurement and control systems for industrial and utility markets. The company's products include water meters, automotive fluid meters and systems, and other related products.
Roper Industries is the largest and most diversified player of the group. The company has a market capitalization of $9.9 billion and sells remote water meter reading devices, testing equipment, control systems, and radio frequency identification devices to industrial markets and academic and government research institutions. The Industrial Technology segment accounts for more than 25% of revenue and includes the water meter business. The Energy Systems and Controls segment serves the power generation market and comprises about 20% of revenue.
Analysts are currently estimating robust growth for these companies ranging from more than 7% for Itron to about 10% for Roper and 12% for Badger. And investors have bid up the shares to reflect these expectations. The P/E for Roper is the highest of the group at 18.9x for a price/earnings to growth (PEG) multiple of 1.9x, which is stretching the preferred 1-2x PEG range. Although a 1.9x PEG is not highly compelling, investors should recognize that Roper‘s revenue is more broadly diversified than Badger and Itron, and Roper is thus better positioned to maintain growth in the face of another economic downturn. Although it has the lowest forward growth estimates for 2013, Itron has the most attractive PEG at just 1.3x based on its 9.2x forward P/E. And Badger is appealing with its 12% growth rate and 17.6x P/E leading to a reasonable 1.5x PEG.
Itron and Roper have grown their revenues at a much faster pace than Badger since 2002, primarily because they have pursued more aggressive acquisition strategies. However, Badger has been able to translate its annual revenue growth of just more than 5% into an operating cash flow growth of more than 11%, while Itron’s annual operating cash flow growth of 20% is lower than the 27% annual rate in revenue. For its part, Roper has been able to grow operating cash flow by 24% annually from revenue growth of more than 18%.
Return on invested capital, including acquisitions, reflects the disparity between the companies. Badger earned a solid 13% and Roper an adequate 7.5% annually. Itron, on the other hand, has essentially returned 0% since 2002. Not surprisingly, shareholders have been rewarded by Badger and Roper since 2002 but disappointed by Itron. Including dividends, Badger has returned a total of 495% or 19.5% compounded annually over the past decade; in contrast, shares of Roper returned 463% or 18.9% compounded annually during that stretch. Itron shares have been lagging since 2002, advancing by only 31.4% or by 2.8% compounded annually, with no dividends paid.
So while there is an opportunity for these companies to prosper from eventual upgrades to power and water infrastructure, they will face significant challenges. The primary obstacle will be for their utility company customers to secure reliable funding sources for the upgrades. Reduced domestic consumption of energy due to conservation efforts will also play a part.
Growth will come mainly from international infrastructure development. Badger generates about 12% of revenue internationally, the bulk of that from Canada and Mexico, while Itron obtains about half of its revenue from outside the Americas, primarily Europe, the Middle East and Africa. Roper generates about 30% of revenue from outside the U.S., so it appears that Badger has the biggest upside to increase its international operations as a percentage of total revenues. This may be a driver for the company to boost its growth rate closer to its competitors, which would be yet another reason to buy Badger instead of either Itron or Roper as a play on utilities infrastructure spending.
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