Zurn Elkay (ZWS) Q3'23 Earnings Update
Margins continue to improve; growth expected to return in Q4'23
Zurn Elkay reported Q3’23 earnings after the bell on October 31. Overall there weren’t any big surprises from the earnings report. This company was covered in a deep dive on October 26 that calculated an implied valuation of ~$31. After a steady quarter and guidance, there’s no material changes to the model.
Revenue of $398M was down -5% YoY but still edged out the consensus estimate of $396.2M. Adjusted EPS of 29 cents beat by two pennies. The positive data point for the quarter was a continued increase in margins with adjusted EBITDA at 24.1%, up 250 basis points from Q2’23 and up 410 basis points when comparing to Q3’22. The bridge from reported EBITDA to adjusted EBITDA was less messy this quarter with 50 basis points in restructuring costs (compared to ~190 basis points in Q2’23). The reduction in non-recurring restructuring costs comes with Zurn Elkay reaching the one-year anniversary of its transformative merger with Elkay.
Looking ahead, management guided Q4’23 revenue at $351M, which fell short of the consensus of $364M. $351M would represent core sales growth of 5% YoY and put Zurn Elkay back on track for growth after the past year saw lackluster core (organic) sales growth. It’s still below historical growth rates and investors will closely watch for signs of Zurn Elkay’s ability to grow in the high single digits again. The adjusted EBITDA guidance similarly fell short at $81.6M (23.2% margin). In response, shares closed higher by 3.36% on November 1.
I’ll note some highlights from the earnings call, starting with a statement from CEO Todd Adams regarding drinking water growth:
1 year into the Zurn Elkay combination, we're really hitting our stride in terms of the benefits from the transaction, both from a synergy savings as well as capturing the enormous secular growth opportunity we see in clean filtered drinking water. Over the next 12 months, we will be introducing more new products in the drinking water category than at any point since Elkay developed the category just over a decade ago. This is both on the filler side as well as the filtration side.
And all this is happening as we see continued positive momentum on the legislative front as well as traction from the significant internal investments we've made to drive growth -- to grow the overall category. One year end, we've accelerated the growth rate of drinking water and now expect mid-teens organic growth for drinking water in 2023.
Zurn Elkay remains on track for cutting costs and capturing merger synergies. CFO Mark Peterson said of profitability:
Our third quarter adjusted EBITDA increased 15% from the prior year third quarter to $96 million, and our adjusted EBITDA margin expanded 410 basis points year-over-year to 24.1% in the quarter. Looking at our margins sequentially. We stepped up 250 basis points from the second quarter of 2023. And as we have been discussing all year, the benefits of our price realization and our productivity initiatives, inclusive of the cost synergies that are a little over $6 million each quarter in calendar year 2023, fully read through in the third quarter with the impact of the sell-through of higher cost inventory completely behind us.
CEO Adams also spent time discussing trends in construction and presented the following slide. 55% of of Zurn Elkay revenue comes from new construction and 45% is retrofit. There’s been a slow-down in commercial construction and Adams used the time to emphasize the end markets Zurn Elkay serves in aggregate are diverse and the new construction markets that are experiencing the harshest downtowns are only a small portion of the revenue pie. Half of the revenue pie is from institutional construction shown in the top left which is projected to grow in-line with historical rates in 2024. Moreover, backlog remains healthy, as seen in the top right chart.
Disclaimer: This is not advice to buy, sell or hold any stock referenced. Do your own due diligence. I have no position in any stock mentioned in this report. Like any financial analyst, doesn’t mean I’m not biased.