Why Watts is raising its growth forecast in a weak housing market

Watts Water Technologies is finding enough business in data centers and other commercial markets to raise its growth forecast, even as homebuilding remains weak. The maker of valves, drainage systems and other water-control equipment is also earning more profit from each dollar of sales.

Third-quarter revenue rose 19% to $728 million. Acquisitions made last year contributed, but the larger part of the increase came from the existing business.

Research by Ticker Byline shows that organic growth, which includes price changes, accounted for about 64% of the $116.3 million sales increase. That calculation compares the company's $74.5 million organic contribution with the total increase. Acquired businesses added $41.3 million, with currency movements contributing the remainder.

Our Watts company profile follows its financial results, growth targets and completed acquisitions.

A different mix of demand

Watts says light industrial demand, including data centers, remains strong. Spending by institutional customers is holding steady, while housing and several commercial construction markets remain soft. Higher prices also supported sales.

That uneven picture shows up in its Americas business. Organic sales increased through wholesale and specialty channels but fell through equipment manufacturers and do-it-yourself retailers. Watts also discontinued some products, which contributed to the declines in those weaker channels.

The company now expects annual organic sales growth of 11% to 12%, up from the 8% to 11% range it gave in August. Organic growth removes the effects of acquisitions and currency movements. It includes both volume and pricing.

The profit improvement goes beyond a refund

A $39.3 million tariff refund helped lift reported quarterly operating profit to $190.8 million from $111.4 million. Watts removed that benefit from its adjusted results, allowing a clearer comparison of ongoing profitability.

Adjusted operating profit still rose 34% to $151.8 million. Its adjusted operating margin increased to 20.9% from 18.5%, helped by higher sales, pricing and cost controls. Adjusted earnings rose to $3.40 a share from $2.50.

Watts raised the bottom of its annual adjusted operating-margin range to 20.3% from 19.8%. The 20.4% ceiling stayed the same. That narrows the forecast toward the stronger end of its earlier expectations.

More investment before the year ends

Cash generation is improving, though more slowly than profit. Free cash flow for the first nine months was $230.2 million, up from $216 million. Operating cash flow includes the benefit of the tariff refund, while higher receivables, inventory and capital spending used cash.

Watts expects capital spending of $65 million to $70 million for the year. It kept its target of generating free cash flow equal to at least 90% of reported net income, compared with about 63% through September. Management expects a seasonally stronger final quarter to help close that gap.

The balance sheet gives it room to invest: Watts ended the quarter with $444.8 million in cash and cash equivalents and $100 million of debt before financing-cost deductions. For Q4, it forecasts organic sales growth of 9% to 12%. The next results will show how much of the stronger demand reaches cash flow as investment spending continues.