DRIP Portfolio Candidate: Badger Meter

This week, Fool analysts Todd Wenning and Bryan Hinmon are presenting two stock ideas for inclusion in the Fool DRIP Portfolio. Industrial stocks are on the docket today, with Bryan presenting Badger Meter and Todd making a case for Caterpillar.

Every day, thousands of independent water utilities are responsible for producing, treating and delivering safe water. We need it to grow our corn, cool our energy plants, and water our Chia Pets. Water is so essential to our lives, underscored by the fact that the U.S has built more than 880,000 miles of drinking water infrastructure -- that's enough pipe to wrap around Todd's head one-and-a-half times! Water is also an important source of revenue for municipalities and serves as stable collateral on which to issue revenue-backed bonds. Yet, developed countries often lose around 20% of water (and related revenue) due to leakage, theft, or inaccurate metering. The creative industry folk call this "non-revenue water," and it's a big problem, in the range of billions of dollars.

Enter Badger Meter (NYSE: BMI  ) . Badger has provided domestic water metering solutions for more than a century. Water utilities like meters because they make it possible to charge customers for the amount of water they use. Meters also encourage conservation by making customers aware of their usage, helping to plan for spikes in demand, and pointing out irregularities in usage patterns as a way to spot leaks and theft. With the non-revenue water problem only getting worse, new life is being breathed into the stodgy water metering industry as a part of the solution.

3 reasons to invest in Badger Meter

  • Wave of the future. Badger specializes in "smart meters," ones that don't have to be read by a human. Instead, readings are taken automatically and transmitted electronically to a receiver in a passing truck or directly to computers via wireless networks. These automatic reading technologies reduce the workforce required to obtain readings, lower costs, and eliminate human error. Such technologies are the future of the meter world, and Badger estimates that only 30% of water meters in the U.S. use these advanced metering technologies -- so there's plenty of room for growth.
  • Just a drop of competition. The water metering industry is an oligopoly, and because there are federal requirements for metering products, it's hard for new players to enter the market. This has led to consistently high returns on capital for the select few industry participants. Badger, over its century of measuring water flow, has been a technology leader and has developed a stellar reputation.
  • Measured progress. Badger is a well-run company. Over the past decade, it has grown sales an average of 5.5% per year and earnings by 14.5% per year. It has almost no debt. And shareholders have done all right too, experiencing annual total returns of 26.5% while receiving 17 consecutive years of increased dividends.

3 reasons not to invest in Badger Meter

  • Shares are more expensive than a bottle of smartwater (tm). At 24.0 times trailing earnings and 28.3 times free cash flow, I can't bring myself to take the plunge. Even using aggressive sales and margin estimates, it's hard to justify a fair value above $35.
  • Municipalities are broke. Badger sells its meter systems to municipal and independent water utilities. But its municipal customers are broke. While they love to hear about cost savings and conservation benefits, the thought of forking over a portion of the local budget to water meter upgrades at the expense of money for schools or roadways is a large stream to cross. Independent water utilities such as California Water Service Group (NYSE: CWT  ) haven't been parting with their cash too easily either. From 2006 to 2009, California Water has grown its sales at a 10.3% compounded rate, but only grown its capital expenditures at a 1.9% rate.
  • Limited market size. Badger is almost exclusively a domestic player and only 13% of U.S. residential buildings are unmetered. The company has realized its limited market size and recently won a contract from Duke Energy (NYSE: DUK  ) to adapt its meters for measuring natural gas. While Badger could eventually become a meaningful player in this market, leaders like Itron (Nasdaq: ITRI  ) are not going to just hand over their electricity and gas metering crown. Itron itself has been in business for more than a century, and would love the opportunity to attack Badger's water meter stronghold while it shifts its focus to expanding into new markets.

Foolish bottom line
Badger Meter is a healthy company that generates great returns on capital and has some secular tailwinds stirring its pot. But the company's valuation makes us hesitate -- we'd be much more excited if shares traded below $30. Given the long timeframe of the DRIP Portfolio, we're OK with waiting for a better entry price. Until then, Todd and I will keep pitting our candidates against one another in search for the next addition to our DRIP lineup.

Do you have an industrial DRIP candidate whose shares are on sale? Drop a comment in the box below and let us know.

Previous DRIP Portfolio Articles:

Fool analyst Bryan Hinmon does not own shares of any company mentioned. Duke Energy is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.


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